Critical Review of Conceptual Framework - Essay Example

Critical review of conceptual framework Introduction The conceptual framework was recently proposed by the IASB (International Accounting Standards Board) and prior its introduction, most accounting standard setters pursued financial accounting operations without any specific framework resulting to disorganized and substandard quality of accounting. This also increased the risk of development of mutually inconsistent standards that violated the main objective behind preparation of financial statements. To meet the need of robustness and consistency in the financial statements, the conceptual framework was proposed by the IASB. The main objective of the conceptual framework was to build up a steady set of accounting standards and to solve accounting controversies. However, considerable amount of issues were recognised in the framework and as a result, development of a converged framework was proposed so that problems and conflicts among similar individual frameworks can be resolved (Pearson Education, n.d.). The paper discusses role of the conceptual framework in financial reporting and examine the issues that has been recognised thereof. Preliminary objectives of the conceptual framework The conceptual framework was premeditated to assist the IASB in creating international quality accounting standards in future and in reviewing the existing standards for consistency. The framework is responsible for assisting the board in promotion of synchronisation among various accounting standards, procedures and regulations so that efficiency is brought in financial statement preparation and presentation. The framework was delivered official responsibility of determining objective financial responsibility, its qualitative characteristics and usefulness and the definition, measurement and recognition of various elements in a financial statement. The framework acts as a guideline for assisting auditors in developing an opinion regarding robustness of financial statements with respect to the standards defined by IASB. Additionally, it delivers ease of understanding and interpreting the financial statements to its users (AASB, 2010). Issues that were recognised in the existing conceptual framework It was determined that the existing conceptual framework has been significantly helpful to the IASB in developing and building further amendments in International Financial Reporting Standards (IFRS). However, the conceptual framework remained largely unchanged since incorporation and recently, IASB recognised certain issues in the existing framework that has been discussed as follows: The board identified that a number of important areas has not been covered in the existing conceptual framework. For instance, the framework provide negligible amount of guidance regarding identification, disclosure, measurement and presentation of reporting entity. Guidance in a number of areas such as definition of assets and liabilities presents strong scope of improvement and future development. A number of aspects were recognised in the existing conceptual framework that has been outdated and are unsuccessful in presenting current opinion of the IASB in an appropriate manner. For illustration, the existing conceptual framework expresses that an asset or a liability ought to be recognised only in case the probability regarding flow of economic earnings is positive in nature. However, the board concluded in this regard that the recognition process is highly situational as in many circumstances, recognition of assets and liabilities result in availability of important information even if that implies no flow of economic earnings. The existing framework was considered for revision because it neglected the fact that whether an asset or a liability should be measured in terms of its cost or in terms of its value. Cost is considered as a reliable measure but it is generally historical in nature whereas value of an asset or a liability is considered relevant because it is usually up-to-date. One drawback of value oriented method is that it is a relatively unreliable method of measurement. The board aims at mitigating this dilemma in the revised conceptual framework. The inefficiency in the existing conceptual framework has resulted in failure of the same in prescribing satisfactory solution to asset measurement under different accounting standards. One such illustration in this regard is that IAS 40 (Investment Properties) and IAS 16 (Property, Plant and Equipment) allows financial report developer to formulate accounting policy regarding measurement of assets as per their requirement. The board proposed a revised conceptual framework because the previously incorporated framework primarily assisted the IASB instead of other parties such as, regulators, preparers, auditors and other users of financial statements in understanding and interpreting existing IFRS in context of various elements. The revised conceptual framework was proposed by the IASB so that precise accounting policies can be developed under circumstances when no specific IFRs can be applied to an event or a transaction. Furthermore, it was determined that the existing