Introduction

This article is officially the very first article of my blog. It has been a long time coming and I am glad to finally be able to share knowledge and contribute to the general body of knowledge.

In this article, I will deal with a fundamental issue pertaining to the profession, without which much of modern-day accounting might not exist. An attempt will be made at covering what has come to be known as the Conceptual Framework for Financial Reporting in a holistic manner, answering fundamental questions such as what it is, how it came to be, and why it is so important.

Given its very rudimentary nature to the accounting profession, a comprehensive analysis will require the subject to be tackled in parts. This article will be part one in the series.

The conceptual framework for Financial Reporting

To start with, the conceptual framework is a document. It serves as a foundation for what is known as accounting standards. For the purposes of history and explanation, this makeshift definition should suffice for now. A proper definition and explanation will follow.

Back to the basics – why accounting?

Accounting, as a profession, developed out of the need to produce information—of a financial nature—useful to users in making various decisions about who or what the financial information concerns (Ionuț & Petec, 2016; Vokshi & Xhelili, 2017). We will refer to this “who” or “what” as the “Reporting Entity”. The reporting entity is the one, person, company, business or any other entity of similar nature, engaging in various activities for which a sort of financial report needs to be prepared.

Are there types of accountants?

Now, it must be said that there are different types of accountants. The effect of this, are the different branches of accounting. Examples include management accounting, cost accounting, financial accounting or financial reporting, tax accounting, forensic accounting, auditing among others. Accountants in these different branches work with financial information, but in different ways.

The conceptual framework being referred to here, in this article, pertains to what has come to be known as Financial Accounting or Financial Reporting.

To illustrate the point, a management accountant’s job is to aid in and directly make management decisions for a company or other organisation (ACCA, 2021). The information they prepare as a result of their work is very confidential and usually nobody else in the organisation, aside the Board of Directors, or its senior leadership might be privy to that information. And so, the financial information thus prepared is for internal consumption.

Financial Reporting on the other hand, involves the preparation of financial information for a variety of users. This includes: employees of the reporting entity, management of the reporting entity, governments and regulators, customers of the reporting entity, suppliers of the reporting entity, and potential lenders to the reporting entity among others.

Each of these “stakeholders”, as they are called, must find the financial information prepared very useful as well as relevant. While the management accountant prepares financial information for the management of the entity (made of a group of persons who have the same information needs), the financial accountant needs to prepare financial information to satisfy all these stakeholder groups, and all at the same time.

This is where the issue arises. This is because, each of these stakeholders have very different information interests. For instance, while the employees want to know whether the company has enough money to pay them their salaries, governments are concerned with how much tax to take from the company. This conundrum marked the birth of “General Purpose Financial Statements”. The job of the financial accountant is to prepare those.

The comparability problem

Over time, a serious problem arose. Financial accountants preparing their general-purpose financial statements, decided and did what they thought was the best thing in any given situation. There were no rules to govern what financial accountants did, and this led to a situation where a decision to compare two businesses based on their financial statements, ended up in the reaching of dysfunctional decisions.

The reason was simple: you would have been comparing apples to oranges. Company A and B could execute the same transaction—say both companies buy a car. Accountant A will record it one way; Accountant B records it in yet another way. The picture created in the two financial statements could be totally different for the same transaction. It was a huge problem.

The advent of standard-setters

Various governments, realising this, decided to step in. They created various bodies to set rules to govern how transaction are to be captured by financial accountants in the general-purpose financial statements. The government-created bodies were supposed to set what is referred to as “Standards”.

Standards are basically the rules which govern how all financial accountants under the jurisdiction of the standard-setting body in question, should treat various types of transactions in their “books”, as they occur. If one would look back all the way to 1939, in the USA, one would find standard-setting was under the purview of the US Securities and Exchange Commission (Historical, n.d.). There is evidence of some of these standard-setting bodies in Australia dating back to 1966 (Australian Accounting Standards Board , n.d.).

