2
Conceptual Framework

  1. Introduction
  2. Conceptual Framework for Financial Reporting 2010
    1. Purpose and Status
    2. The Accounting Model
    3. The Objective of General-Purpose Financial Statements
    4. Qualitative Characteristics of Useful Financial Information
    5. The 1989 Framework: The Remaining Text
  3. Conceptual Framework Project
    1. 2013 Discussion Paper
    2. Exposure Draft—Conceptual Framework for Financial Reporting
      1. Chapter 1—The Objective of General Purpose Financial Reporting
      2. Chapter 2—Qualitative Characteristics of Useful Financial Information
      3. Chapter 3—Financial Statements and the Reporting Entity
      4. Chapter 4—The Elements of Financial Statements
      5. Chapter 5—Recognition and Derecognition
      6. Chapter 6—Measurement
      7. Chapter 7—Presentation and Disclosure
      8. Chapter 8—Concepts of Capital and Capital Maintenance
    3. Further Considerations Following the Issue of the Exposure Draft
      1. Chapter 1—The Objective of General Purpose Financial Reporting
      2. Chapter 2—Qualitative Characteristics of Useful Financial Information
      3. Chapter 3—Financial Statements and the Reporting Entity
      4. Chapter 4—The Elements of Financial Statements
      5. Chapter 5—Recognition and Derecognition
      6. Chapter 6—Measurement
      7. Chapter 7—Presentation and Disclosure
  4. Hierarchy of Standards
  5. IFRS Practice Statement Management Commentary
    1. Nature and Scope
    2. Principles
    3. Qualitative Characteristics
    4. Presentation
    5. Elements
  6. US GAAP Comparison

Introduction

The IASB inherited the IASC's Framework for the Preparation and Presentation of Financial Statements, which was issued in July 1998. Like the other current conceptual frameworks among Anglo-Saxon standard setters, this derives mainly from the US conceptual framework.

IASB and FASB have been, since 2005, revisiting their respective conceptual frameworks to build on them by refining and updating them and developing them into a common framework, which both can use in developing accounting standards. The objective of the conceptual framework project is to create a sound foundation for future accounting standards, which are principles based, internally consistent and, ultimately, internationally converged. The new framework builds on existing IASB and FASB frameworks. The IASB Framework is, for instance, relatively silent on measurement issues. The three paragraphs which address this matter merely mention that several different measurement bases are available and that historical cost is the most common.

The Boards completed Phase A of the new conceptual framework, the Objectives and Qualitative Characteristics, in September 2010. Both the Boards will amend sections of their conceptual frameworks as they complete individual phases of the project. The IASB issued a new framework, Conceptual Framework for Financial Reporting 2010, containing the two new chapters and the rest of the previous framework that was not adjusted. FASB issued Concepts Statement 8 to replace Concepts Statements 1 and 2. This chapter provides a review of the framework issued in September 2010, the future phases of the framework project and IFRS Practice Statement Management Commentary that was issued in December 2010.

The IASB's Discussion Paper A Review of the Conceptual Framework for Financial Reporting issued in June 2013 was followed by the issue on 28 May 2015 of an Exposure Draft proposing a revised framework. Feedback on the Exposure Draft has led the IASB to redeliberate on its contents and in May 2016 a document was published summarising changes that would be made to the proposed framework as a result of tentative decisions it had made up to that point. The proposals aim to improve financial reporting by providing a more complete, clearer and updated set of concepts, which can be used by the IASB when it develops new standards, and by others to help them understand and apply the IASB's standards. The Exposure Draft's proposals are examined in more detail later in this chapter.

Conceptual Framework for Financial Reporting 2010

Purpose and Status

The purpose of the conceptual framework is to set out the concepts which underlie the preparation and presentation of financial statements. The preparation of financial statements is based on estimates, judgements and models rather than exact depictions. The conceptual framework provides the foundations upon which these constituents are based.

The main aim is therefore to help the IASB in preparing new standards and reviewing existing standards. The conceptual framework also helps national standard setters, preparers, auditors, users and others interested in IFRS in achieving their objectives. The conceptual framework is, however, not itself regarded as an IFRS and therefore cannot override any IFRS although there might be potential conflicts. The IASB believes that over time any such conflicts will be eliminated.

The Accounting Model

The introduction to the conceptual framework states that accounting statements are most commonly prepared in accordance with an accounting model based on recoverable historical cost and the nominal financial capital maintenance concept. Other models and concepts may be more appropriate but there is currently no consensus for change. The conceptual framework is prepared to be applicable to a wide range of accounting models and concepts of capital and capital maintenance. It is envisaged that the objective and qualitative characteristics in the conceptual framework will be used to make the appropriate decisions.

The Objective of General-Purpose Financial Statements

The objective of general-purpose financial statements in the conceptual framework is defined as follows:

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 other creditors in making decisions about providing resources to the entity.

