Far 600 T5 PYQ Conceptual Framework

Limitations of conceptual framework in providing guidance to accounting standard setters.

1. Being principally economic in focus, general purpose financial reports typically ignore transactions or events that have not involved market transactions or an exchange or property rights. 2. CF simply represent a codification of existing practice, putting in place series of documents that describe existing practice, rather than prescribing an 'ideal' or logically derived approach to accounting.

Describe the recognition criteria set out by the IASB Framework. Liabilities

Liabilities 1. An expected future disposition or transfer of economic benefits to other entities. 2. A present obligation 3. A past transaction or other event must have created the obligation.

Conceptual frameworks are used as a means of legitimising standard-setting bodies. conti

Rather than seeing the role of conceptual frameworks as being part of a process to improve the process of general purpose financial reporting, it may be argued that conceptual frameworks project is seen as a process to provide benefits to those parties that are responsible for developing the frameworks. The view is that there are certain attributes that society expects a profession to exhibit (such as objectivity, neutrality, reliability, etc) and therefore, if a profession wants to be seen as being legitimate, then a profession should release documents which associates them with these legitimising characteristics. And if professions, are able to establish a perspective that they are objective and professional then this assists their quests for autonomy and enhances their ability to self-regulate without the unwanted intervention of government.

Explain the major roles of conceptual framework in the development of accounting standards. cont.

- Accounting standards derived from a conceptual framework reduces the need for detailed requirements as issues not addressed specifically in the standards can be referred to the conceptual framework.

Explain the major roles of conceptual framework in the development of accounting standards.

- Development of accounting standards based on a conceptual framework reduces the probability of accounting standard setters focusing on the most important issue arising at a particular time. Instead, accounting standard setters can channeled their efforts and resources in developing new and existing standards in a more organized manner. - Accounting standard setters are exposed to pressures from various parties in developing the accounting standards, particularly where there are conflicts between the various parties. In this situation, the accounting standard setters work will be subject to less criticism if the accounting standards are derived from a conceptual framework.

Explain why the Conceptual Framework for financial reporting identifies faithful representation characteristic as an important consideration in reporting financial information to users of financial statements.

- Explain - faithful representation characteristic is an important consideration in reporting financial information to users of financial statements. - Financial information must be faithfully represented for it to be useful to users (such as investors and creditors). For information to be faithfully represented, it must faithfully represent the economic phenomena which it purports to represent. - faithfully represented information should be complete, neutral and free from error. Overall, information that is faithfully reported will provide relevant and useful information to users. Otherwise, it may not be useful and possibly misleading.

Explain why the Conceptual Framework for financial reporting identifies faithful representation characteristic as an important consideration in reporting financial information to users of financial statements cont.

-For example, an entity leases an asset where the lease period represents a substantial period of the useful life of the asset. In this case, the entity may treat the leased asset similar to other non-current assets purchased by the entity, as in substance, it is the asset of the entity even though the entity may not necessarily own the asset legally throughout the useful life of the asset. (Candidates may provide other relevant example). Hence, the information is accounted for in accordance to its substance and economic reality, i.e. faithfully reported to users of financial statements.

Discuss why a trade-off between the two characteristics (relevance and reliability) is necessary in certain circumstances

-It appears that the IASB Framework gives greater prominence to reliability and relevance then to understandability and comparability. -In balancing relevance and reliability 'Information might be relevant but so unreliable in nature or representation that its recognition may be potentially misleading.' -The potential constraints on producing relevant and reliable information: timeliness and balancing costs and benefits.

Discuss why a trade-off between the two characteristics (relevance and reliability) is necessary in certain circumstances cont.

-There will be a trade-off between being able to produce information quickly (and thereby enhancing the relevance of the information) and measuring this information accurately (and thereby reliably), as the production of accurate information often requires corroboration that occurs sometime later. -In these circumstances, it is a matter of judgement as how to balance relevance and reliability (that is, how long to wait against the extent of reliability required). -That is, the longer we take to ensure information is reliable (perhaps through various forms of auditing), the less relevant the information becomes.

4 main reasons?benefit for having CF for accounting

1. Accounting standards should be more consistent and logical because they are developed from an orderly set of concepts That is, the accounting standards will be developen on the basis of agreed principles. The view is that the absence of a coherent theory, the development of accounting standards could be somewhat ad hoc

4 primary qualitative characteristics

1. Understandability 2. Comparability 3. Relevance 4. Reliability

Describe the recognition criteria set out by the IASB Framework. Assets

Assets 1. There must be an expected future benefit. 2. The reporting entity must control the resource giving rise to these future economic benefits. 3. The transactions or other event giving rise to the reporting entity's control over the future economic benefits must have occurred.

4 main reasons for having CF for accounting cont

2. the standard-setters should be more accountable for their decisions because the thinking behind specific requirements should be more explicit, as should any departures from the concepts that may be in particular accounting standards. 3. the process of communication between the standard-setters and their constituents should be enhanced because the conceptual underpinnings of proposed accounting standards should be more apparent when the standard-setters seek public comment on them. Preparers and auditors will have a better understanding of why they are reporting/auditing

Limitations of conceptual framework in providing guidance to accounting standard setters. cont.