conceptual framework is neither a standard nor an interpretation. Consequently, conflict has been recognised in few rare cases between the framework and standards (IFRS, 2007; Ernst & Young, 2013). Detailed discussion on issues and amendments in the conceptual framework The existing definitions of various elements of the financial statements as per the existing conceptual framework was determined to be relatively useful in standard setting process as they primarily focussed on economic reality that are relevant to financial report users. However, the IASB exclaimed in a discussion paper regarding scope for greater clarification as the existing framework often result in misunderstanding between assets and liabilities and underlying resources and obligations in terms of ultimate economic benefit flow. The board have made further suggestion regarding consideration of uncertainty in asset or liability recognition. it was suggested that no revenue or resource should be retained with reference to uncertainty or probability (Ernst & Young, 2013). It was determined that some of the important aspects regarding a liability are ambiguous in its definition under the conceptual framework. Additionally, little guidance has been provided in this regard resulting to greater level of inconsistency thereof. The discrepancy resulted in development of difficulty in reaching conclusion by the IFRS and the IASB interpretation committee regarding measurement and timing of liabilities. Furthermore, it was determined that the existing framework failed to deliver guidance within individual standards such as identification of substance related to contractual right and obligation. The revised conceptual framework comprises additional work on the existing one. For instance, the existing framework presents negligible information regarding difference between constructive obligation and present obligation and distinction between economic compulsion and constructive obligations. The existing conceptual framework does not differentiate profit from revenue and loss from business expenditure. On the contrary, gain and revenue are considered same element as they generate economic benefit while loss and expense are considered same because they cause economic loss (Ernst & Young, 2013; IFRS, 2004; 2007). Asset and liability recognition and derecognition are considered as vital aspects of financial accounting and the conceptual framework is expected to present direction in this regard. However, it was gathered that the present conceptual framework neglects derecognition of assets and liabilities. It was also observed that the existing conceptual framework explains that income, expenses and profit and loss depends on the notions of capital and capital maintenance. The revaluation of asset and liability result in increase or decrease in equity but are not included in income statement; instead they are shown as revaluation reserve. However, the existing framework does not provide any clear statement in this regard. The other issues associated with the existing conceptual framework comprise exclusion of separate elements with respect to cash flow statement and change in equity statement. The existing framework does not specifically define concepts such as cash receipts and payments, contribution, distribution and transfer in ‘change in equity’ statement. The revised version of conceptual framework addresses issues such as lack of clarity regarding impact of equity instruments bearing prior claims on future flow of cash to investors. Additionally, the current IFRSs under conceptual framework do not provide consistent definition of a liability so that financial liabilities are differentiated from equity instruments (IFRS, 2004; 2007). The actual conceptual framework provides minimal guidance regarding measurement and its implication on an element. The revised format of conceptual framework provides detailed information regarding financial reporting’s objective and qualitative characteristics of various information of financial nature that influence measurement requirements. It further discloses information regarding three classes of measurement, namely, cost based measurement, fair value and cash flow based measurement. The new guidelines discuss method of identifying the most suitable measurement and also highlight other cash flow based measurements in a detailed manner. Relevance was determined to be an important aspect with respect to measurement. In the conceptual framework, the IASB has the choice of adopting either same basis of measurement or different basis. The choices involve measurement using fair value method or cost based method. It was determined that if assets and liabilities were measured on same basis, it will deliver greater understanding of the financial statements. However, the problem in this approach is that adoption of any one choice may not deliver appropriate outcome for some investor may put greater emphasis on fair value such as market price while other may prefer cost based approach. Therefore, it was concluded that the conceptual framework must not recommend measurement using same basis for all the assets and liabilities (IFRS, 2004; 2007; Ernst & Young, 2013). Besides