The objective confirms the decision-useful orientation on which financial reporting is based. It is clearly stated that financial reporting does not provide information regarding the value of a reporting entity, but assists in making such valuations. The information needs of investors, lenders and other creditors are the main focus. Since these users are generally not in a position to have information issued directly to them they have to rely on the general-purpose financial statements to make decisions regarding the purchase or sale of equity and debt instruments or to provide finance to the entity and thus they are identified as the primary users of general-purpose financial statements.

The conceptual framework holds that users need to evaluate the prospects for future net cash inflows to an entity. To assess these net inflows, information is needed of an entity's resources, claims to those resources and the ability of management and the governing board to discharge their responsibility to use the resources. Assessing stewardship is thus included in the ability of users to assess the net cash flows of an entity.

General-purpose financial statements provide information about the financial position of an entity, its resources and claims against the resources. The financial position is affected by the economic resources controlled by the entity, its financial structure, its liquidity and solvency and its capacity to adapt to changes in the environment in which it operates. Information is provided about the strengths and weaknesses of an entity and its ability to acquire finance.

Changes in an entity's resources and claims are a result of an entity's financial performance and are derived from other transactions such as issuing debt and equity instruments. Financial performance is assessed both through the process of accrual accounting and changes in cash flows. This helps users to understand the return on the resources of an entity and how well management has discharged its stewardship responsibilities. Both these changes and the implications of these changes reflected in the historical information help to assess future performance.

Qualitative Characteristics of Useful Financial Information

The qualitative characteristics identify the information, which is most useful in financial reporting. Financial reporting includes information in financial statements and financial information that is provided by other means. The qualitative characteristics are divided into fundamental qualitative characteristics and enhancing qualitative characteristics. The fundamental qualitative characteristics are relevance and faithful representation. The enhancing qualitative characteristics are comparability, verifiability, timeliness and understandability.

No hierarchy of applying the qualitative characteristics is determined. The application is, however, a process. The fundamental characteristics are applied by following a three-step process. Firstly, it is necessary to identify the economic phenomenon which has a potential to be useful. Secondly, the type of information regarding the phenomenon that is most relevant that could be faithfully represented should be identified. Finally, it should be determined whether the information is available and could be faithfully represented. After that, the enhancing characteristics are applied to confirm or enhance the quality of the information. The different qualitative characteristics are explained as follows:

  1. Relevant financial information is capable of making a difference in decision making. Information is capable of making a difference if it has predictive value, confirmatory value or both. Financial information has predictive value if it can be used as an input in the process to predict future outcomes, and has confirmatory value if it provides feedback about previous evaluations. Materiality is included in relevance. Information is material if omitting it or misstating it could influence the decisions of users.
  2. Faithful representation is achieved when information is complete, neutral and free from error. A complete depiction includes all information needed to understand the phenomena. A neutral depiction is without bias. Free from error means that there are no errors or omissions in the description of the phenomena and in the process applied. In order to be useful, financial information must not only represent relevant phenomena (as described above) but also faithfully represent the phenomena which it purports to represent.
  3. Comparability refers to the ability to identify similarities in, and differences between, items. Consistency (the use of the same accounting policies and procedures within an entity from period to period, or in a single period across entities) aids comparability.
  4. Verifiability helps to assure users that information represents faithfully the economic phenomena that it purports to represent. It implies that knowledgeable and independent observers could reach a general consensus (but not necessarily absolute agreement) that the information does represent faithfully the economic phenomena it purports to represent without material error or bias, or that an appropriate recognition or measurement method has been applied without material error or bias. It means that independent observations would yield essentially the same measure or conclusions.
  5. Timeliness means that the information is provided in time to be capable of influencing decisions. Generally, the older the information is, the less useful it may be to the users.
  6. Understandability is classifying, characterising and presenting information clearly and concisely. Understandability enables users who have a reasonable knowledge of business, economic and financial activities and financial reporting, and who apply reasonable diligence to comprehend the information, to gain insights into the reporting entity's financial position and results of operations, as intended.

The cost constraint is the only constraint included regarding the information provided in useful financial reports. The question is whether the benefits of providing information exceed the cost of providing and using the information. Presumably this would constrain the imposition of certain new requirements, although this is a relative concept, and as information technology continues to evolve and the cost of preparing and distributing financial and other information declines, this constraint conceivably would be relaxed as well.

The 1989 Framework: The Remaining Text

The current guidance of the IASB's 1989 framework, not changed by the new objective and qualitative characteristics, is included in Chapter 4 of the 2010 conceptual framework. More detailed discussions of the remaining text are included in other chapters of this book. For instance, the definitions of assets, liabilities and equity are discussed in greater detail in Chapter 4, Statement of Financial Position. A condensed discussion is set out below.

