Question

The conceptual framework set by the International Accounting Standards Board, issued in 1989 and revised in 2018, consists of a set of fundamental principles and concepts that underlie the preparation and presentation of financial statements for external users.

Critically examine how the establishment of the framework enhances financial reporting. (Approx 1000 words). Support your answer with examples.

Answer 1

The Framework's purpose is to assist the IASB in developing and revising IFRSs that are based on consistent concepts, to help preparers to develop consistent accounting policies for areas that are not covered by a standard or where there is choice of accounting policy, and to assist all parties to understand and interpret IFRS

In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8.

The Objective of general purpose financial reporting

The primary users of general purpose financial reporting are present and potential investors, lenders and other creditors, who use that information to make decisions about buying, selling or holding equity or debt instruments, providing or settling loans or other forms of credit, or exercising rights to vote on, or otherwise influence, management’s actions that affect the use of the entity’s economic resources.

The primary users need information about the resources of the entity not only to assess an entity's prospects for future net cash inflows but also how effectively and efficiently management has discharged their responsibilities to use the entity's existing resources (i.e., stewardship).

The IFRS Framework notes that general purpose financial reports cannot provide all the information that users may need to make economic decisions. They will need to consider pertinent information from other sources as well.

The IFRS Framework notes that other parties, including prudential and market regulators, may find general purpose financial reports useful. However, these are not considered a primary user and general purpose financial reports are not primarily directed to regulators or other parties.

Example

Different companies and countries follow different methods of financial accounting and reporting. This might not always be due to choice but also a requirement of the business model itself. For example, a company working with the distributorship model records its sale when the goods leave the factory against a purchase order from the distributor. On the other hand, a company working under the consignment sale model can record a sale only when goods are actually sold to customer (and not the sale channel intermediaries). As such, there arise differences in financial accounting and reporting, which magnify upon reaching the analysis and reporting stage.Having a fixed set of definitions of each line item, hence, becomes useful and rather indispensable to ensure conceptual consistency amongst the audience of the report. It also helps the potential investor better gauge and compare the performances of target companies, regardless of their physical location and differences in business models.