Essay On Conceptual Framework Accounting

Table of contents:

A) The Conceptual Framework
1. The Introduction
2. The main reasons
3. The scope
4. The aim
5. The reason for the UK

B) The Qualitative Characteristics of the Statement of Principles
1. The Introduction
2. The Characteristics
3. The Clash

C) The Impact on the Standard Setting Process
1. The Introduction
2. Accounting Standard Definitions
3. Rule-Based Approach
4. Principles-Based Approach
5. The Conclusion

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A) The Conceptual Framework

1. The Introduction

“A conceptual framework is a statement of principles providing generally accepted guidance for the development of new reporting practices and for challenging and evaluating the existing practices. “ (Weetman, 2003a)

An accounting conceptual framework can be defined as:

“a coherent system of inter-related objectives and fundamentals that should lead to consistent standards that prescribe the nature, function and limits of financial accounting and financial statements.” (Lynch, 1998)

The International Accounting Standards Committee (now Board) published its conceptual framework in 1989. It is intended to guide both international and national standard setters when setting standards, and to assist prepares and auditors when interpreting standards or dealing with issues that the standards do not cover.

2. The main reasons

The main reasons for developing an agreed conceptual framework are that it provides:

- a framework for setting accounting standards;
- a basis for resolving accounting disputes;
- fundamental principles, which then do not have to be repeated in accounting standards.

3. The scope

The scope of a conceptual framework embraces general-purpose financial statements, including consolidated financial statements but “…not special purpose financial reports, which are outside its scope.” (PWC, 2003) The Framework applies to the financial statements of all commercial, industrial and business reporting entities, whether in the public or the private sectors. A reporting entity is one for which there are users who rely on the financial statements as a major source of financial information about the entity.

4. The aim

The purpose of a conceptual framework is to ensure a transnational comparability of accounting and to make information about enterprises more significant and more transparent.

Specific user groups of financial statements could be:

- “Investors and their advisers
- Lenders, suppliers and other trade creditors
- Employees and their representative groups” (Cairns, 2001)
- “Customers…
- Management…
- Government and their agencies…
- [The] public…” (Weetmann, 2003b)

Sir Robert Smith (2003), chair of a committee of financial experts was the opening general session speaker at The Institute of Internal Auditors' 63rd International Conference. He said about the conceptual framework:

"I firmly believe in principles-based governance …. . A set of governance principles that can be adapted to every size and type of company is more effective than a set of rules that, if complied with, gives the impression of absolving people from further responsibility."

5. The reason for the UK

Over the last few years many of the ASB standards have been rules-based, as opposed to principles-based. Rules-based accounting standards provide extremely detailed rules that attempt to contemplate virtually every application of the standard. This encourages a tick-the-box mentality to financial reporting that eliminates judgements from the application of the reporting. Rules-based standards make it more difficult for preparers and auditors to step back and evaluate whether the overall impact is consistent with the objectives of the standard. An ideal accounting standard is one that is principles-based and requires financial reporting to reflect the economic substance, not the form, of the transaction. The quality of an accounting standard has to be related to its objective.

Both rules-based and principles-based standards aim to provide information that is helpful to users in making economic decisions. Pursuing the same objective, each uses a different way of getting there – at least that is what the defenders of the two accounting sets advance as their main argument. On the one hand, e.g. US-GAAP is totally rules-based, setting out very detailed and precise rules for very specific accounting problems. On the other, e.g. IAS is completely principles-based, providing more general guidelines.

The United Kingdom is moving from rules-based standards to principles-based standards. Therefore it was necessary to introduce a conceptual framework for the UK. Conceptual framework statements have existed since the 1980s in the USA, Canada and Australia. From 1999 the UK has its own conceptual framework: the Statement of Principles issued by the Accounting Standards Board (ASB).

It was very important for the UK to create a conceptual framework. The increasing international needs of accounting, the influence of the USA and growing global economic cooperation (globalisation) made the development of the Statements of Principles crucial for the United Kingdom. The fundamental reason for a conceptual framework in the UK is that the UK does not want to lag behind in accounting methods. The background of a conceptual framework is that every country has got the same thought process in accounting. Britain wanted to be ´on the same boat´ as the important nations e.g. Australia, Canada and the USA. The growing numbers of stakeholders are interested in comparable, reliable and understandable financial statements. The framework makes clear that the financial statements “…should be useful to a wide range of users.” (Cairns, 2001) The Statement of Principles is also largely consistent with the framework statements issued in “Australia, Canada, New Zealand, the USA” (ASB, 2004) and elsewhere. This reflects the Accounting Standards Board’s view that it will be easier to achieve “harmonisation of accounting practice” (ASB, 2004) if standard-setters work with a common set of principles. The long-term objective is “…to promote the convergence of accounting, economic and regulatory measures of capital.” (KPMG, 2003a)