Globalisation and the internationalisation of trade

Now, at the dawn of the 19^th century when things began to develop and globalisation started setting in, business started transcending borders. The problem of comparability and consistency in accounting standards arose once again. Different countries had different standards and accounting treatments governing transactions and it was just chaos when financial statements had to be compared to reach a decision or something of the sort. A solution was needed badly.

Formation of the IASC and the IFAC

And so, finally in 1973 professional bodies from Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the United Kingdom and Ireland, and the United States of America agreed, and then came together to form the International Accounting Standards Committee (IASC) (IASPlus, n.d.). It was made up of various parts including the IASC Board, Consultative Group, Standards Interpretations Committee (SIC) etc. Other “Sponsoring members” were later added to the membership of the IASC.

The formation of the IASC also resulted in the formation of other international bodies such as the International Federation of Accountants (IFAC) in 1977 (IFAC, n.d.). In 1982 the sponsoring members of the IASC comprised all the professional accounting bodies that were members of the IFAC (IASPlus, n.d.). The goal of the IASC was basically to ensure convergence of standards throughout the world. The ideal end-goal was a situation where every single country on the face of this earth used and adopted a single set of standardised accounting rules for financial reporting. This was to be achieved by coming out with documents prescribing how various transactions by reporting entities were to be treated. These “documents” were to be and are still today called “Standards”.

In order to achieve this goal, the standards needed to be consistent themselves—internally. And so what was needed was a sort of foundation, on which all other standards would be built. This foundation would define basic concepts, as well as tackle the very fundamental issues and concepts which any financial accountant needed to know. These same concepts would be referred to by the standards which would then now be built on this foundation. The culmination of this was the conceptual framework issued in 1898 by the IASC. It was titled “Framework for the Preparation and Presentation of Financial Statements”.

The conceptual framework of 1989 and its successor

The Framework of 1989 was divided into various sections and paragraphs. It started with a preface and an introductory section followed by seven (7) main sections tackling the following:

• The objective of financial statements
• Underlying assumptions of financial statements
• Qualitative characteristics of financial statements
• The elements of financial statements
• Recognition of the elements of the financial statements
• Measurement of the elements of the financial statements
• Concepts of capital and capital maintenance

Since it was introduced in 1968, this framework stood the test of time. However calls for the erstwhile framework to be reviewed grew stronger in the early 2000s. Finally in 2006, the Board gave in. The Board announced it was reviewing the framework in phases, and with the joint support of the US Standard-Setter. That is, the Financial Accounting Standards Board (FASB). The discussion paper for phase one of the project was issued, with comments allowed till November 3 of 2006 (IASPlus, Discussion Paper on Conceptual Framework, 2006). Harmonisation of accounting standards across the world was becoming more realistic.

And so finally on 28 September, 2010, the first phase of the conceptual framework revision project was published. The way it turned out, two chapters of the new conceptual framework (Chapters 1 and 3) were published which were effective immediately upon publishing (IASPlus, 2010). The effect was to annul the relevant sections of the 1989 Framework and then to still keep the rest of the old Framework intact.

The conceptual framework of today

The conceptual framework, today, is a totally different document from that which it once was. Today’s framework is the result of the completion, by the IASB alone, of the joint-project started by the IASB and the FASB. Unfortunately, in 2012, the IASB and the FASB parted ways on the joint-conceptual framework project which was agreed upon back in 2004 (IASPlus, 2012).

On March 29 2018, the final revised version of the conceptual framework was published to replace the old conceptual framework (IASB, 2018). Chapters were introduced—8 chapters in total. They included the following:

• Chapter 1— The Objective of General Purpose Financial Reporting
• Chapter 2— Qualitative Characteristics of Useful Financial Information
• Chapter 3— Financial Statements and the Reporting Entity
• Chapter 4— The Elements of Financial Statements
• Chapter 5— Recognition and Derecognition
• Chapter 6— Measurement
• Chapter 7— Presentation and Disclosure
• Chapter 8— Concepts of Capital and Capital Maintenance

And so new concepts were introduced. In coming out with this new framework the IASB “sought a balance between providing high-level concepts and providing enough detail for the Conceptual Framework to be useful” (IASB, 2018).