The going concern assumption is retained. Financial statements are prepared on the assumption that the entity is a going concern and will continue its operations in the foreseeable future.

Elements determining the financial position remain as assets, liabilities and equity. The current definitions in the 1989 framework are retained: an asset is “a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.” A liability is a “present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying future benefits.” Equity is simply a residual arrived at by deducting the liabilities from assets.

The elements determining financial performance are income and expenses. Elements are identified based on the substance and economic reality of the transaction or events and not based on the legal form. Elements are only recognised in the financial statements when they are probable and have a cost or value that can be measured reliably, which means that some assets and liabilities may go unrecognised.

Measurement is the assignment of a monetary amount to an element. The following measurement bases are identified, without determining when they should be applied: historical cost, current cost, realisable value and present value. Currently, in IFRS other measurement bases, which are not mentioned in the conceptual framework, such as amortised cost and fair value, may be applied.

Finally, financial capital maintenance and physical capital maintenance continue to be identified as the concepts of capital maintenance.

Conceptual Framework Project

2013 Discussion Paper

The IASB issued a Discussion Paper, A Review of the Conceptual Framework for Financial Reporting, in July 2013 to obtain feedback on the main areas that the IASB will consider in developing a new framework. The areas dealt with in the Discussion Paper include:

  • The scope of the conceptual framework;
  • The definitions of assets and liabilities;
  • The recognition and derecognition of assets and liabilities;
  • Equity and its separation from liabilities;
  • Measurement;
  • Profit or loss and other comprehensive income (OCI); and
  • Presentation and disclosure.

The IASB decided not to include the reporting entity in the discussion as they received feedback on this topic on the Exposure Draft for Phase D, Reporting Entity. The Reporting Entity Exposure Draft describes a reporting entity as follows:

A reporting entity is a circumscribed area of economic activities whose financial information has the potential to be useful to existing and potential equity investors, lenders and other creditors who cannot directly obtain the information they need in making decisions about providing resources to the entity and in assessing whether management and the governing board of that entity have made efficient and effective use of the resources provided.

The Reporting Entity Exposure Draft clarifies that the existence of a legal entity is neither necessary nor sufficient to identify a reporting entity. Further, a reporting entity can include more than one entity or it can be a portion of a single entity.

This Exposure Draft confirms that if an entity controls one or more entities, it should present consolidated financial statements. An entity controls another entity when it has the power to direct the activities of that other entity to generate benefits for (or limit losses to) itself. However, if one entity has significant influence over another entity, it specifically does not control that other entity. “Parent-only” financial statements may be presented provided they are presented with consolidated financial statements. Combined financial statements may be prepared for commonly controlled entities in a group.

In May 2014, the IASB published a Staff Paper setting out the tentative decisions it had made as a result of responses received to the July 2013 Discussion Paper. The Staff Paper noted that all tentative decisions made would be exposed for public comment in an Exposure Draft of a revised conceptual framework.

The IASB has tentatively decided that assets should be viewed as rights, or bundles of rights, rather than underlying physical or other objects. The draft definition of an asset has been amended to state that it is a present economic resource controlled by the entity as a result of past events, while a liability is defined as a present obligation of the entity to transfer an economic resource as a result of past events. Economic resources are rights, which are capable of producing economic benefits.

The IASB also tentatively decided to amend Chapter 1 of the conceptual framework to increase the prominence of stewardship within the overall objective of financial reporting, and to reintroduce a reference to prudence in the conceptual framework.

Exposure Draft—Conceptual Framework for Financial Reporting

Following on from the 2013 Discussion Paper, on 28 May 2015 the IASB published for public comment an Exposure Draft proposing a revised conceptual framework. The comment period on the Exposure Draft closed on 26 October 2015. The IASB's stated aim is to improve the quality of financial reporting by providing a more complete, clearer and updated set of concepts, which can be used by the IASB when it develops IFRS Standards, and by others to help them understand and apply those standards. The framework proposed in the Exposure Draft:

  • Is more complete than the 2010 conceptual framework because it addresses a number of areas which are either not covered, or not covered in sufficient detail, in the earlier framework. These areas include measurement, financial performance (including the use of other comprehensive income), presentation and disclosure, derecognition and the reporting entity; and
  • Clarifies some aspects of the 2010 framework. These clarifications include the assertion that the information needed to meet the objective of financial reporting includes information which can be used to help assess management's stewardship of the entity's resources, explanations of the roles of prudence and substance over form in financial reporting, the assertion that a high level of measurement uncertainty can make financial information less relevant, the assertion that important decisions on, for example, recognition and measurement are driven by considering the nature of the resulting information about both financial performance and financial position, and the provision of clearer definitions of assets and liabilities and more extensive guidance to support those definitions; and
  • Updates the parts of the 2010 framework which are out of date. For example, the proposed framework clarifies the role of probability in the definitions of assets and liabilities.

