Wiley Insight IFRS Conceptual Framework

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IFRS Conceptual FrameworkThe cornerstone of high qualityfinancial reporting

Defining the fundamentals



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IFRS Conceptual Framework

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Table of Contents

The cornerstone of high quality financial reporting . . . . . 2

Jan McCaheyPartner, PwC, Australia

Warren McGregor, Joint Editor-in-Chief Wiley Insight IFRSIndependent financial reporting consultant, inaugural member of the International

Accounting Standards Board and Consultant to the Australian AccountingStandards Board and PwC, Australia

Defining the fundamentals . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

David Tweedie, Joint Editor-in-Chief Wiley Insight IFRSFormer Chairman, International Accounting Standards Board, Chairman,International Valuation Standards Council

Warren McGregor, Joint Editor-in-Chief Wiley Insight IFRS

Independent financial reporting consultant, inaugural member of the International Accounting Standards Board and Consultant to the Australian AccountingStandards Board and PwC, Australia

Andrew Watchman, Editorial Board member, Wiley Insight IFRSGlobal Head, IFRS, Grant Thornton

Henning Zülch, Editorial Board member, Wiley Insight IFRSChair of Accounting and Auditing, HHL, Europe, Germany

IntroductionWarren McGregor and Jan McCahey, in their paper, The cornerstone of high quality

financial reporting, take a fresh look at the Conceptual Framework highlighting areaswhich need to be revised while endorsing the current focus on economic decision-making and real world economic phenomena. They urge interested parties to jointhe debate and put aside their prejudices relating to what is or is not consideredacceptable in practice today but to instead work towards a truly aspirationalframework.

In the accompanying article, Defining the fundamentals, Sir David Tweedie providesa retrospective view on initial efforts to define the framework during his tenureas chairman of the IASB while Andrew Watchman and Henning Zülch discuss thedefinitions of key elements.




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Why another paper on theconceptual framework?The IASB’s decision to reactivate its conceptual frameworkproject and its desire to complete the project expeditiouslyhas created an atmosphere of both optimism and

apprehension in the financial reporting community.Optimism because it signals a commitment on the part ofthe Board to complete what it heralded as one of its mostimportant projects, in the context of establishing a setof high quality global accounting standards, when it firstcommenced the project in 2004. Apprehension becausethe Board has signalled its intention to complete the projectin a time frame that most experienced observers wouldconsider to be very ambitious and in so doing may exposeitself to the risk of compromising the quality of the finishedproduct.

We have a deep interest in the conceptual frameworkproject. We believe the conceptual framework is the

cornerstone of high quality financial reporting and thatstandard setters are custodians, not owners, of theconceptual framework. We have spent a considerableportion of our professional careers developing conceptualframeworks nationally and internationally, using thoseframeworks in developing accounting standards nationallyand internationally and advising on the practical applicationof those frameworks and the standards based on them.We are convinced that the quality of financial reportingis enhanced significantly if accounting standards, andultimately decisions taken in practice, are based on a set oflogically interrelated concepts.

We view the IASB’s decision to devote significant resourcesto improving and completing the conceptual framework

as a significant event in the development of a set of highquality global accounting standards; it is an opportunityto put in place something that will have lasting benefit forthose involved in and impacted by financial reporting. Thisopportunity arises only rarely, so it is important that the

Board and its constituents are given the necessary timeto make the most of the opportunity. In this respect, weencourage interested parties to participate in the IASB’sprocess, and refer them to its recently issued discussionpaper, “ A Review of the Conceptual Framework for FinancialReporting ”.

In this short paper, we explain why we believe theconceptual framework is the cornerstone of high qualityfinancial reporting and why the IASB’s decision to reactivatethe conceptual framework project is warranted. In addition,we identify the remaining areas of the framework that webelieve need to be updated or developed. These includethe areas of the framework that were previously addressedbut not completed by the IASB in conjunction with the FASBin an early incarnation of this project, i.e. the reportingentity, definition and recognition of the elements of thefinancial statements and measurement. They also includetwo additional sections: the scope of financial reporting, andpresentation and disclosure.

