In 1978, the FASB Statement of Pinancial Accounting Concepts (SFAC) No. I (paragraph 34) stated the following basic objective of external financial reporting for business entities:
Financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions.
Both the IASB and FASB frameworks consider the main objective of financial reporting is to communicate financial information to users. The information is to be selected on the basis of its usefulness in the economic decision-making process. This objective is seen to be achieved by reporting information that is:
• useful in making economic decisions
• useful in assessing cash flow prospects
o about enterprise resources, claims to those resources and changes in them.
CHAPTER 4 A conceptual framework 97
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Users of accou11ting infc>rmalicm l'ervasive ccmslraint
User-specific f{Ualitics
Primary decision-specific
qua lilies
Ingredients of primary f]Ualilics
In order to provide useful financial information, the accountant must choose which information to transmit. It therefore becomes necessary to develop a hierarchy of qualities which make information useful. Principal qualitative characteristics include:
understandability to decision-makers, relevance, reliability and comparability ( and aspects of those qualities such as materiality, faithful representation, substance over form, neutrality, prudence and completeness). The hierarchical arrangement of the qualitative characteristics presented in SFAC No. 2 is shown in figure 4.2.
SFAC No. 2 and the IASB Framework explain the qualitative characteristics.
Understandability refers to the ability of information to be understood by users. Users are assumed to have a reasonable knowledge of business and economic activities and accounting, and a willingness to study the information with reasonable diligence.
Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming or correcting their pasl evaluations. To be reliable, financial information should faithfully represent transactions and events without material bias or error (IASB Framework, paragraphs 24-42).
Decision 111c1kcrs and their chc1ractcrislics (for example, understanding or prior knowledge)
C
[ Benefits > Costs
---·
.Understandability Decision usefulness
- - - '
--~o:_-::_-::_-_-_----'---r---~_,_ _ _ ,
Relevance Reliability
Vcrifia~J [lrcdictivc feedback
value value
,___
J
Representational faithfulness
Secondary and inlcraclivc qualilics
Comparabilily
(including consistency)
Neutrality
Threshold for
recognition
c-
MaterialityFIGURI: 4.2 SFAC No. 2 Qualitative characteristics of accounting information
'.>'ource rASB/JJ\SB, 'Revisiting the concepts: /\ new concPptual framework project', diagram p. 4
The IASB's Framework was developed following the lead of the United States standard setter, the FASB. In the period 1987-2000 the FASB issued seven concept statements covering the following topics:
• objectives of financial reporting by business enterprises and non-profit organisations
• qualitative characteristics of useful accounting information
• elements of financial statements
e criteria for recognising and measuring the elements
• use of cash flow and present value information in accounting measurements.
98 PART 2 Theory and accounting practice
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The IASB has just one concept statement, the Framework for the Jlrep{lr(l/io,1 ,md Presentation of Financial Statements. It was issued by the International Account in J Standards Committee (IASC), the predecessor organisation to the JASB, in 198~
and subsequently adopted by the IASB in 2001. The Framework describes the basic concepts by which financial statements are prepared. It serves as a guide to the IASB in developing accounting standards and as a guide to resolving accounting issues that are not addressed directly in an International Accounting Standard (!AS) or International Financial Reporting Standard (IFRS) or Interpretation. The IASB states that the Framework
• defines the objectives of financial statements
0 identifies qualitative characteristics that make information in financial statements useful
• defines the basic elements of financial statements and the concepts for recognising and measuring tl1em in financial statements. The framework acknowledges that a variety of measurement bases are used in financial reports ( e.g. historical cost, current cost, net realisable value and present value) but it does not include principles for selecting measurement bases (paragraphs 1, 100, 101).
!AS 1 Presentation of Financial Statements and !AS 8 Accounting Policies, Changes in Accounting Estimates and Errors deal with the presentation of financial statements and make reference to the Framework. !AS 8 (paragraph 10) requires that in the absence of an lASB standard or interpretation that specifically applies to a transaction, other event or condition, management must use its judgement in developing and applying an accounting policy that results in information tliat is:
0 relevant to the economic decision making needs of users
0 reliable, in that the financial statements:
(i) represent faithfully the financial position, financial performance and cash flows of the entity;
(ii) reflect the economic substance of transactions, other events and conditions, and not merely the legal form;
(iii) are neutral, i.e. free from bias;
(iv) are prudent; and
(v) are complete in all material respects.
!AS 8 (paragraph 11) provides a 'hierarchy' of accounting pronouncements. It requires that in making the judgement required in paragraph 10
management shall refer to, and consider the applicability of, the following sources, in descending order:
0 the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and
0 tl1e definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.