The Exposure Draft adopts the sections of the 2010 framework covering the Objective of General Purpose Financial Reporting, the Qualitative Characteristics of Useful Financial Information and Concepts of Capital and Capital Maintenance with only limited changes. New sections are included dealing with Financial Statements and the Reporting Entity, the Elements of Financial Statements, Recognition and Derecognition, Measurement and Presentation and Disclosure.

Chapter 1—The Objective of General Purpose Financial Reporting

The IASB has decided not to fundamentally reconsider this area, although some relatively minor changes to the wording of the equivalent chapter in the 2010 framework are proposed. These serve to give more prominence to the importance of providing information needed to assess management's stewardship of the entity's resources.

Chapter 2—Qualitative Characteristics of Useful Financial Information

The IASB has decided not to fundamentally reconsider this area, although some relatively minor changes to the wording of the equivalent chapter in the 2010 framework are proposed.

An explicit reference to the notion of prudence is reintroduced. The proposed framework describes prudence as the exercise of caution when making judgements under conditions of uncertainty. It is noted that the exercise of prudence means that assets and income are not overstated and that liabilities and expenses are not understated, and that this also avoids the understatement of assets and income and the overstatement of liabilities and expenses because this could lead to the overstatement of income or the understatement of expenses in future periods.

In connection with the characteristic of faithful representation, the proposed framework notes that a faithful representation provides information about the substance of an economic phenomenon rather than merely about its legal form. It is noted that providing information only about a legal form that differs from the economic substance of the underlying economic phenomenon would not result in a faithful representation.

The IASB observes that a number of respondents to the Discussion Paper were concerned at the removal of reliability as a qualitative characteristic of useful financial information from the 2010 framework. The IASB proposes addressing this by clarifying that measurement uncertainty is one factor which can make financial information less relevant. Thus, there is a trade-off between the level of measurement uncertainty and other factors that make information relevant.

Chapter 3—Financial Statements and the Reporting Entity

The newly-written Chapter 3 discusses the role of financial statements and the concept of the reporting entity.

In describing the role of financial statements, the proposed framework states that financial statements are prepared from the perspective of the entity as a whole, instead of from the viewpoint of any particular group of investors, lenders or other creditors. It also sets out the going concern assumption, which has been brought forward from the 2010 framework with little change.

The proposed framework describes a reporting entity as an entity which chooses, or is required, to prepare general-purpose financial statements. It notes that a reporting entity is not necessarily a legal entity, and could comprise a portion of an entity, or two or more entities.

The proposed framework discusses the boundary of a reporting entity and notes that, in situations where one entity has control of another entity, the boundary of the reporting entity can be determined either by direct control only (resulting in unconsolidated financial statements) or by direct and indirect control (resulting in consolidated financial statements). Where a reporting entity is not a legal entity, the boundary of the reporting entity needs to be set in such a way that the financial statements provide the relevant financial information needed by those existing and potential investors, lenders and other creditors who rely on the financial statements, and faithfully represent the economic activities of the entity.

The IASB expresses the view that consolidated financial statements are usually more likely than unconsolidated financial statements to provide useful information to users, but that unconsolidated financial statements may also provide useful information. It states that in situations where an entity produces unconsolidated financial statements, whether because it chooses to or is required to, it should disclose how users may obtain the consolidated financial statements.

Chapter 4—The Elements of Financial Statements

Chapter 4 deals with the elements of financial statements, including assets, liabilities, equity, income and expenses. The proposed framework notes that financial statements provide information about the financial effects of transactions and other events by grouping them into broad classes—the elements of financial statements.

  1. An asset is defined as a present economic resource controlled by the entity as a result of past events. An economic resource is defined as a right that has the potential to produce economic benefits.
  2. A liability is defined as a present obligation of the entity to transfer an economic resource as a result of past events.
  3. Equity is defined as the residual interest in the assets of the entity after deducting all its liabilities.
  4. Income is defined as increases in assets or decreases in liabilities which result in increases in equity, other than those relating to contributions from holders of equity claims.
  5. Expenses are defined as decreases in assets or increases in liabilities which result in decreases in equity, other than those relating to distributions to holders of equity claims.

The proposed framework also recognises other changes in resources and claims, being either contributions from, and distributions to, holders of equity claims, or exchanges which do not result in increases or decreases in equity (for example, acquiring an asset for cash).

As will be seen from the above, the proposed framework continues to define income and expenses in terms of changes in assets and liabilities but also notes that important decisions on matters such as recognition and measurement are driven by considering the nature of the resulting information about both financial performance and financial position.

