The IASB and its Conceptual Framework

1. Chapter 1 The IASB and its Conceptual Framework

2. Learning Objectives • Describe organizational structure of IASB • Describe the purpose of a conceptual framework • Qualitative characteristics that make information useful • Assumption underlying the preparation of financial statements

3. Learning Objectives • Define the basic elements in financial statements • Explain the recognition criteria of the basic elements • Distinguish between alternative measurement bases • Outline concepts of capital maintenance

4. The International Accounting Standards Board (IASB) • Replaced IASC in 2001 • Full time board • Standards Advisory Council appointed • Initially adopted IAS with some modifications • Issues IFRSs

5. The International Accounting Standards Board (IASB)

6. IFRIC & Advisory Bodies • IFRIC – Two key roles • Reviews newly identified financial reporting issues that are not dealt with by IFRSs • Overviews emerging interpretation issues • Advisory bodies: • IFRS Advisory Council • Capital Markets Advisory Group • Emerging Economics Group • Global Preparers Forum • SME Interpretation Group

7. The Purpose of The Conceptual Framework • To assist in developing a consistent set of standards & dealing with topics not covered by a standard • To assist preparers of financial statements • To assist auditors in forming an opinion • To assist users in the interpretation of information

8. “The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and creditors (‘primary users’) in making decisions about providing resources to the entity.”3 Consequently, primary users need information to help them assess the prospects of future net cash inflows to an entity. To assess an entity’s prospects for future cash inflows, primary users need information about the resources of the entity, claims against the entity and how efficiently and effectively the entity’s management and governing board have discharged the responsibilities to use the entity’s resources. 3SFAC No. 8, Conceptual Framework for Financial Reporting, Chapter 1, “The Objective of General Purpose Financial Reporting,” OB2. The Objective of Financial Reporting

9. Continued: General purpose financial reports do not and cannot provide all the information that primary users need, therefore, pertinent information from other sources needs to be considered, such as general economic conditions, political events and climate and industry outlook. General purpose financial statements are not designed to show the value of the reporting entity, are not designed for the sole use of management and are not directed towards regulators or other parties that are not primary users. 4SFAC No. 8, Conceptual Framework for Financial Reporting, Chapter 1, “The Objective of General Purpose Financial Reporting,” OB11. The Objective of Financial Reporting

10. The Objective of Financial Reporting • This objective reflects value judgements made by IASB & FASB • Key objectives: • Financial statements should reflect the perspective of the entity • The key users of financial statements are capital providers

11. Qualitative Characteristics of Useful Financial Information Pervasive constraint: Costs Comparability, verifiability, timeliness and understandability Enhancing characteristics: Fundamental characteristics: Relevance and faithful representation Costs Costs Pervasive constraint: Costs

12. Relevance: Capable of making a difference in the decisions made by users. Capable of making a difference in decisions if it has predictive value, confirming value or both. Materiality: “Materiality is an element of relevance and is entity-specific based on the nature or magnitude or both of the items to which the information relates, in the context of an individual entity’s financial report.”14 “Information is material if omitting it or misstating it could influence decisions that users make on the basis of the financial information of a specific reporting entity.”15 14SFAC No. 8, Conceptual Framework for Financial Reporting, Chapter 3, “Qualitative Characteristics of Useful Financial Information,” QC11. 15Ibid. Fundamental Qualitative Characteristics of Useful Financial Information

13. Faithful representation: “Financial reports represent economic phenomena in words and numbers. To be useful, financial information must be relevant but also must faithfully represent the phenomena that it purports to represent.”16 Completeness: “all information that is necessary for a user to understand the phenomena being depicted.”17 Neutrality: there should not be bias in the selection or presentation of financial information. Financial information should not be slanted, weighted, emphasized, de-emphasized or otherwise manipulated to increase the probability that financial information will be received favorably or unfavorably. Free from error: “no errors or omissions in the description of the phenomenon, and the process used to produce the reported information.”18 16SFAC No. 8, Conceptual Framework for Financial Reporting, Chapter 3, “Qualitative Characteristics of Useful Financial Information,” QC12. 7Ibid, QC13. 18Ibid, QC15. Fundamental Qualitative Characteristics of Useful Financial Information