We also identify what we believe are the desirable qualitiesof a conceptual framework, noting that the lower levelsof the framework should be built on the higher levels (i.e.the objective of financial reporting and the qualitativecharacteristics of financial information), which have recentlybeen revised by the IASB, and that the framework should beaspirational in nature. We believe designing the conceptualframework in this way is essential if it is to continue to be theprimary platform for developing improvements in financialreporting and if those improvements are going to be able tosuccessfully address the concerns we often hear about thelack of relevance of the existing financial reporting model.

We hope that by sharing our views and experiences withstandard setters and others who may be intimately involved

in the project, we can contribute to the development of acomprehensive, high quality conceptual framework that willbetter enable standard setters and practitioners to meetthe ongoing financial reporting challenges they will face.

This paper contains the personal views of the authors and not necessarily those of organisations with which theyare associated.

Warren J McGregor

Joint Editor-in-Chief, Wiley Insight IFRSIndependent financial reporting consultant, inauguralmember of the International Accounting Standards Board

Jan McCaheyPartner, PwC, Australia

The cornerstone of high quality financial reporting“… the objective is economicdecision-making, the conceptssupporting the objective …have been framed in a way thatreflect real world economic

phenomena, i.e. scarceresources, claims to scarceresources and changes in scarceresources and claims. Thishas enhanced the relevanceof the information providedto users by better reflectingthe economic substance oftransactions and other events.

It has also helped improvethe comparability of reportedinformation…”




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Financial reporting and standardsetting prior to the advent of

conceptual frameworksPrior to the advent of conceptual frameworks, accountingstandards and financial reporting were based onvague principles and conventions, such as true and fairview, prudence, stewardship, conservatism, matchingand earnings process, rather than on a robust set ofinter-related concepts reflecting underlying economicphenomena. Standard setters developed ‘rules’ thattypically reflected emerging consensuses in practice andsometimes involved eliminating ‘undesirable’ practicesrather than identifying ‘best practice’ . Their frame ofreference was implicit and held individually (personalconceptual frameworks) rather than being explicit and

commonly applied. As a result, decisions tended to be adhoc, inconsistent and unrelated to higher order outcomes.Those involved with trying to improve financial reportingduring this time were well motivated and brought aboutimprovements in financial reporting. However, progresswas slow and there was no explicit benchmark againstwhich to assess whether the quality of financial reportingwas being advanced or retarded.

The first seeds of a conceptual framework emerged in theUnited States in the 1960’s with attempts to identify anobjective of financial reporting. It gained real momentum atthe beginning of the next decade as the newly establishedFinancial Accounting Standards Board (FASB) immediately

experienced the frustration of trying to resolve issueswithout a common frame of reference.

The FASB developed the first conceptual framework duringthe 1970’s and 1980’s. This path-breaking work led to aflurry of activity amongst other national standard setters,and at an international level [the International AccountingStandards Committee (IASC)], as they sought to emulateand build on the FASB’s framework.

How did the conceptualframework change things?

The conceptual frameworks were originally and primarilydesigned to aid standard setters in their standardsdevelopment activities. However, their role evolved into amore direct impact on practice as the IASC, followed by theAustralians and New Zealanders (and ultimately the IASB),embedded the framework in their standards dealing withthe selection of accounting policies.

The advent of the conceptual framework had a profoundeffect on standard setters and practitioners and byextension the quality of financial reporting. Standardsetters now had a common frame of reference for theirdecision making, which was comprised of a set of inter-related concepts based on the decision making needs of

the users of financial statements. This imposed a degreeof discipline on standard setters that had previouslybeen lacking. The onus was now on standard settersto formulate standards that, where possible, wereconsistent with the framework and would therefore be

expected to meet the objective of the framework, i.e. toprovide information that is useful to the users of financialstatements in making economic decisions.

This self-imposed discipline had two related effects on thebehaviour of standard setters. It improved the consistencyof their decision making as fundamental issues were lesslikely to be redebated as new standards were developedor existing standards were improved or as membershipof the standard setting body changed. It also providedstandard setters’ constituents with a clear frame ofreference for making standard setters accountable for theirdecisions, since the concepts or principles underpinningthe standards were now explicit and any departures fromthem more evident. Indeed, as part of this self-imposeddiscipline, standard setters typically undertook to explainin an addendum to new or amended standards how the

decisions on key issues were consistent with the frameworkor, if they were not, why the standard setter had decided todeviate from the framework.

