The Conceptual Framework & Qualitative Characteristics of Useful Financial Information - Lecture 1

What is another recent development?

Concept of materiality: Reliable financial information needs to present, in all material respects, a true and fair view of financial performance. The IASB issued a project on materiality in 2014, followed by a Practice Statement.

What is the pervasive constraint of useful financial information?

Cost < Benefit

What are the three fundamental characteristics of relevance?

Financial information is capable of making a difference in decisions if it has predictive value, confirmatory value Relevance should be supported by materiality. Information is regarded as material if omitting it or misstating it could influence decisions made by users

What type of users are financial statements presented for?

Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information diligently.

What is the conceptual framework?

It is a set of accounting concepts and principles, helps improve decision-usefulness

What are the fundamental characteristics of useful financial information?

Relevance and faithful representation

What are the four fundamental characteristics of faithful representation?

- financial information must also faithfully represent the phenomena that it purports to represent. Completeness: All information is necessary (including descriptions and explanations) for a user Neutrality: Information must not be biased or manipulated in order to affect users' decisions. Free from error: Financial information produced ad the phenomenon described must be free from errors However, free from error does not mean perfectly accurate in all respects

What are the three main concerns about information disclosed in general purpose financial statement?

- not enough relevant information; - too much irrelevant information; and - ineffective communication of information provided

Why do capital providers need useful information?

- to assess the company's ability to generate net cash inflows - To assess management's ability to protect or enhance the investors' interest in the company

What are the purposes of the conceptual framework and why?

- to assist the Board in the development of future IFRSs and in its review of existing IFRSs; - to assist the Board in promoting harmonisation of regulations, accounting standards and procedures relating to the presentation of financial statements by providing a basis for reducing the number of alternative accounting treatments permitted by IFRSs; - to assist national standard-setting bodies in developing national standards; - to assist preparers of financial statements in applying IFRSs and in dealing with topics that have yet to form the subject of an IFRS; - to assist auditors in forming an opinion on whether financial statements comply with IFRSs; to assist users of financial statements in interpreting the information contained in financial statements prepared in compliance with IFRSs; and - to provide information about the IASB's approach to the formulation of IFRSs.

What is the cost constraint on useful financial reporting?

The IASB acknowledges that the cost is a pervasive constraint on the information provided by financial reporting. So, the IASB notes that the cost of producing information must be justified by the benefits that it provides. However, this is a subjective area, therefore the IASB seeks to consider costs and benefits in relation to financial reporting generally, and not just in relation to individual reporting entities.

What are the recent developments of the conceptual framework?

The IASB announced in 2012 that it would restart work on its Conceptual Framework. In March 2018, the IASB issued the revised Conceptual Framework for Financial Reporting, which is effective from 1 January 2020.

When was the conceptual framework originally published?

The existing version of the Framework was published in 2010.

What is the objective of financial reporting?

The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions in their capacity as capital providers.

What changes are included in the new conceptual framework?

The revised Framework includes some minor changes in the qualitative characteristics. E.g. the notion of prudence has been reintroduced and defined as "the exercise of caution when making judgements under conditions of uncertainty". Further, the concept of substance over form has been reinstated explicitly as part of faithful representation. The most significant developments in the Framework are related to measurement bases.

Is the statement a standard and what is it designed to do?

This statement is not a standard, but will help preparers, auditors and regulators use judgment when applying the concept of materiality. It suggests a systematic process in making materiality judgements, such as identification and assessment of the information to be included in financial statements.

What are the decisions capital providers need financial information for?

Those decisions involve buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit.

What is the enhancing characteristic of timeliness?

Timeliness - Information will be relevant if it is provided within the decision time frame. - Undue delays may lose the relevance of information.

What did the IASB decide to do in its disclosure paper?

To develop guidance to help improve disclosure in IFRS, To develop guidance and examples to help entities apply materiality judgments.

What is the enhancing characteristic of understandability?

Understandability - Classifying, characterising and presenting information clearly and concisely makes it understandable. So, information should be clearly presented and explained.

What is decision usefulness?

Useful financial information for good decision-making

What is the enhancing characteristic of verifiability?

Verifiability: It helps assure users that information is faithfully represented. Verification can be direct (e.g. counting cash) or indirect (e.g. the carrying value of inventory).

What are the four things that the The IASB Conceptual Framework (2010) deal with?

deals with: - the objective of financial reporting; - the qualitative characteristics of useful financial information; -the definition, recognition and measurement of the elements from which financial statements are constructed; and -concepts of capital and capital maintenance.

Why are capital providers interested in financial reporting?

- Investors make investment decisions (when, how much, how long)

Why do investors need information to make decisions?

- They need information: to estimate future returns (earnings) to predict future cash flows to choose the best alternative investment

Financial information should meet the needs of a lot or a small amount of users?

A wide range

What are the enhancing characteristics of financial information?

Comparability Verifiability Timeliness Understandability

What is the enhancing characteristic of comparability?

Comparability: Users' decisions involve choosing between alternatives. E.g. selling or holding an investment, or investing in a subsidiary. It should enable users to identify and understand similarities and differences within the entity or between entities. It is not the same as uniformity.

Why is a conceptual framework necessary?

Financial statements are prepared and presented for external users by many entities around the world. There are a variety of social, economic and legal circumstances, definitions of the elements of financial statements, measurement bases, recognition criteria, and disclosure preferences. Further, financial statements are expected to meet the common needs of most users in decision making. So, we need to have a set of accounting concepts and principles to narrow down these differences and achieve consensus on a sound basis. This theoretical approach removes possible inconsistencies / contradictions across accounting standards (i.e. IFRS) and help improve decision-usefulness.