Measurement; Presentation and Disclosure; and Derecognition are totally new concepts when compared to the framework of old. Various definitions have also been updated. These include those of an Asset and a Liability. The criteria for recognition of the elements of the financial statements have also been updated.

Prudence, Stewardship, Measurement Uncertainty and Substance Over Form –as concepts—have also now been clarified.             

Conclusion

In this article, what a conceptual framework is has been touched upon. The effort has also been made to explain why it was needed in the first place. This was done through the detailing of how the accounting profession has evolved over time.

The various historical versions of the all-important document have also been briefly touched upon.

For the framework itself, various scholars have commented on whether or not the problems which plagued it, necessitating its revision, have actually been resolved. Those have been hotly debated. Views such as those of Thelle (2019) are relevant.

In future parts of this article, the March 2018 conceptual framework as promulgated by the IASB will be discussed in further detail.

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References

ACCA. (2021). Management Accountant. Retrieved from ACCA Global: https://www.accaglobal.com/in/en/qualifications/why-acca/competency-framework/job-profiles/corporate-and-business-accounting/management-accountant.html

Australian Accounting Standards Board . (n.d.). For Students. Retrieved from About the AASB: https://www.aasb.gov.au/About-the-AASB/For-students.aspx#qa1440

Historical, S. (n.d.). The Richard C. Adkerson Gallery on the SEC Role in Accounting Standards Setting. Retrieved from SEC Historical.org: http://www.sechistorical.org/museum/galleries/rca/rca04a-committee-accounting-procedure.php

IASB. (2018, March 29). Fact Sheet Project Summary. Retrieved from IFRS.org: https://www.ifrs.org/-/media/project/conceptual-framework/fact-sheet-project-summary-and-feedback-statement/conceptual-framework-project-summary.pdf

IASB. (2018, March 29). IASB completes revisions to its Conceptual Framework. Retrieved from News and Events: https://www.ifrs.org/news-and-events/2018/03/iasb-completes-revisions-to-its-conceptual-framework/

IASPlus. (2006, July 6). Discussion Paper on Conceptual Framework. Retrieved from News: https://www.iasplus.com/en/news/2006/July/news2768

IASPlus. (2010). Conceptual Framework Phase A – Objective and qualitative characteristics. Retrieved from Projects: https://www.iasplus.com/en/projects/completed/framework/framework-a

IASPlus. (2012). Conceptual Framework — Comprehensive IASB project. Retrieved from Projects: https://www.iasplus.com/en/projects/completed/framework/cf-iasb

IASPlus. (n.d.). International Accounting Standards Committee (IASC). Retrieved from About the International Accounting Standards Committee (IASC): https://www.iasplus.com/en/resources/ifrsf/history/resource25

IFAC. (n.d.). Who we are. Retrieved from Our Purpose: https://www.ifac.org/who-we-are/our-purpose

Ionuț, S., & Petec, D. (2016). The importance of accounting information in decision making. Ovidius University Annals, Economic Sciences, 611-615. Retrieved from http://stec.univ-ovidius.ro/html/anale/ENG/2016/2016-I-full/Section-V/32.Spatarelu_Ionut.pdf

Thelle, C. (2019, July 2). Conceptual Framework - So, Where's the Concept? Retrieved from LucaNet: https://www.lucanet.com/en/blog/conceptual-framework

Vokshi, B. N., & Xhelili, K. F. (2017). Role of Accounting Information in Decision-Making Process, the Importance for its Users. 2017 ENTRENOVA Conference Proceedings. Retrieved from https://ssrn.com/abstract=3282