The accounting conceptual framework
| by Christopher J Pyke
01 Jun 1999
The syllabus for Drafting Financial Statements (C1 and C1A) requires candidates to be able to explain the nature and purpose of a financial reporting conceptual framework. In particular, candidates need to have a knowledge of the role and general issues covered by the ASB Statement of Principles, and be able to apply the fundamental accounting concepts.
This article begins by outlining the nature and purpose of a conceptual framework, explains the purpose and scope of the Statement of Principles and defines the fundamental accounting concepts.
Nature and purpose of a conceptual frameworkAn accounting conceptual framework can be defined as:
(AT Foulks Lynch)
However, it is easier to state what a conceptual framework should be, than to actually precisely define it. There have been several attempts made to devise such a framework, most recently (March 1999) the revised Exposure Draft — Statement of Principles for Financial Reporting, which is examined later in this article.
The main reasons for developing an agreed conceptual framework are that it provides:
However, the main draw-back of a conceptual framework is that it can be too general in nature and the principles may, therefore, not help when actually producing the financial statements. In addition, there may be further disagreement as to the content of the framework and the contents of standards.
Purpose and scope of the Statement of Principles
The purpose of the draft Statement of Principles is to define the principles that should underlie the preparation and presentation of general purpose financial statements. It also provides the conceptual underpinnings for preparing future accounting standards. The Statement comprises the following eight chapters:
2 The Reporting Entity.
3 The Qualitative Characteristics of Financial Information.
4 The Elements of Financial Statements.
5 Recognition in Financial Statements.
6 Measurement in Financial Statements.
7 Presentation of Financial Information.
8 Accounting for Interests in Other Entities.
The ASB believe that the draft Statement will assist preparers and users of financial statements, as well as auditors and others, to understand better its approach to formulating accounting standards. It should also help them to understand better the general nature and function of information reported in financial statements.
It is important to remember that the Statement of Principles is not an accounting standard and, therefore, does not prescribe how financial statements should be prepared or presented.
The draft Statement focuses on the financial statements that are either intended to give a true and fair view of the organisation’s financial performance and financial position or are intended to be consistent with financial statements that give such a view. This includes annual and interim financial statements, as well as preliminary announcements and summary financial statements.
Relevance of the Statement
The draft Statement is primarily designed to be relevant to the financial statements of profit-oriented organisations including those in the public sector, regardless of their size. However, it could also be relevant to not-for-profit organisations if some of the principles are re-expressed or their emphasis changed. A separate paper on not-for-profit entities and the Statement of Principles is to be issued in due course.
The draft Statement recognises that the concept of a true and fair view is fundamental to the whole system of financial reporting. An example of this is its insistence on relevance and reliability as the main indicators of the quality of financial information. The concept of a true and fair view is considered to be the ‘ultimate’ and lies at the core of all financial reporting. It is regarded as the ultimate test for financial statements and, as such, has a direct effect on accounting practice.
Financial statements will not give a true and fair view unless the information they contain is sufficient in quantity and quality to satisfy the reasonable expectations of the readers to whom they are addressed. These expectations change over time and the ASB seeks, through its accounting standards and other pronouncements, to respond to these expectations.
The objectives of financial statements
The Statement of Principles defines the objective of financial statements as:
This definition provides the basis for developing all the subsequent principles within the Statement. Fundamentally, the Statement assumes that it can achieve this objective by focusing on the information needs of present and potential investors. This is because they need information about the organisations financial performance and financial position that is useful to them in evaluating its ability to generate cash, and in assessing its financial adaptability.
Fundamental to the preparation of financial statements is the need to provide relevant, reliable, comparable and understandable information. In deciding which information to include in financial statements and how to present it, the aim should be to ensure that they provide information that is useful. The materiality test is used to determine whether the information’s usefulness is of such significance as to require it to be given in the financial statements. An item of information is considered material to the financial statements if its misstatement or omission might reasonably be expected to influence the economic decisions of the users of those financial statements.
Fundamental accounting concepts
Academic writers on accountancy, and others, have identified many accounting concepts which could be regarded as forming part of the accounting conceptual framework. However, the fundamental accounting concepts are defined in SSAP 2 and are often referred to in later SSAPs. The four concepts are defined in the standard as follows:
Going concern: “the enterprise will continue in operational existence for the foreseeable future. This means in particular that the profit and loss account and balance sheet assume no intention or necessity to liquidate or curtain significantly the scale of operation”.
Accruals: “ revenues and costs are accrued (that is recognised as they are earned or incurred, not as the money is received or paid), matched with one another so far as their relationship can be established or justifiably assumed”.
Consistency: “there is consistency of accounting treatment of like items within each accounting period and from one period to the next”.
Prudence: “revenue and profits are not anticipated, but are recognised by inclusion in the profit and loss account only when realised in the form either of cash or of other assets the ultimate cash realisation of which can be assessed with reasonable certainty; provisions made for all known liabilities (expenses and losses) whether the amount of these is known with certainty or is a best estimate in the light of the information available”.
SSAP 2 acknowledges that the relative importance of these concepts will vary according to the circumstances of a particular case; however, it is made clear that where the accruals concept is inconsistent with the prudence concept then prudence should take precedence. At level C candidates need to be able to define the concepts and apply them when preparing financial statements.
This article has outlined the nature and purpose of a conceptual framework and explained the purpose and scope of the Statement of Principles. Candidates often overlook this important area of the syllabus which is fundamental to understanding the whole process of preparing financial statements.
Accounting Standards Board, (1999), Revised Exposure Draft — Statement of Principles for Financial Reporting, ASB Publications.
AT Foulks Lynch (1998), Drafting Financial Statements (Industry & Commerce), AT Foulks Lynch Ltd, Chapter 2.
Black, G. (1998), Students’ Guide to Accounting and Financial Reporting Standards, Letts, Chapter 2.
BPP, (1998), CAT Interactive Text — Drafting Financial Statements, BPP Publishing Ltd, London, Chapter 3
Wood F., and Sangster A., (1999), Business Accounting 1, Financial Times Professional Ltd, Chapter 10.
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