Practitioners have been affected by the advent of theconceptual framework in a variety of ways. Since standardshenceforth would be developed in the context of theframework, practitioners needed to be schooled in theframework in order to understand fully the particularrequirements of standards. Moreover, in those countrieswhere the framework was embodied in standards specifyinga hierarchy for determining appropriate accounting policiesfor matters not specifically addressed in a standard oran interpretation, practitioners have been required to

apply the framework directly in resolving those practiceissues. With the widespread use of IFRSs around theworld, practitioners in most countries are now applying theframework in practice. Professional bodies and educatorshave generally responded to this changed environmentby changing their professional requirements and coursecontent to include knowledge of the conceptual framework.

Practitioners, and standard setters’ constituents moregenerally, were also impacted by the conceptual frameworkin the context of their interactions with standard setters.Because standards henceforth were to be developed in thecontext of the framework, constituents soon realised thatif they were to be able to communicate effectively with the

standard setter they would have to adopt the new standardsetting language. This too contributed to the ‘education’of practitioners about the conceptual framework. It alsoenhanced the quality of the dialogue between standardsetters and their constituents and contributed to improvedunderstanding of their respective points of view.

The combined effect of these changes has in our view beena demonstrable improvement in the quality of financialreporting.

Standard setters are now developing accounting standardswith a clear objective in mind – to meet users’ informationneeds. Because that objective focuses on economic

decision making, the concepts supporting the objective(and ultimately the standards based on them to the extentpossible) have been framed in a way that reflects ‘realworld’ economic phenomena, i.e. scarce resources, claimsto scarce resources and changes in scarce resources




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and claims. This has enhanced the relevance of theinformation provided to users by better reflecting theeconomic substance of transactions and other events. Ithas also helped improve the comparability of reported

information by having economically similar transactions andother events accounted for in like ways and economicallydissimilar transactions and other events accounted fordifferently.

Practitioners have become better equipped to apply theimproved standards as intended by the standard setters,as a result of their enhanced knowledge of underlyingconcepts, and better able to use their professional skil l and

judgement in a conceptually consistent manner in resolvingissues not explicitly dealt with in the literature. Again, thishas helped improve the quality of financial statements andthe usefulness of reported information in the hands ofusers.

Standard setters and their constituents are now better ableto communicate with each other, and this has enhancedthe effectiveness of the standard setting process. While weacknowledge that the timeliness of needed improvementsin the quality of financial reporting continues to be an issue,the fact that the engagement of standard setters with theirconstituents now takes place in the context of a commonlyunderstood set of concepts has contributed to improvingthe quality of accounting standards and ultimately thequality of financial reporting.

What is the current state of

play with the IASB’s conceptualframework?The IASB’s conceptual framework is incomplete. It doesnot contain sections on the scope of financial reporting, thereporting entity or presentation and disclosure. In addition,the section dealing with measurement of the financialstatement elements does not contain measurementconcepts but merely describes a number of measurementbases and techniques that have been applied in practice.

Older sections of the framework are in need of revision.The IASB recently revised the sections of the frameworkdealing with the Objective of General Purpose Financial

Reporting and the Qualitative Characteristics of UsefulFinancial Information. However, the sections dealing withthe Definition and Recognition of the Elements of theFinancial Statements were developed many years ago, andit is evident from the work of the Board at a standardslevel that its thinking relating to these concepts has beenevolving. For example, the standards dealing with financialinstruments and business combinations, work on revisingIAS 37 Provisions, Contingent Liabilities and Contingent Assets and the current proposals on insurance contracts provideexamples of the Board taking decisions at variance with theconceptual framework and provide evidence of the need forit to be revised, as i llustrated below:

(a) in IAS 32 Financial Instruments: Presentation, the IASBrequired certain transactions involving share-basedpayments to be treated as liabilities even though theydid not meet the definition of a liability in the framework,

and certain transactions involving shares that can be putback to the issuing entity to be classified as equity eventhough they appear to meet the definition of a liability inthe framework.

(b) in IFRS 3 Business Combinations, the Board required‘contingent liabilities’ to be recognised as liabilities ofthe acquiring entity even though IAS 37 prohibited theirrecognition as liabilities of the acquiree, presumablyin accordance with the then Board’s interpretationof the framework definition of a liability. (The IASBsubsequently proposed to amend IAS 37 to beconsistent with the view taken in IFRS 3.)