relevance, the other qualitative characteristics are faithful representation and enhancing characteristics such as understandability, verifiability, comparability and timeliness. It was determined that relevance of a measurement technique depends on investors, creditors, and lenders because they are the parties that are responsible for determining impact of asset and liabilities on future cash flow. It was also gathered that minimum number of measurement techniques should be deployed for establishing relevance of certain information. The amendments by the board suggest that redundant measurement changes must be avoided. Additionally, advantages of a specific measurement technique to financial report users should sufficiently justify the underlying costs. Presentation and disclosure can be defined as mechanisms by means of which reporting entities communicate various information regarding their financial position and performance thereof to investors and other users of financial reporting. Presentation and disclosure has not been discussed in the existing conceptual framework. According to eminent individuals, lack of transparency has resulted in IFRS disclosures being highly voluminous and unfocussed. In this regard assessment suggests that the amendment should provide a well defined structure that simplifies the disclosure procedure and reduce overall cost involved (Ernst & Young, 2013). The recommendations regarding amendment in the existing conceptual framework further suggest that the framework should include statement of materiality so that relevant information are disclosed and clear communication should be maintained so that disclosure is relevant and comprehensible. The total financial statements can be classified in primary financial statement and notes thereof. Primary financial statements consist of balance sheet (financial position), income statement, change in equity statement and cash flow statement; these statements together present different facets of summarised information regarding an entity. The existing framework fails to accommodate any specific guidance regarding presentation of the primary financial statements. In this regard, a positive point regarding the existing conceptual framework is that it clearly defines the materiality concept and as a result no amendment has been recommended. However, the amendments will include detailed disclosure about the reporting entity; amounts identified in the primary statements of the entity and changes thereof; nature and worth of unrecognised assets and liabilities of the entity and the existing risk therein. The notes to financial statements are prepared with the objective to disclose additional information but no specific guidelines have been provided in this regard as well in the conceptual framework. It was also gather that amendment is necessary regarding financial performance in income statement and other comprehensive income statement because the existing conceptual framework reveal no information in this regard (IFRS, 2004; 2007; Ernst & Young, 2013). Conclusion The paper present an elaborate analysis of original conceptual framework that was initially proposed by the IASB and it was determined that due to lack of continuous evaluation, the framework has become outdated. The issues in existing framework were assessed and discussed in a detailed manner. Additionally, the paper discussed various amendments that have been proposed by the board along with FASB (Financial Accounting Standards Board). It was determined that the existing guidelines in the actual conceptual framework are very useful but the proposed recommendations will improve its efficiency and effectiveness. Reference List AASB, 2010. Third pre-ballot draft of a revised AASB conceptual framework. [pdf] AASB Available at: [Accessed 02 January 2015]. Ernst & Young, 2013. A Review of the Conceptual Framework for Financial Reporting. [pdf] E&Y. Available at: [Accessed 02 January 2015]. IFRS, 2004. Conceptual Framework. [PDF] IFRS. Available at: [Accessed 02 January 2015]. IFRS, 2007. Conceptual Framework: Phase A Redeliberations: Issues Related to the Conceptual Framework Project in General. [pdf] IFRS. Available at: [Accessed 02 January 2015]. Pearson Education, no date. Conceptual framework for financial reporting. [pdf] Pearson Education. Available at: [Accessed 02 January 2015]. Bibliography Hines, R. D., 1991. The FASBs conceptual framework, financial accounting and the maintenance of the social world. Accounting, Organizations and Society, 16(4), PP.313-331. IFRS, 2013. Snapshot: Review of the Conceptual Framework. [pdf] IFRS Available at: [Accessed 02 January 2015]. International Accounting Standards Board., 2010. Conceptual Framework for Financial Reporting 2010. [pdf] IFRS Foundation. Available at: http://www.ifrs.org/News/Press-Releases/Documents/ConceptualFW2010vb.pdf [Accessed 02 January 2015]. Whittington, G., 2008. Fair Value and the IASB/FASB Conceptual Framework Project: An Alternative View. Abacus, 44(2), pp. 139-168. Working Group on Fundamental Concepts, 2004. Conceptual Framework of Financial Accounting. [pdf] Working Group on Fundamental Concepts. Available at: [Accessed 02 January 2015]. Read More