This statement articulates the relationship of the Framework, the standards and interpretations of the standards. It also makes material in the Framework binding on preparers. Consequently, the development of the revised framework is being closely scrutinised by constituents. Deliberations about.its content are being and will be subject to the political process which accompanies standard setting.
Since the Framework was issued in 1989 many new standards have been issued, including standards that conflict with the Framework. For example, Bradbury outlines many inconsistencies between !AS 39 Financial Instruments: Recognition and Measurement and the Framework.'' They arose because of the demand for a standard to be part of the set of core standards presented to the International Organization of Securities
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Commissions {IOSCO) in 2000, the complexity of accounting for financial instruments, the incompleteness of the Framework, and the lack of acceptance of a Framework based solution by preparers. Areas where the Framework provides inadequate guidance include accounting for derecognition of financial assets and hybrid financial instruments.
Further, Bradbury suggests that the Framework ignores risk, one of the main attributes of financial instruments. Not only should Framework guide the standard setting process, it should also assist practitioners to interpret standards. Theory in action 4.1 explores whether the Framework appears to have assisted in deriving an interpretation, in this case IFRIC 3 (released by the International Financial Reporting Interpretations Committee), which relates to emissions trading.
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IFRIC 3 and Emissions Trading
Accounling for carbono
by Georgina Dellaportas, /CAA Development of IFRIC 3
Cap-and-trade schemes have been in operation in Europe for a number of years. In December 2004, the International Accounting Standards Board (IASB) issued IFRIC 3 Emission Rights to address accounting for emission rights arising from such schemes. However, the interpretation met with significant resistance on the basis that it resulted in accounting mismatches between the valuation of assets and liabilities leading to potential volatility in the profit and loss. Consequently, the IASB decided to withdraw the Interpretation in June 2005 despite the fact that it continued to consider it to be an appropriate interpretation of existing IFRS.
Possible approaches
Until definitive guidance on accounting for cap-and-trade emission rights schemes is issued, an entity has the option of either:
• applying the principles of IFRIC 3 (UIG 3 in Australia); or
• developing its own accounting policy for cap-and-trade schemes based on the hierarchy of authoritative guidance in IAS 8/AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors.
IFRIC 3 approach
IFRIC 3 takes the view that a cap-and-trade scheme gives rise to various items that are to be accounted for separately:
(1) An asset for allowances held: allowances, whether allocated by government or purchased, are to be accounted for as intangible assets under IAS 38/AASB 138 Intangible Assets.
Allowances issued for less than fair value are to be measured initially at their fair value.
On a go-forward basis, entities have the choice to carry the intangibles at cost or at fair value (to the extent that there exists an active market for the allowances).
(2) A government grant: this arises when allowances are granted for less than fair value and represents the differential between the fair value and the nominal amount paid. The grant is accounted for under AASB 120 Accounting for Government Grants and is recognised as deferred income in the balance sheet and subsequently recognised as income on a systematic basis over the compliance period for which the allowances are issued regardless of whether the allowances are held or sold.
(3) A liability for the obligation to deliver allowances equal to emissions that have been made:
as emissions are made, a liability is recognised as a provision under IAS 37/AASB 137 Provisions, Contingent Liabilities and Contingent Assets. The liability is the best estimate of the expenditure required to settle the obligation at the balance sheet date. This would usually be the present market price of the number of allowances required to cover the emissions made up to the balance sheet date.
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The application of IFRIC 3 met with significant resistance on the basis that it results in the following accounting mismatches:
0 a measurement mismatch between the assets and liabilities recognised
0 a mismatch in the location in which the gains and losses on those assets are reported; for example, to the extent that the intangibles are carried at fair value any upward revaluation would be recognised in equity while changes in the liability would be charged to the
income statement
• a possible timing mismatch as allowances would be recognised when they are obtained, typically at the start of the year, whereas the emission liability would be recognised during the year as it is incurred.
Given these mismatches, very few overseas companies in countries where such schemes exist have applied IFRIC 3 on a voluntary basis.
Source: An excerpt from an article by Georgina Dcl!aµortas, CA, Charter m.1ga;,inc, Jun<-' 2008. !"ht' Institute of Chartered Acrnuntant!> in Australia.
Questions
1. What would be the likely impact of the 'mismatch' arising under IFRIC 3?
2. To what extent is 'matching' a principle proposed by the IASB Framework?
3. In what ways can you see the influence of the IASB Framework on IFRIC 3?
4. In relation to IFRIC 3, do you consider that the IASB Framework provides a 'theory of accounting' That is, does the Framework explain and predict accounting practice?