The IASB notes that it is not proposing in the Exposure Draft to change the definitions of equity and liabilities to address the problems that arise in classifying instruments with characteristics of both equity and liabilities. It states that it is considering these matters in its project on financial instruments with the characteristics of equity. The outcomes of that project will assist the IASB in deciding whether it should add a project on amending standards, the conceptual framework or both to its active agenda.

Chapter 4 also includes proposed guidance on the term “present obligation,” which is included within the definition of a liability. The proposed guidance states that an entity has a present obligation to transfer an economic resource if the entity has no practical ability to avoid the transfer AND the obligation has arisen from past events (in other words the entity has received the economic benefits or conducted the activities which establish the extent of its obligation).

Chapter 4 also includes proposals for further guidance on the definitions of the elements, on executory contracts, on reporting the substance of contractual rights and contractual obligations and on the unit of account.

Chapter 5—Recognition and Derecognition

Chapter 5 discusses recognition and derecognition.

The basis on which assets and liabilities (and any related income, expenses or changes in equity) are to be recognised is stated to be if such recognition provides users of financial statements with relevant information about the asset or liability and about any income, expenses or changes in equity, a faithful representation of the asset or liability and of any income, expenses or changes in equity, and information which results in benefits which exceed the cost of providing that information.

Certain circumstances are identified in which the above criteria may not be met, including if it is uncertain whether an asset exists or is separable from goodwill, or whether a liability exists, if there is only a low probability that an inflow or outflow of economic benefits will result, and if a measurement of an asset or liability is available but the level of measurement uncertainty is so high that the resulting information has little relevance and no other relevant measure is available.

It is proposed that the accounting requirements for derecognition should aim to represent faithfully both any assets and liabilities retained after the transaction or other event that led to the derecognition, and the change in the entity's assets and liabilities as a result of that transaction or other event.

The Exposure Draft notes that most decisions about derecognition are straightforward, with the discussion in the proposed framework focusing on cases where the two aims referred to above conflict with each other. For example, where the retained component contains a disproportionate exposure to variations in economic benefits, derecognition may faithfully represent the fact that the entity no longer has the components that have been transferred, but may not faithfully represent the extent of the change in the entity's assets or liabilities as a result of the transaction. Alternatively, it may be the case that at the same time as transferring an asset, the entity enters into another transaction (for example, a forward contract, a written put option or a purchased call option) under which the entity must or may reacquire the asset. Because the component that has been transferred must or may be reacquired, derecognising it may misrepresent the extent of the change in the entity's financial position. It is noted that in some of these circumstances, derecognition may achieve the two aims described above if supported by separate presentation, or explanatory disclosure, in the notes to the financial statements. However, where this is not sufficient to achieve the two aims it may be necessary to continue to recognise not only the retained component but also the transferred component without recognising any income or expenses on the transaction and with any proceeds received or paid being treated as a liability or asset respectively, with separate presentation or explanatory disclosure being given to confirm that the entity no longer has any rights or obligations under the transferred component.

Proposed guidance on derecognition is also given for situations where contracts are modified.

Chapter 6—Measurement

Chapter 6 discusses different measurement bases, the information that they provide and their advantages and disadvantages, and factors to consider when selecting a measurement basis.

Measurement bases are categorised as either historic cost or current values. Four measurement bases are then described, being historic cost, current value, fair value and value in use (for assets) or fulfilment value (for liabilities), alongside a discussion of the information which each basis provides.

Guidance is provided on factors to consider when selecting a measurement basis. It is noted that for the information provided by a particular measurement basis to be useful to the users of the financial statements, it must be relevant and it must faithfully represent what it purports to represent. Cost is recognised as a constraint on the selection of a measurement basis, as it is with all other areas of financial reporting. The enhancing qualitative characteristics of comparability, verifiability and understandability are also recognised as having implications for the selection of a measurement basis, but it is noted that timeliness does not have such implications.

Situations where more than one measurement basis is needed to provide information about an asset, liability, income or expense are discussed and it is noted that, in most cases, the most understandable way to provide such information is to use one measurement basis in both the statement of financial position and the statement(s) of financial performance, and to use the other measurement basis for disclosure only. However, in some cases more relevant information may be provided by using a current value measurement basis in the statement of financial position and a different measurement basis to determine the related income or expenses in the statement of profit and loss.

Chapter 7—Presentation and Disclosure

Chapter 7 discusses the objective and scope of financial statements, presentation and disclosure as communication tools, and information about financial performance.

In the commentary on the objective and scope of financial statements it is noted that financial statements provide information about an entity's assets, liabilities, equity, income and expenses that is useful to users of financial statements in assessing the prospects for future net cash inflows to the entity and in assessing management's stewardship of the entity's resources. Some of this information is provided by the recognition of items that meet the definition of an element in the statements of financial position and financial performance. Financial statements also provide additional information about recognised items and items which meet the definition of an element but which have not been recognised.

