Financial Accounting Theory

Craig Deegan

Chapter 6
Normative theories of accounting—the
case of conceptual framework projects
Slides written by Craig Deegan
 Learning objectives
• In this chapter you will be introduced to:
– the role that conceptual frameworks (CFs) can
play in the practice of financial reporting
– the history of the development of the various
existing conceptual framework projects
– the various building blocks that have been
developed within various conceptual framework
projects
 Learning objectives (cont.)
– perceived advantages and disadvantages that arise
from the establishment and development of
conceptual frameworks
– recent initiatives being undertaken by the IASB and
the FASB to develop an improved conceptual
framework
– factors, including political factors, that might help or
hinder the development of conceptual framework
projects
– groups within society which are likely to benefit from
the establishment and development of conceptual
framework projects
 What is a conceptual framework?
• 'A coherent system of interrelated objectives
and fundamentals that is expected to lead to
consistent standards' (Statement of Financial
Accounting Concepts No. 1: Objectives of
Financial Reporting by Business Enterprises
1978)

• Attempts to provide a structured theory of

accounting
 Conceptual frameworks as normative
theories
• Conceptual frameworks provide prescription
so they are considered normative theories of
accounting

• 'Prescribes the nature, function and limits of

financial accounting and reporting' (Statement
of Financial Accounting Concepts No. 1:
Objectives of Financial Reporting by Business
Enterprises, 1978)
 A revised conceptual framework
• In recent years the FASB and IASB have been
jointly working towards the development of an
improved conceptual framework
• In 2008 they released a document entitled:
Exposure Draft of an improved Conceptual
Framework for Financial Reporting
• This phase of the project specifically addressed
the objective of financial reporting and the
qualitative characteristics and constraints of
decision-useful financial reporting information.
 Rationale for conceptual frameworks
• To develop the practice of financial reporting
logically and consistently we need to address
such issues as:
– what we mean by 'financial reporting' and what
should be its scope;
– which organisational characteristics indicate that an
entity should produce financial reports;
– the 'objective' of financial reporting;
– qualitative characteristics financial information should
possess;
– what are the elements of financial reporting; and
– what measurement rule should be employed.
 Rationale for conceptual frameworks
(cont.)
• Proponents argue that without agreement on
these issues accounting standards will be
developed in an ad hoc manner

• Limited consistency between accounting

standards in the absence of a conceptual
framework
The 'building blocks' of the conceptual
framework
• The framework must be developed in a
particular order
– some issues (or assumptions) need to be resolved
or made before moving on to subsequent 'building
blocks'
– One obvious issue that needs early agreement
would be what is meant by 'financial reporting'.
– Other issues that would also need agreement
early in the process would be:
• Definition of a reporting entity
• Definition of the users of financial statements
• The objective of financial reporting
The 'building blocks' of the conceptual
framework (cont.)
• Because the rest of the framework flows from
assumptions about the 'objective', if we reject
the assumption, then we personally might be
prepared to reject the prescriptions provided
by the framework
• Refer to Figure 6.1 (p.213) in the text for an
overview of the IASB Framework for the
Preparation and Presentation of Financial
Statements (which in 2005 replaced the
Australian Conceptual Framework)
 History of the development of CFs
• CFs were developed in a number of jurisdictions
including
– US, UK, Canada, Australia, New Zealand, International
Accounting Standards Committee
• In recent years many countries have adopted the
IASB Framework given that they have decided to
adopt the accounting standards released by the
IASB
• No standard-setters had developed a complete
CF; measurement issues typically unaddressed
• Limited or no progress in recent years, although
there is now a joint IASB/FASB project to develop
a new and improved conceptual framework
 Development of frameworks of
accounting in the US
• 1961 and 1962: Moonitz, and Moonitz and
Sprouse prescribed that accounting practice
should be based on current values

• 1965: Grady developed theory based on

description of existing practice
– led to the release of Accounting Principles Board
(APB) Statement No. 4
– however, accounting profession under criticism for
lack of any real framework
 Development of frameworks of
accounting in the US (cont.)
• Led to formation of Trueblood Committee in
1971 which produced Trueblood Report
– report outlined 12 objectives of accounting and
seven qualitative characteristics which financial
information should possess
– objective 1: focused on information needs of
financial statement users
– objective 2: need to serve users with limited
ability to demand financial information
 Development of frameworks of
accounting in the US (cont.)
• 1974: APB replaced by FASB which then embarked on
its CF project
• Six Statements of Financial Accounting Concepts
(SFACs) released from 1978 to 1985
• Initial SFACs normative in nature, but SFAC No. 5
relating to recognition and measurement largely
descriptive of current practice
– received much criticism
– since 2005 FASB and IASB have been jointly working
towards the development of a revised conceptual
framework that would be used by both boards—referred
to as the 'convergence project'
 Development of a CF in the UK
• Early moves towards guidance relating to
objectives and identification of users provided
by The Corporate Report (1976)
– concerned with addressing the rights of the
community in terms of their access to financial
information (broader than notion of users
adopted in other frameworks)
– ultimately contents generally not accepted by the
accounting profession
Development of a CF in the UK (cont.)
• 1991: ASB adopted the IASC's CF

• IASC framework was generally consistent with

the US and Australian frameworks—
subsequently became known as the IASB
Framework

Ppt slide 185-200