(c) in IAS 39 Financial Instruments: Recognition andMeasurement and IFRS 9 Financial Instruments, and inthe insurance contract proposals and the proposedrevisions to IAS 37, separate criteria for the recognitionof assets and liabilities were either not included or weremodified from those in the framework.

Apart from the gaps in the framework that need to befilled and the evolution in thinking that (subject to dueprocess) needs to be captured in future revisions to theframework, the Board needs to address a related concern.There continues to be a number of standards that havenot been revised to reflect, to the extent feasible, theconcepts in the existing conceptual framework let alonepossible improvements to the framework. These includeIAS 19 Employee Benefits, IAS 20 Accounting for GovernmentGrants and Disclosure of Government Assistance, IAS 28Investments in Associates and IAS 38 Intangible Assets. The

improvements in financial reporting referred to earlier inthis paper resulting from improved standards developed inthe context of the conceptual framework will not be realisedto the extent possible until these revisions take place.The Board’s renewed focus on the conceptual frameworkprovides an opportunity for it to also renew a commitmentof its predecessor standard setters to revise these olderstandards and where possible align them with the conceptsin the framework.

What needs to be done?

Reaffi rm the role of the conceptual framework

The IASB (and its standard setting partners) should reaffi rmthe role of the conceptual framework in the standardsetting process.

Conceptual frameworks have traditionally been viewedby standard setters as aspirational documents, settingthe direction for reform of financial reporting whileacknowledging that at any point in time the ‘conceptuallycorrect’ approach may not be achievable at a standards level.If financial reporting is to continue to evolve and meet theneeds of the users of financial statements, it is importantthat this continues to be the case. There will always be atemptation when standard setters revisit the conceptualframework to see it as an opportunity to justify previous

decisions at a standard setting level that, at the time, weredriven more by compromise and pragmatic solutions thanunderlying concepts. Such re-engineering would underminethe integrity of the conceptual framework both as a vehiclefor facilitating the development of new ideas by the standard




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setter at a standards level and as vehicle for holding thestandard setter accountable for its decisions.

In our view, the IASB faces precisely this issue in itsconceptual framework project as it endeavours to respond

to calls from some of its constituents for it to identify aconceptual basis for the recognition of i tems of incomeor expense in ‘other comprehensive income’. Decisionsby standard setters in the past to allow or require thistreatment have been made in response to concerns byconstituents, in particular concerns by preparers, aboutvolatility in reported profit or loss resulting from recognisingchanges in the values of assets and liabilities in profit or lossin the accounting periods in which those changes occur.

Whether items are recognised ‘above or below the line’ inthe performance statement they will, in the period in whichthe changes are first recognised, in concept be incomeor expense and will be a part of an entity’s net result forthat period. Changing the geography of the performancestatement does not change the conceptual nature of theitems. On the other hand, recycling these items from ‘othercomprehensive income’ to profit or loss in subsequentaccounting periods results in items being included inprofit or loss that are characterised as income or expenseof the period but do not meet the existing conceptualdefinitions of income and expense because they do notresult from changes in assets and liabilities in that period.If the conceptual framework were to be amended toincorporate this practice, presumably it would require theexisting definitions of income and expense to be amendedto include recycled items from previous reporting periods.

That would result in the definitions no longer being solelya description of economic phenomena but rather being acombination of such descriptions and a practice condonedby the standard setter. We recall something similar thatemerged in the United States in pre conceptual frameworkdays when the then standard setter developed the followingdefinitions of assets and liabilities:

• assets are economic resources and certaindeferred debits that are not resources but arerecognised and measured in conformity withGAAP; and

• liabilities are economic obligations and certain

deferred credits that are not obligations butare recognised and measured in conformitywith GAAP.

It is also important for standard setters to understandthe role of the cost constraint section of the conceptualframework within the overall role of the framework, andto apply the constraint conscientiously. This section ofthe framework acknowledges that cost is a pervasiveconstraint on the information that can be provided byfinancial reporting and states that the standard setterneeds to assess whether the benefits of reportingparticular information are likely to justify the costs incurredto provide and use the information. When a standard

setter invokes the cost constraint as a justification for notrequiring an approach that would be more consistentwith the relevant concepts in the framework, it is actuallycomplying with the framework. Standard setters need toresist the temptation to opportunistically invoke the cost

constraint when endeavouring to navigate contentiousfinancial reporting issues.