Forward-looking information about likely or possible future transactions and events is included in financial statements only if that information is relevant to understanding the entity's assets, liabilities and equity which existed at the end of, or during, the period (even if they are unrecognised), or income and expenses for the period.

As regards presentation and disclosure as communication tools, the proposed framework states that efficient and effective communication of the information presented or disclosed in the financial statements improves its relevance and contributes to a faithful representation of the assets, liabilities, equity, income and expenses. Efficient and effective communication includes classifying information in a structured manner which reports similar items together and dissimilar items separately, aggregating information so that it is not obscured by unnecessary detail, and using presentation and disclosure objectives and principles instead of rules which could lead to purely mechanistic compliance.

In relation to information about financial performance, the proposed framework does not prescribe a single-statement or dual-statement structure for the statement of financial performance. It refers to the statement (or section) of profit and loss as the primary source of information about an entity's financial performance for the period, and requires a total (or subtotal) for profit or loss to be provided. Profit or loss is not defined, but it is stated that the income and expenses included in the statement of profit or loss are the primary source of information about the entity's financial performance for the period. From this there follows a rebuttable presumption that all income and expenses will be included in the statement of profit or loss. Income or expenses may only be reported outside the statement of profit or loss and included in other comprehensive income if the income or expenses relate to assets or liabilities measured at current values, and excluding those values from the statement of profit or loss would enhance the relevance of the information in the statement of profit or loss for the period.

It is further presumed that items of income or expenses included in other comprehensive income in one period will be reclassified into the statement of profit or loss in some future period (i.e., be recycled), if doing so will enhance the relevance of the information included in the statement of profit or loss for that future period. This presumption could be rebutted, for example if there is no clear basis for identifying the period in which that reclassification would enhance the relevance of the information in the statement of profit or loss. If there is no such basis, it may indicate that the income or expense should not be included in other comprehensive income.

Chapter 8—Concepts of Capital and Capital Maintenance

The IASB has decided not to fundamentally reconsider this area, although some minor changes to the wording of the equivalent chapter in the 2010 framework are proposed. These changes are made solely to achieve consistency of terminology throughout the proposed framework. For instance, references to “owners” are replaced with “holders of equity claims.”

Further Considerations Following the Issue of the Exposure Draft

IASB received significant feedback on the Exposure Draft and has considered this feedback over a period of time. It has issued and periodically updated a summary of the effects of its consideration of the feedback. Overall it has decided to redeliberate topics which have proved controversial or where new information has become available. The main changes to the draft framework which the IASB has tentatively decided upon are described below.

Chapter 1—The Objective of General Purpose Financial Reporting

The discussion of stewardship will be amended to clarify the link between the objective of financial reporting and stewardship by explaining resource allocation decisions as decisions to buy, sell or hold equity and debt instruments; decisions to provide or settle loans and other forms of credit; and decisions needed to exercise rights while holding investments, such as rights to vote on or otherwise influence management's actions.

Chapter 2—Qualitative Characteristics of Useful Financial Information

It will be acknowledged that the exercise of prudence does not imply a need for asymmetry—for example, a need for more persuasive evidence to support the recognition of assets than liabilities or to support the recognition of income than expenses. Nevertheless, in financial reporting standards such asymmetry may sometimes arise as a consequence of requiring the most useful information.

An explicit statement that a faithful representation represents the substance of an economic phenomenon instead of merely representing its legal form will be included in the framework.

Measurement uncertainty will be described as a factor affecting faithful representation, and the Basis for Conclusions will be amended to clarify that a trade-off can exist between the fundamental qualitative characteristics of relevance and faithful representation.

Chapter 3—Financial Statements and the Reporting Entity

The statement in paragraph 3.25 of the draft framework that an entity that presents unconsolidated financial statements must disclose how a user may obtain the entity's consolidated financial statements will be removed.

Chapter 4—The Elements of Financial Statements

Regarding a present obligation the concepts on the meaning of “no practical ability to avoid” will be refined. Past events in the definition of a liability will refer to an activity of the entity “that will or may oblige it to transfer an economic resource that it would not otherwise have had to transfer,” instead of the activity “that establishes the extent” of the entity's obligation. It will further be clarified that the enactment of a law (or the introduction of some other enforcement mechanism, policy or practice, or the making of a statement) is not in itself sufficient to give an entity a present obligation.

Chapter 5—Recognition and Derecognition

The concepts proposed will be enhanced to provide more direction on the recognition of assets and liabilities with a low probability of inflows or outflows of economic benefits. Only two criteria for recognition will be identified: relevance and faithful representation.

Chapter 6—Measurement

The Board agree with the approach followed in the Exposure Draft, but aspects are refined and clarified.

Chapter 7—Presentation and Disclosure

High-level guidance on reporting financial performance will be provided in the conceptual framework, and will be based on the proposals in the Exposure Draft, modified in the light of the feedback received on the Exposure Draft.