A conceptual framework of accounting can be considered to be a normative theory of accounting. A conceptual framework makes prescriptions in regards to what the objectives of accounting are, what qualitative characteristics general-purpose financial information should possess, how the elements of accounting should be defined and when they should be recognised and how the elements of accounting should be measured. The view often promoted by various advocates of conceptual framework projects is that it is difficult and perhaps illogical to develop systems of financial accounting if we do not initially agree on important issues such as what general purpose financial reporting is, what the objective of a general purpose financial reporting system is and in relation to this, what the qualitative characteristics of the information generated from that system should be.

Further, to make the system consistent we need to agree on how we define, recognise and measure the elements of that system. The view taken is that there are a number of building blocks involved in developing a logical system of accounting and that a conceptual framework develops such building blocks in a logical order. For example, we initially need some consensus on the definition of general purpose financial reporting and of a reporting entity, before we can consider the objective of financial reporting. Once we have considered the objective of financial reporting we can then consider defining the qualitative characteristics of financial reporting, as well as how to define the elements of financial reporting and so forth.

Without some consensus on issues such as those mentioned above, it is likely that the development of rules of accounting (assuming that we need rules) will be undertaken in a rather piecemeal manner with limited consistency between the various rules (which raises another issue: do we need consistency?). This inconsistency appeared to be the case in many countries prior to the development of conceptual frameworks. There was a great deal of inconsistency between the various standards in terms of definitions (often implied) of the elements of accounting, as well as inconsistencies in determining when the elements should be recognised and how they should be measured. With a conceptual framework, the accounting standards are expected to be more consistent.

Across time, the accounting profession attracted a great deal of criticism for the lack of agreement on key issues—so from a ‘legitimacy’ perspective, the profession probably needed a conceptual framework.

The United States, the United Kingdom, Australia, Canada and New Zealand had all put considerable efforts into developing a conceptual framework but much of this work is now being overtaken by the revised conceptual framework project being undertaken jointly by the United States’ Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). As Australia has agreed to adopt the accounting standards issued by the IASB it also had to adopt the IASB conceptual framework in to maintain consistency.

Some of the advantages that have been advanced in relation to conceptual frameworks of accounting include:

Accounting standards developed by applying the contents of a conceptual framework should be consistent and logical. Because many countries have developed conceptual frameworks that are similar (or they have adopted the IASC framework) there should be greater international compatibility between various countries’ accounting rules, and this should lead to greater consistency and comparability between international financial reports (which some people have argued is important for flows of foreign investment capital). Because conceptual frameworks provide the fundamentals of an accounting system, standard-setters should be more accountable for their decisions.

If they deviate from key issues addressed in a conceptual framework this should be clear and some explanation would be necessary. Conceptual frameworks provide a means of communicating key concepts to financial report preparers and users, as well as providing guidance to reporting entities when no specific standards address a particular issue. Because issues such as the objective of financial reporting, recognition criteria (and so on) have been determined when developing a conceptual framework, then accounting standard-setters will be subject to less political pressure when developing new standards. Because standard-setters will have consensus on many key issues, the development of accounting standards should be more economical. There will be no need to go back to the ‘drawing board’ on many fundamental issues.

Some of the disadvantages that have been associated with conceptual frameworks of accounting include:

Conceptual frameworks are costly to develop. The development of conceptual frameworks is subject to political interference—some people (for example, Hines) argue that conceptual frameworks are no more than residue of a political process. Tied to the above point, when conceptual frameworks have attempted to consider issues in which there is much underlying disagreement (for example, measurement issues), they have tended to lose progress. Following on from the above point, conceptual frameworks have tended not to tackle difficult issues.

Conceptual frameworks focus on economic (financial) performance alone. As such, they tend to ignore other aspects of performance (for example, the social and environmental performance of a reporting entity). Further, by focusing on financial performance alone and by giving it prominence, conceptual frameworks tend to deflect attention away from other important areas of corporate performance. They represent a codification of existing practice and do not provide ideal methods of accounting. They only act to provide a means of legitimising a profession under threat.

Whether we accept or reject the above advantages or disadvantages of conceptual frameworks will really be based on our own personal opinions and beliefs.

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