Accounting Theory Godfrey Chapter 4
Accounting Theory Godfrey Chapter 4
HODGSON
HOLMES
TARCA
CHAPTER 4
A CONCEPTUAL FRAMEWORK
Kuliah Sesi 4 – Dr. Zaroni
CONCEPTUAL FRAMEWORK
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Development of a Conceptual Framework
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Overview of the Conceptual Framework
Three levels:
First Level = Objectives of Financial Reporting
Second Level = Qualitative Characteristics and
Elements of Financial Statements
Third Level = Recognition, Measurement, and
Disclosure Concepts.
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ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition
Third level
3. Monetary unit 3. Expense recognition
The "how"—
4. Periodicity 4. Full disclosure implementation
5. Accrual
QUALITATIVE
CHARACTERISTICS ELEMENTS
1. Fundamental 1. Assets
qualities 2. Liabilities Second level
2. Enhancing 3. Equity Bridge between
qualities 4. Income
levels 1 and 3
5. Expenses
ILLUSTRATION
Conceptual Framework
for Financial Reporting OBJECTIVE
Provide information
about the reporting
entity that is useful
to present and potential
equity investors,
First level
lenders, and other The "why"—purpose
creditors in their of accounting
capacity as capital
providers.
FIRST LEVEL: BASIC OBJECTIVE
OBJECTIVE
“To provide financial information about the reporting entity
that is useful to present and potential equity investors,
lenders, and other creditors in making decisions about
providing resources to the entity.
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SECOND LEVEL: FUNDAMENTAL CONCEPTS
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SECOND LEVEL: FUNDAMENTAL CONCEPTS
Hierarchy of Accounting
Qualities
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SECOND LEVEL: FUNDAMENTAL CONCEPTS
Fundamental Quality—Relevance
Fundamental Quality—Relevance
Fundamental Quality—Relevance
Fundamental Quality—Relevance
Enhancing Qualities
Enhancing Qualities
Enhancing Qualities
Enhancing Qualities
LO 4
SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements
Equity
Income
Expenses
SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements
Asset
A present obligation of the entity arising
from past events, the settlement of which
Liability
is expected to result in an outflow from the
entity of resources embodying economic
Equity benefits.
Income
Expenses
SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements
Asset
Liability
Income
Expenses
SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements
Asset
Liability
Asset
Liability
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THIRD LEVEL: ASSUMPTIONS
Basic Assumptions
Economic Entity – company keeps its activity separate from its
owners and other business unit.
Measurement Principles
Historical Cost is generally thought to be a faithful
representation of the amount paid for a given item.
IASB has given companies the option to use fair value as the
basis for measurement of financial assets and financial
liabilities.
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THIRD LEVEL: BASIC PRINCIPLES
Measurement Principles
IASB established a fair value hierarchy that provides insight into
the priority of valuation techniques to use to determine fair value.
ILLUSTRATION 2-4
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THIRD LEVEL: BASIC PRINCIPLES
Revenue Recognition
When a company agrees to perform a service or sell a product to
a customer, it has a performance obligation.
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THIRD LEVEL: BASIC PRINCIPLES
Full Disclosure
Providing information that is of sufficient importance to
influence the judgment and decisions of an informed user.
Provided through:
Financial Statements
Notes to the Financial Statements
Supplementary information
THIRD LEVEL: BASIC PRINCIPLES
Cost Constraint
Companies must weigh the costs of providing the information
against the benefits that can be derived from using it.
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Summary of
the Structure
ILLUSTRATION 2-7
Conceptual Framework
for Financial Reporting
LO 8
The role of a conceptual framework
• A structured theory of accounting
• States the scope and objective of financial reporting
• Identifies and defines qualitative characteristics of financial
information and the basic elements of accounting
• Deals with principles and rules of recognition and
measurement, and report disclosures
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The role of a conceptual framework
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The role of a conceptual framework
Issues:
– Do we need a general theory of accounting?
– Is current accounting too permissive?
– Are current accounting practices too inconsistent?
– Is there too much political interference in the neutrality of accounting
reports?