The statement of profit or loss will be described as the primary source of information about an entity's financial performance for the period, but the purpose of the statement will not be set out.

A principle will be set out that income and expenses should be included in the statement of profit or loss unless the relevance or faithful representation of the information provided in the statement of profit or loss for the period would be enhanced by including a change in the current value of an asset or a liability in OCI. This principle would replace the rebuttable presumption about the use of the statement of profit or loss proposed in the Exposure Draft. The revised conceptual framework would state that this is only expected to occur in exceptional circumstances.

A statement will be included that a decision about including income and expenses in OCI can be made only by the Board in setting standards. In making such a decision the Board would need to explain why excluding a change in the current value of an asset or a liability from the statement of profit or loss for the period would enhance the relevance or faithful representation of the information provided in that statement.

A statement will be included that, in principle, income and expenses included in OCI should be recycled when doing so would enhance the relevance or faithful representation of the information in the statement of profit or loss for that period. This principle would replace the rebuttable presumption about recycling proposed in the Exposure Draft.

A statement will be included that income and expenses included in OCI may not be recycled if, for example, there is no clear basis for identifying the period in which recycling should occur or the amount that should be recycled to enhance the relevance or faithful representation of information provided in the statement of profit or loss for that period.

A statement will be made that a decision about whether and when income and expenses included in OCI should be recycled can be made only by the Board in setting Standards. In making such a decision the Board would need to explain why recycling would enhance the relevance or faithful representation of the information provided in the statement of profit or loss for that period.

The statement in the Exposure Draft that an inability to identify a clear basis for recycling may indicate that such income or expenses should not be included in OCI will be removed.

Hierarchy of Standards

The conceptual framework is used by IASB members and staff in their debate, and they expect that those commenting on Exposure Drafts for new or revised standards will articulate their arguments in terms of the conceptual framework. However, the conceptual framework is not normally intended to be used directly by preparers and auditors in determining their accounting methods. In the 2003 revision of IAS 8 the IASB introduced a hierarchy of accounting rules that should be followed by preparers in seeking solutions to accounting problems. This hierarchy says that the most authoritative guidance is IFRS, and the preparer should seek guidance as follows:

  1. IAS/IFRS and SIC/IFRIC Interpretations, when these specifically apply to a transaction or condition.
  2. In the absence of such a directly applicable standard, judgement is to be used to develop and apply an accounting policy, which conforms to the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expense set forth in the Framework.
  3. If this is not possible, the preparer should then look to recent pronouncements of other standard setters which use a similar conceptual framework to develop their standards, as well as other accounting literature and industry practices, which do not conflict with guidance in IFRS dealing with the same or similar circumstances or with the definitions set out in the Framework.

IFRS Practice Statement Management Commentary

Nature and Scope

IFRS Practice Statement Management Commentary was issued in December 2010 and is prospectively applicable. The Practice Statement provides a broad, non-binding framework for the presentation of narrative reporting to accompany financial statements prepared in accordance with IFRS. It is therefore not an IFRS standard, and local authorities may voluntarily choose to implement the Practice Statement. However, it is foreseen that many countries will not implement the Practice Statement and will implement the developments regarding integrated reporting instead. Further, many local authorities have similar local guidance.

Management commentary is a narrative report, which provides the context within which the financial position, financial performance and cash flows of an entity need to be interpreted. Management also has the opportunity to explain its objectives and strategies applied to fulfil those objectives. Management commentary falls within the scope of financial reporting, and thus the conceptual framework, and should be read in conjunction with the conceptual framework. The Practice Statement provides the principles, elements and qualitative characteristics of decision-useful information regarding management commentary, and therefore assists management in presenting management commentary.

Management needs to identify the extent of applying the Practice Statement. Full compliance can only be claimed if an entity complies with all the requirements. In applying the Practice Statement, management must consider the needs of the primary users of the financial statements. The primary users are similar to the 2010 conceptual framework: existing and potential investors, lenders and other creditors.

Principles

Management commentary is based on the principles of providing management's view and supplementing and complementing information presented in the financial statements. Management commentary should include forward-looking information and information possessing the qualitative characteristics described in the conceptual framework. Management commentary should present management's perspective and should be derived from the information important to management decision making.

Supplementary and complementary information explains the amounts provided in financial statements and the conditions and events forming that information. It includes all information that is important in understanding the financial statements.

Regarding forward-looking information, it must provide management's perspective regarding the entity's direction. It does not predict the future, but rather focuses on the entity's objectives and strategies to achieve those objectives. Forward-looking information is provided regarding uncertainties, trends and factors, which could influence an entity's revenue, performance, liquidity and capital resources. Forward-looking information is provided through both narrative descriptions and quantitative data and must include disclosures of the assumptions used.