Reaffi rm the status of the conceptual framework

In some parts of the world that are yet to embrace IFRSsthe conceptual framework does not have the same statusit has in IFRS literature. In those countries the conceptualframework is used by the standard setter in developingaccounting standards but is not required to be used bypractitioners in applying the standards. For the reasonsstated earlier in this paper, we believe that, while theprimary role of the framework is as an aid to the standardsetter, making it mandatory for use by practitioners inspecified circumstances has both enhanced the standardsetting process and helped improve the quality of financialreporting. Accordingly, we believe it is important forthe IASB to confirm the existing status of the conceptualframework in its literature and also encourage thosestandard setters not yet using IFRSs to elevate its status intheir jurisdictions.

Update the framework for changes at astandards level

Earlier in the paper we mentioned that the IASB’sconceptual thinking seems to have been evolving at astandards level, particularly in the areas of definition andrecognition of the elements of the financial statements.The review of the conceptual framework provides theopportunity to formally translate these developmentsinto tangible revisions of the relevant concepts, includingexplaining the underlying conceptual rationale for thechanged thinking. This will reduce or eliminate perceiveddifferences between the conceptual framework and therelevant standards and will provide a stronger foundationfor reaching consistent conclusions when deliberatingissues at a standards level in the future.

Complete the work commenced by the IASB jointlywith the FASB

The IASB and the FASB devoted a considerable amount oftime and effort to three as-yet-uncompleted sections oftheir conceptual frameworks: namely, the reporting entity,definition of the elements of the financial statements, andmeasurement of the elements of the financial statements.

Reporting entity

Work on the reporting entity was all but completed. Thiswork needs to be brought to a conclusion as soon aspossible because it deals with a number of fundamentalconcepts, including the concept of ‘control’ and its role incircumscribing the boundaries of a reporting entity. We seelittle point in the IASB conducting lengthy redeliberations,as the relevant issues have already been subjected toextensive due process.

Definition of the elements

An extensive amount of work has already been undertaken

on definitions of the elements: at a conceptual level with theFASB, where tentative decisions were reached on definitionsof assets and liabilities; and, at a standards level with theFASB (financial instruments with characteristics of equity)and separately by the IASB (review of IAS 37, revision of IAS




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32, etc). This work should inform the IASB and hopefullyenable it to accelerate its deliberations.

Measurement of the elements

Work on measurement of the elements by the IASB andthe FASB reached only a preliminary stage and tended tobe more descriptive than aspirational. We encourage theIASB to make a fresh start in this area and try to developmeasurement concepts that are based on higher levelsof the framework, i.e. try to identify a measurement basisor measurement bases that would provide the mostuseful information for users of the financial statements. Aforthcoming paper by Mary Barth, a former member ofthe IASB, entitled Measurement in Financial Reporting: TheNeed for Concepts, outlines how such an approach might beapplied.

Fill in the gaps in the existing framework

Scope of financial reporting

The existing conceptual framework does not have asection dealing with the scope of financial reporting. Thisis a significant omission, given the aspirational nature ofthe framework on the one hand and the development ofpotentially competing reporting models on the other.

In our view, the conceptual framework should includean initial section that sets out a broad scope for financialreporting. This would facilitate the evolution of financialreporting as the demands of constituents’ change, asthe institutional environment within which informationis provided changes, and as the capacity to provide new

and enhanced information changes. For example, theconceptual framework should not be a barrier to theprovision of more forward-looking information in financialstatements. Nor should it be a barrier to financialreporting harnessing developments in informationtechnology that endeavour to enhance the communicationprocess between reporting entities and those that use theinformation they produce.

In addition, articulating a broad scope for financialreporting should clarify that other reporting models, suchas integrated reporting, complement the ‘conventional’reporting model rather than compete with it.

The growing interest in integrated reporting is symptomatic

of growing discontent with the conventional reportingmodel. Preparers and users are increasingly voicing theirconcerns about the failure of financial statements preparedin accordance with existing accounting standards to providerelevant information, and are responding by developing andfocussing on various non-GAAP measures. Whether or notsuch concerns are valid, they are sincerely and passionatelyheld. Accordingly, standard setters need to respond, andneed to have the tools at their disposal to respond in aneffective manner. A broad scope for financial reportingand articulation of appropriate concepts relating to thepresentation and disclosure of information (discussedbelow), would enable standard setters to explore alternativesolutions that respond to the present concerns.