14. Enhance the usefulness of information that is relevant and faithfully represented. Comparability: “Enables users to identify and understand similarities and differences among items.” Consistency is not the same as comparability although related and is described as “the use of the same methods for the same item either from period to period within a reporting entity or in a single period across entities.” Verifiability: “Assures users that information faithfully represents the economic phenomena it purports to represent.” “Means that different and knowledgeable and independent observers could reach consensus, although not necessarily complete agreement, that a particular depiction is a faithful representation.” 23SFAC No. 8, Conceptual Framework for Financial Reporting, Chapter 3, “Qualitative Characteristics of Useful Financial Information,” QC33.24Ibid, QC21.25Ibid, QC22.26Ibid, QC26. 27Ibid. Enhancing Qualitative Characteristics of Useful Financial Information

15. Timeliness: providing information to decision makers in time to be capable of influencing their decisions. Understandability: “Classifying, characterizing, and presenting information clearly and concisely.”28 Pervasive constraint on useful financial information: costs, which are a pervasive constraint on financial information, should be assessed as to whether the benefits of reporting particular information are likely to justify the costs incurred to provide and use the information. 28SFAC No. 8, Conceptual Framework for Financial Reporting, Chapter 3, “Qualitative Characteristics of Useful Financial Information,” QC30. Enhancing Qualitative Characteristics of Useful Financial Information

16. Assumption Underlying Financial Statements • Financial statements are prepared under the going concern assumption • Implications of going concern: • Allocation of depreciation over useful life • Supports inclusion of good will in statement of financial position • Set aside if management intends to liquidate the entity’s operations

17. Definition of Elements in Financial Statements Assets • Controlled resources expected to reap future benefits that have arisen from a past event • Three essential characteristics: • Future economic benefits • The entity must have control • There must be a past event

18. Definition of Elements in Financial Statements Liabilities • A present obligation arising from a past event requiring resources to settle • Three essential characteristics: • A present obligation • Must result in the giving up of resources • Must have resulted from a past transaction or event

19. Definition of Elements in Financial Statements Equity: • The residual interest in assets less liabilities • Increases as a result of profitable operations • Is influenced by the measurement system adopted • May be sub classified in the statement of financial position

20. Definition of Elements in Financial Statements Income: • Increases in economic benefits from inflows, asset enhancements or decreased liabilities • Note connection with assets and liabilities Expenses: • Decreases in economic benefits from outflows, asset depletions or incurrences of liabilities

21. ConvergencePhase B – Elements and Recognition – Proposed Changes Asset “… is a present economic resource to which an entity has a right or other access that others do not have,” which is: Present – at date of financial statements. Economic resource – scarce, provides cash. A right or other access that others do not have – legally enforceable or equivalent. • Liability“… is a present economic obligation for which the entity is the obligor,” which is: • Present – at date of financial statements. • Economic obligation – to provide resources. • Entity is the obligor – enforceable against entity. • The Boards are to reconsider the definition of a liability. • A Discussion Paper was expected in 2011???

22. Recognition of Elements of Financial Statements Asset recognition • Probable that future economic benefits will flow • Can be measured reliably Liability recognition • Probable that an outflow of economic benefits will occur • Settlement amount can be measured reliably

23. Recognition of Elements of Financial Statements Income recognition • When an increase in future economic benefits relating to an increase in an asset or decrease in a liability can be measured reliably Expense recognition • When a decrease in future economic benefits relating to a decrease in an asset or increase in a liability can be measured reliably • Matching is no longer the recognition criterion

24. Measurement of the Elements of Financial Statements • Measurement involves assigning valuations on all elements reported in financial statements • Measurement bases: • Historical cost • Current cost • Realisable or settlement value • Present value

25. Concepts of Capital Financial capital concept: • Capital is synonymous with the net assets or equity of the entity • Profit exists only after the entity has maintained its capital Physical capital concept: • Viewed as the operating capability of the entity’s assets • Profit exists only after the entity has set aside enough capital to maintain the operating capability of its assets

26. In 2002 the FASB and the IASB agreed to make their accounting standards compatible, including the Conceptual Framework. Framework broken into eight phases as follows: Phase A – Objectives and Qualitative Characteristics – issued Sept. 2010 Phase B – Elements and Recognition – Discussion Paper expected soon???? Phase C – Measurement – Discussion Paper expected soon???? Phase D – Reporting Entity Concept – Discussion Memorandum out Not started yet: Phase E – Presentation and Disclosure Phase F – Framework Purpose and Status in US GAAP Phase G – Applicability to the Not-for-Profit Sector Phase H – Remaining Issues Convergence with FASB

27. Homework • Exercise 1.11 • DUE THURSDAY, SEPTEMBER 12