Qualitative Characteristics

The conceptual framework fundamental qualitative characteristics of relevance and faithful representation are applied and the enhancing qualitative characteristics of comparability, verifiability, timeliness and understandability should be maximised. Management should include all information that is material to its management commentary.

Presentation

The presentation of management commentary should be clear and straightforward. Management commentary should be consistent with the related financial statements, avoid duplication and avoid generic disclosure. To assist in assessing the performance of an entity, management commentary should include the entity's risk exposures, the risk strategies and how effective the strategies are, how resources recognised could affect the financial performance and how non-financial information affects the financial statements.

Elements

The following main elements should be included:

  • Nature of business;
  • Management's objectives and strategies to achieve the objectives;
  • The most significant sources, risks and relationships;
  • The results of the entity's operations and prospects; and
  • The critical performance measures and indicators used by management to assess the performance against objectives.

A description of the business to understand the entity and its environment is the starting point of management commentary. It includes information about the entity's industry, its market and competition, the legal, regulatory and macroeconomic environment, its main projects, services, business processes and distribution channels, structure and how it creates value.

Objectives and strategies, and changes thereof, must be disclosed in a way which enables users to understand the priorities of the entity and the resources used to achieve them. This includes performance indicators and the time frame over which success is measured. Relationships between objectives, strategies, management actions and executive remuneration are also helpful.

A clear description of the most important resources, risks and relationships which affect the entity's value and how they are managed is needed. This includes analysis of financial and non-financial resources, capital structure, financial needs, liquidity and cash flows and human and intellectual capital. Risk disclosure includes principal risk exposures, changes therein, uncertainties, means of mitigating risks and effectiveness of risk strategies. Risk disclosures could be divided into principal strategic, commercial, operational and financial risks. Significant relationships with stakeholders, which are value driven and managed, should also be disclosed.

A clear description of financial and non-financial performances and prospects should be included. A description of performance and progress during the year helps to predict the future by identifying main trends and factors affecting the business. Comparison of financial position, performance, liquidity and financial position with previous years is essential.

Performance measures and indicators (financial and non-financial) used by management should be disclosed and the reasons why they change over time. This increases the comparability of management commentary over time.

US GAAP Comparison

The FASB Framework consists of different concept statements. Chapters 1 and of the new joint framework have also been included in the FASB Framework as CON 8. Both frameworks focus on the asset and liability approach and define assets and liabilities similarly. The IASB Framework only defines two elements of changes in assets and liabilities, namely income and expenses. The FASB Framework identifies more elements such as investments by owners, distributions to owners and other comprehensive income, and subdivides comprehensive income into revenue, expenses, gains and losses. The FASB Framework does not identify probability as a recognition criterion, but includes relevance as a recognition criterion. The FASB Framework separates measurement in (1) a selection of the monetary unit and (2) choice of attribute. Both frameworks provide a list of measurement attributes but provide no guideline on when each should be applied. Neither framework has an adequate concept of the reporting entity.

The FASB does have an active project on the definition of a non-public entity. The goal of the project is to re-examine the definition of a non-public entity and a public entity in the FASB Accounting Standards Codification®. The FASB issued Accounting Standards Update 2013–12 in December 2013 that defines a public entity to fulfil phase 1 of this project. When complete, entities that are not defined as public entities will be within the scope of the Private Company Decision-Making Framework: A Guide for Evaluating Financial Accounting and Reporting for Private Companies. Phase 2 is under way.

While the FASB's conceptual framework project continues, it is no longer a joint project with the IASB. The IASB has pursued advancement of the conceptual framework through the Accounting Standards Advisory Forum meetings. The FASB participates in those meetings as a representative of the USA.

The FASB has held several meetings on a project entitled Disclosure Framework—Board's Decision Process. The objective and primary focus of the Disclosure Framework project is to improve the effectiveness of disclosures in notes to financial statements by clearly communicating the information that is most important to users of each entity's financial statements. It is anticipated that the result will be a lower volume of disclosures, although that is not a primary goal.

Regarding the IFRS Practice Statement for Management commentary, the US Securities and Exchange Commission maintains regulations that specify the form and content of management commentary as well as other disclosures.

In August 2014, the FASB issued Accounting Standards Update 2014–15—Presentation of Financial Statement—Going Concern. The main provisions of this Update are that in connection with preparing financial statements for each annual and interim reporting period, an entity's management should evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity's ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable). Additionally, the Update requires management to consider plans that are in place to mitigate the risks of an entity's ability to continue as a going concern. If management concludes it is not able to continue as a going concern, it must make specific disclosures. Prior to this update, US GAAP provided no guidance to management on assessing and disclosing doubts about the ability of the entity to continue as a going concern; however, US auditing and public company regulations did provide such guidance. The Update is effective for annual and interim financial statements issued after December 15, 2016.

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