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The role of a conceptual framework
Benefits:
– consistent, logical reporting requirements
– greater compliance
– enhanced accountability
– fewer specific standards
– enhanced understanding of reporting requirements
– more economical standard setting
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Objectives of conceptual frameworks
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Objectives of conceptual frameworks
• Information should be
– useful in making economic decisions
– useful in assessing cash flow prospects
– about enterprise resources, claims to those resources and changes in
them
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Objectives of conceptual frameworks
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Developing a conceptual framework
• The development of conceptual frameworks is influenced by
two key issues:
– principles versus rules-based approaches to standard setting
– information for decision making and the decision-theory approach
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Principles-based and rule-based standard setting
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Principles-based and rule-based standard setting
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Information for decision making and the decision-
theory approach
• Accounting data are required for decision making or
accountability purposes
– stewardship
– decision making
• users
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Information for decision making and the decision-
theory approach
• The decision-theory approach maps the process by which the
outputs of the accounting system provide inputs to the
decision model of a user
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Information for decision making and the decision-
theory approach
Decision-theory process
Overall
Overalltheory
theory
of
ofaccounting
accounting
Individual
Individual Prediction
Prediction Decision
Decision
accounting
accounting model
modelofof model
modelofof
system
system user
user user
user
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International developments: the IASB and FASB
Conceptual Framework
• In 2004 the FASB and IASB agree to undertake a joint project
to:
– develop an improved, common conceptual framework
– goal of developing standards that are principles-based, internally
consistent and internationally converged
– an Exposure Draft was produced - June 2009
– deferred consideration of not-for-profit sector issues
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International developments: the IASB and FASB
Conceptual Framework
• ED has several contentious areas:
– entity vs proprietorship perspective
– primary user group
– decision usefulness and stewardship
– qualitative characteristics
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International developments: the IASB and FASB
Conceptual Framework
• Australia follows an approach whereby issues for both the not-
for-profit and for-profit sectors are considered together
• Standards are intended to apply to both sectors
• IFAC’s International Public Sector Accounting Standards Board
has begun a project to develop a public sector CF
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A critique of conceptual framework projects
• Approaches to developing a CF:
– scientific
• recourse to logic and empiricism or both
– professional
• prescribes the best course of action by recourse to professional values
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A critique of conceptual framework projects
Scientific criticisms:
• prescriptive
• unspecified rules and conventions
• do not resolve contemporary disclosure issues
• vague definitions
• do not address measurement issues
• risk of mechanical decision making
• framework may become an end in itself
• overreliance on definitions
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Ontological and epistemological assumptions
• Freedom from bias (neutrality)
– an information quality that avoids leading users to conclusions that secure the
particular needs, desires or preconceptions of the preparers
• Solomons: freedom from bias as ‘financial mapmaking’
• Feyerabend: scientific truth is not absolute
• Hines claims mainstream accounting is ‘taken-for-granted’
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Circularity of reasoning
• Objective of a conceptual framework: guide the everyday practice of
accountants
• A superficial view
– deducing principles from generalised theory
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An unscientific discipline
• Is accounting a science?
– prescriptive by nature and value laden
• Stamp
Until we are sure in our minds about the nature of accounting, it is
fruitless for the profession to invest large resources in developing a
conceptual framework to support accounting standards.
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Positive research
• Conceptual framework projects ignore the empirical findings of positive
accounting research
– in conflict with each other
• Mounting evidence that capital markets are not efficient
• If the conceptual framework could ensure users receive useful
information this would serve a useful purpose
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The conceptual framework as a policy document
– As a generalised body of knowledge, conceptual frameworks fail a
number of ‘scientific’ tests
– The distinction between theories and policies is important
– CFs not produced in a political vacuum
– CFs may just be a reflection of the dominant group’s will
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Professional values and self-preservation
• ‘Self-preservation’
– implies the pursuit of self-interest
• ‘Professional values’
– suggests idealism and altruism
• Gerboth
– sense of personal responsibility
• Hines
– professional legitimacy
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Conceptual framework for auditing standards
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Summary
• The conceptual framework is intended to provide a coherent and
prescriptive guide to accounting practice
• If effective it should result in the communication of more useful financial
information to users
• Developing a conceptual framework has been a long and complicated
process
• Criticisms of conceptual framework projects exist
• Others debate the importance of these criticisms
• In auditing there has been a shift away from substantive testing toward
the role of client business risk
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Quiz Session #4
1. Some people argue that there is no need for a general theory of accounting, as
established in a conceptual framework. They say there is no overall theory of
physics, biology, botany or psychology, so there is no need for an overall theory of
accounting. Furthermore, attempts to develop such a theory are futile and
unnecessary, since accounting has not needed a conceptual framework so far.
Debate this view!
2. Explain the advantages and disadvantages of principles-based and rule-based
standards!
3. What type of information do you think is useful for shareholders, lenders, and
creditors? Is this type of information that is currently provided?
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Key terms and concepts
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