We also believe the scope section of the conceptualframework should identify that the concepts articulatedwithin the framework are ‘transaction neutral’. In otherwords, the concepts should be capable of being applied

by all reporting entities, irrespective of their operatingstructure, the sector of the economy in which they operate,i.e. private or public, and the operating objective theypursue, i.e. for-profit or not-for profit. We acknowledge

that this is more of a medium-term objective and shouldultimately be the product of a co-operative effort betweenthe IASB and its public sector counterpart, the InternationalPublic Sector Accounting Standards Board, informed bythe work of the FASB in addressing private sector not-for-profit entity issues. However, we think it is important forthe IASB to acknowledge the desirability of having a singleconceptual framework that can be applied by al l reportingentities around the world. We note that ‘transaction neutral’conceptual frameworks have been developed in the past bythe Australian and New Zealand standard setters.

Presentation and disclosure

The existing conceptual framework also does not have a

section dealing with presentation and disclosure. Thistoo is a significant omission given the ongoing focus ofusers and preparers on presentation and disclosure issues(including, whether valid or not, concerns about complexityand disclosure overload) and given the current problemsstandard setters have in resolving presentation anddisclosure issues.

We believe the IASB should try to develop presentationand disclosure concepts based on higher levels of theframework. This may involve investigating whether thosehigher levels are complete in terms of providing a basis forclear articulation of presentation and disclosure concepts.In this respect, we note that the IASB and FASB undertook

a major project on financial statement presentation aspart of their convergence programme and devoted aconsiderable amount of time and effort to developing somekey presentation and disclosure principles. In addition, weare aware of a recent paper by Kevin Stevenson, Chairmanof the Australian Accounting Standards Board and a formerhead of staff at the IASB, entitled Rethinking the Path froman Objective of Economic Decision Making to a Disclosure andPresentation Framework , that contends there is a gap in theconceptual framework between the objective level and thelower levels. He argues that there are a limited numberof generic types of information, termed stocks and flows,that characterise all types of entities and that by specifyingthese information components in the upper level of theconceptual framework a better, purpose-driven, disclosureand presentation framework can be developed.

Where to from here?We strongly encourage all interested parties to join thedebate and help the IASB develop a comprehensive,high quality conceptual framework. We would urgecommentators to put aside their preferences andprejudices relating to what is or is not considered‘acceptable’ in practice today and focus instead onthe development of concepts that will give the revisedconceptual framework a truly aspirational character. Such

a framework will, we believe, be a powerful tool for the IASBand practitioners in the quest for ongoing improvements inthe quality of financial reporting.




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Defining the fundamentalsThe IASB published a discussion paper in July inviting comment on revisions to the Conceptual Framework which forms thebasis of all IFRS standards. Wiley Insight IFRS asked our Editorial Board members to comment on the following areas whichform the foundation on which the framework is built.

• Definitions of assets and liabilities

• Recognition and derecognition

• The distinction between equity and liabilities

• Measurement

• Presentation and disclosure

• Other comprehensive income

David Tweedie provides a retrospective view on initial efforts to define the framework during his tenure as chairman of theIASB while Warren McGregor, Andrew Watchman and Henning Zülch highlight some important points for further discussion.

To join in the discussion and contribute to revisions in the framework, please send your comments [email protected]

The IASB has quite rightly responded to the call from itsconstituents to make the conceptual framework a priority.So why was it not a priority when I was at the IASB? Itwas. However, we had other urgent tasks such as improvingthe IASs we inherited for those countries adopting IFRSs in2005 and then the aim to converge IFRS and US GAAP toencourage US adoption of IFRS.

Consequently, due to our limited resources, we had initiallyto outsource the project to other national standard setterswho not surprisingly also had other priorities to consider.As a result, and much to the board’s frustration, only twochapters of the existing framework were revised.

The current board is tackling the project head on. In itsrecently published discussion paper it has raised issueswhich have plagued financial reporting for decades (andthe IASB since its inception) and led to inconsistenciesin standards and practice. It is now vital that the criticalquestions raised by the board are answered carefully andthoughtfully. The answers to these controversial issues

could shape financial reporting for a generation or more.