3. CF can be too general in nature and the principles, therefore, may produce inconsistent standards. 4. The static nature of the framework may not be able to keep up with the changing and dynamic environment that accounting operates in. 5. CF is theoretical and prescriptive in nature, and thus it may not help in coming up with standards that could resolve problems in accounting practices.

4 main reasons for having CF for accounting conti.

4. The development of accounting standards should be more economical because the concepts developed will guide the standard-setters in their decision making. Where accounting concept cover a particular issue, there might be a reduced need for a developing additional accounting standards. CF have had the effect of emphasizing the decision usefulness role of financial reports, rather than just restricting concern to issues associated with stewardship.

Discuss the significance of the conceptual framework in developing useful general purpose financial reports cont.

At the highest theoretical level, the CF states the objectives and scope of financial reporting which include the decision usefulness, stewardship and social objectives. At the fundamental level, it identifies and defines the qualitative characteristics of financial information (such as understandability, relevance, reliability, timeliness and comparability) and the basic elements of accounting reports (such as assets, liabilities, equity, revenue, expenses and profit). At the lower operational level, it deals with the principles and rules of recognition and measurement of the basic elements of financial statements or reports. At the reporting level, it specifies the types of information to be displayed in financial reports or statements. Purposes and benefits of CF:

Argument by some researchers that conceptual framework of accounting is normative in nature.

Conceptual framework in Malaysia is still lack of expertise, even though conceptual frame work act as a guideline, it still hard to implement in the business because of lack of expertise. It also can make the smaller organizations may feel overburdened by reporting requirement. Since conceptual framework provide perspective about such issue as the qualitative characteristics that financial information should be possess, the identification of the types of entity should be defined and recognized, and so forth (note the emphasis on should) the conceptual framework in providing prescription are considered to be normative in nature.

3. Relevance

Information is regarded as relevant if it ...influences the economic decisions or users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations. There are two main aspects to relevance -for information to be relevant it should have both predictive value and feedback (or confirmatory) value, the latter referring to the information's utility in confirming or correcting earlier expectations.

4. Reliability

Something is deemed to be reliable if it 'is free from material bias and error and can be depended upon by users to represent faithfully' the underlying items it claims to represent. Reliability is defined as 'the quality of information that assures that information is reasonably free from error and bias and faithfully represents what it purports to represent'. Reliability is a function of representational faithfulness, verifiability and neutrality.

Conceptual Framework definition

The FASB defined its conceptual framework as 'a coherent system of interrelated objectives and fundamentals that is expected to lead to consistent standards'. The conceptual framework 'prescribes the nature, function and limits of financial accounting and reporting'. According to the exposure draft, the conceptual framework is a coherent system of concepts that flow from an objective. The objective of financial reporting is the foundation of the framework.

Discuss the significance of the conceptual framework in developing useful general purpose financial reports

The conceptual framework of accounting is a structured theory of accounting that guides the development of accounting standards and rules to be used in accounting practice. The divergence of theoretical propositions from different perspectives and the difficulties faced by profession to adopt the solution to accounting problems warrants the need for an integrated and interpretive framework.

1. Understandability

The information is considered to be understandable if it is likely to be understood by users with some business and accounting knowledge. However, this does not mean that complex information that is relevant to economic decision making should be omitted from the financial statements just because it might not be understood by some users.

2. Comparability

To facilitate the comparison of the financial statements of different entities (and for a single entity over a period of time), method of measurement and disclosure must be consistent - but should be changed if no longer relevant to an entity's circumstances.

Conceptual frameworks are used as a means of legitimising standard-setting bodies.

• Hines states that Conceptual Frameworks (CF) presume, legitimise and reproduce the assumption of an objective world and such they play a part in constituting the social world... CF provide social legitimacy to the accounting profession. • Since the objectivity assumption is the central premise of our society... a fundamental form of social power accrues to those who are able to trade on the objectivity assumption. • Legitimacy is achieved by tapping into central proposition because accounts generated around this preposition are perceived as 'normal'.

Conceptual frameworks are used as a means of legitimising standard-setting bodies. cont.

• It is perhaps not surprising or anomalous then that CF projects continue to be undertaken which rely on information qualities such as 'representational faithfulness', 'neutrality', 'reliability', etc..., which presume a concrete, objective world, even though past CF have not succeeded in generating Accounting Standards which achieve these qualities. • The very talk, predicted on the assumption of an objective world to which accountants have privileged access via their 'measurement expertise', serves to construct a perceived legitimacy for the profession's power and autonomy. • if we accept Hines argument, we would perhaps reject the notion that the profession was attempting to uncover any truths or ideas, and, rather, we would consider that the development of CF was a political action to ensure the survival of the profession.