When does an asset exist? - Is today’s asset the right of apublic utility to raise prices in the future? When EXACTLYdoes an obligation exist? Has a company REALLY sold

an asset or has it in economic terms used it as collateralfor a loan? Given the hybrid nature of some financialinstruments, where should the boundary between equityand debt instruments be drawn? When should fair value asopposed to cost be used? Can the business model used inIFRS 9 solve this problem?

Which economic events, if any, should be reflected in OtherComprehensive Income (OCI)? If OCI continues to be usedshould any gain or loss arising upon the derecognition of anasset or liability together with any previous changes in valueof the element be ‘recycled ‘ to the profit and loss account.

These are not simple issues but the answers to them willalter balance sheets, affect leverage ratios and changethe measurement of profit. Accountants are not bynature huge consumers of conceptual products but therevised Conceptual Framework will have major practicalimplications. The IASB needs your help. Respond now orregret not doing so later!

David Tweedie Joint Editor-in-Chief Wiley Insight IFRS

Former Chairman, International Accounting Standards Board, Chairman,International Valuation Standards Council

Tackling the project head on




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The Conceptual Framework is the cornerstone of highquality financial reporting. It provides a common frame ofreference for IASB members to make decisions about thecontent of accounting standards. This facilitates consistentdecision-making by board members and enhances thequality of those decisions. This latter outcome derivesfrom the fact that the conceptual framework establishesunderlying concepts that are based on real world economicphenomena – economic resources, claims on economicresources and changes in those resources and claims.These are essential inputs to the economic decisions madeby investors and other users of financial statements. Thisproject is therefore a critical step towards the IASB’s goal of

establishing high quality global accounting standards thatproduce financial information that is useful to investors andother users.

Like many of the standards the IASB inherited from itspredecessor the IASC, the Conceptual Framework needs tobe updated and improved.

Three new sections are needed on:

1. The scope of financial reportingIn order to address matters such as the role offorward-looking information and the relationshipof financial reporting with other reporting modelssuch as integrated reporting.

2. The reporting entityIn order to address matters such as the role of theconcept of control in circumscribing the boundaryof the reporting entity and identifying whenconsolidated or combined financial statementsshould be prepared.

3. Presentation and disclosureIn order to identify concepts that will enable theIASB to deal more effi ciently and effectively withdisclosure and presentation issues. This will alsoaid the IASB in addressing the perennial concernsabout financial reporting complexity and disclosure

overload.

The two remaining sections of the existing framework thathave yet to be reviewed by the board, i.e. definition andrecognition and measurement, need to be revised.

A good deal of work has already been done by the IASB andthe FASB in their joint conceptual framework project and instandards level projects on the definition and recognition ofassets and liabilities, the distinction between liabilities andequity, the definition and recognition of revenue and thederecognition of assets and liabilities. The IASB can build onthis work.

The measurement section of the existing conceptualframework merely describes measurement bases and

techniques used in practice. This is the section of theconceptual framework where the IASB needs to ensure thatthe aspirational nature of the framework, evident in othersections, is reflected. This would be achieved by identifyingmeasurement concepts with reference to the higher levelsof the framework, such that a measurement basis/basesthat would best meet the objective of financial reporting is/are identified.

Warren McGregor Joint Editor-in-Chief Wiley Insight IFRS

Independent financial reporting consultant, inaugural member of theInternational Accounting Standards Board and Consultant to the

Australian Accounting Standards Board and PwC, Australia

Bases and boundaries




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Defining assets and liabilities

The discussion paper aims to clarify two main aspectsof the existing definitions: first that assets and liabilitiesare resources or obligations - not the potential inflows oroutflows of resources that might stem from them; secondthat an asset or liability can exist whether or not inflows oroutflows are actually expected to arise.

These clarifications are welcome. That said, some mayperceive that the removal of expectationfrom the definitionsreduces the role of uncertainty. This may disappoint thosecalling for more emphasis on the role of prudence andreliable measurement.

These definitions are important but we should not expect

these broad clarifications to answer the most diffi cultissues. For example, is deferred tax really an asset orliability? And, in the context of the controversial new leasingproposals, is the resource the right to use the asset (asproposed), the underlying asset (as per IAS 17) or eventhe lease itself? Does an entity have an obligation forsomething that is legally avoidable through future actions ifthose actions are unrealistic in practice?

As these questions illustrate, definitions are only the start.The amounts in the balance sheet depend also on theunit of account, recognition criteria and the measurementbasis. In summary, we should welcome clearer definitionsof an asset and a liability - but also be realistic about their

limitations.

Distinguishing between equity and liabilities

The classification of a claim as equity or as a liability has aprofound effect on financial statements. For a conventionalcompany with creditors and ordinary shareholders thedistinction is unproblematic – the challenges arise becausemany entities, and many claims, do not neatly fit thisdescription.

Currently the Conceptual Framework provides a high leveldefinition of equity as the residual interest in an entity afterdeducting liabilities, with detailed guidance left to a specificstandard (IAS 32) . The discussion paper retains the basic

definition but goes into more detail. It proposes that:

• equity instruments are defined strictly as claims thatdon’t meet the definition of a liability. This is also IAS32’s starting point but the standard then sets variousrules about, and exceptions to, how that principle isapplied

• more information is provided on different classes ofequity claim and how they interact (upgrading thestatement of changes in equity).

These proposals would address some (but by no meansall) of the interpretive issues we see today. They wouldalso shift the classification of some instruments from debtto equity and vice versa – which will undoubtedly prove

controversial given IAS 32’s history.I see considerable merit in enhancing the statement ofchanges in equity by providing information about thepriority of, and interaction between, different classes ofequity claim. This would of course imply more work forpreparers and some commentators may therefore raiseconcerns over added complexity.

I am less convinced that the conceptual framework is theright place for developing a new classification model. Theboard understandably seeks a model that is simpler andmore principle-based than IAS 32. But perhaps complexityis the inevitable price for applying the same principles to alltypes of entity. A more fruitful way forward might be moreanalysis of the reasons for distinguishing debt from equity,and the broader effects of making that distinction. Such ananalysis could help the board to improve IAS 32 withoutdiscarding the hard work that has gone into it.

Andrew WatchmanEditorial Board member, Wiley Insight IFRS

Global Head, IFRS, Grant Thornton




10

Consistency is vital

The IASB’s efforts to revise its conceptual basis have beenhalted since the publication of the first two chaptersof its new Conceptual Framework (Objectives of GeneralPurpose Financial Reporting and Qualitative Characteristicsof Useful Financial Information) in September 2010. Hencethe recent publication of the discussion paper. Having asound and comprehensive conceptual basis outlining basicprinciples, element definitions and theoretical views onaccounting constructs is most important when aiming atthe development of a global set of high-quality accountingstandards. Otherwise the IASB’s standard-setting decisionscould easily become unpredictable. A globally consistentinterpretation and application of IFRS is barely possible

without a solid conceptual foundation.Now, the IASB is tackling the most significant conceptualissues in only one discussion paper. It proposesclarification on the elements of financial statements,changes in the asset and liability definitions, rethinkingthe identification of equity instruments, basic principleson recognition and derecognition, a classification andprioritization of measurement concepts, comprehensiveideas on presentation and disclosure and including ‘othercomprehensive income’ as a defined element. Dealingwith all these issues in just one project seems to bevery ambitious. However, it should help ensure that acertain degree of consistency may be achieved in the new

Conceptual Framework– a characteristic that is missingso far.

What is remarkable when looking at the project’s big pictureis that it is explicitly statedthat the main function of theConceptual Framework is ‘to assist the IASB by identifyingconcepts that can be used consistently when developingand revising IFRSs’. One needs to applaud the IASB fortaking such an honorable aim on board, which promisesthat clearly explained concepts will be formulated and usedin future standard setting projects. When having a closerlook at the IASB’s proposals and elaborations, however,one finds that the board will always allow itself to deviatefrom the concepts and definitions to be codified. Moreover,the very technical nature of the discussion paper fails toprovide a general idea as to how new standard setting

projects will be approached and how they will actually beinformed by the conceptual underpinnings which are beingdeveloped now.

Henning ZülchEditorial Board member, Wiley Insight IFRS

Chair of Accounting and Auditing, HHL, Europe, Germany



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Transcript of Wiley Insight IFRS Conceptual Framework