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　　RELEVANT TO ACCA QUALIFICATION PAPER F7 AND P2
　　Studying Paper F7 or P2
　　Performance objectives 10 and 11 are relevant to this exam
　　The IASB抯 Conceptual Framework for Financial Reporting
　　I am from England, and here in the UK, unlike most countries, our system of
　　government has no comprehensive written constitution. Many countries do
　　have such constitutions and in these circumstances the laws of the land are
　　shaped and influenced by the constitution. Now while the International
　　Accounting Standards Board （IASB） is not a country it does have a sort of
　　constitution, in the form of the Conceptual Framework for Financial Reporting
　?。╰he Framework）， that proves the definitive reference document for the
　　development of accounting standards. The Framework can also be described
　　as a theoretical base, a statement of principles, a philosophy and a map. By
　　setting out the very basic theory of accounting the Framework points the way
　　for the development of new accounting standards. It should be noted that the
　　Framework is not an accounting standard, and where there is perceived to be a
　　conflict between the Framework and the specific provisions of an accounting
　　standard then the accounting standard prevails.
　　Before we look at the contents of the Framework, let us continue to put the
　　Framework into context. It is true to say that the Framework:
　　seeks to ensure that accounting standards have a consistent approach to
　　problem solving and do not represent a series of ad hoc responses that
　　address accounting problems on a piece meal basis
　　assists the IASB in the development of coherent and consistent
　　accounting standards
　　is not a standard, but rather acts as a guide to the preparers of financial
　　statements to enable them to resolve accounting issues that are not
　　addressed directly in a standard
　　is an incredibly important and influential document that helps users
　　understand the purpose of, and limitations of, financial reporting
　　used to be called the Framework for the Preparation and Presentation of
　　Financial Statements
　　?is a current issue as it is being revised as a joint project with the IASB's
　　American counterparts the Financial Accounting Standards Board .
　　Overview of the contents of the Framework
　　The starting point of the Framework is to address the fundamental question of
　　why financial statements are actually prepared. The basic answer to that is
　　they are prepared 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.
　　In turn this means the Framework has to consider what is meant by useful
　　information. In essence for information to be useful it must be considered both
　　relevant, ie capable of making a difference in the decisions made by users and
　　2THE IASB CONCEPTUAL FRAMEWORK FOR FINANCIAL
　　REPORTING
　　MARCH 2011
　　be faithful in its presentation, ie be complete, neutral and free from error. The
　　usefulness of information is enhanced if it is also comparable, verifiable,
　　timely, and understandable.
　　The Framework also considers the nature of the reporting entity and, in what
　　reminds me of my school chemistry lessons, the basic elements from which
　　financial statements are constructed. The Framework identifies three elements
　　relating to the statement of financial position, being assets, liabilities and
　　equity, and two relating to the income statement, being income and expenses.
　　The definitions and recognition criteria of these elements are very important
　　and these are considered in detail below.
　　The five elements
　　An asset is defined as 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.
　　Assets are presented on the statement of financial position as being
　　noncurrent or current. They can be intangible, ie without physical presence, eg
　　goodwill. Examples of assets include property plant and equipment, financial
　　assets and inventory.
　　While most assets will be both controlled and legally owned by the entity it
　　should be noted that legal ownership is not a prerequisite for recognition,
　　rather it is control that is the key issue. For example IAS 17, Leases, with
　　regard to a lessee with a finance lease, is consistent with the Framework's
　　definition of an asset. IAS 17 requires that where substantially all the risks and
　　rewards of ownership have passed to the lessee it is regarded as a finance
　　lease and the lessee should recognise an asset on the statement of financial
　　position in respect of the benefits that it controls, even though the asset
　　subject to the lease is not the legally owned by the lessee. So this reflects that
　　the economic reality of a finance lease is a loan to buy an asset, and so the
　　accounting is a faithful presentation.
　　A liability is defined as 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 economic benefits.
　　Liabilities are also presented on the statement of financial position as being
　　noncurrent or current. Examples of liabilities include trade payables, tax
　　creditors and loans.
　　It should be noted that in order to recognise a liability there does not have to
　　be an obligation that is due on demand but rather there has to be a present
　　obligation. Thus for example IAS 37, Provisions, Contingent Liabilities and　3THE IASB CONCEPTUAL FRAMEWORK FOR FINANCIAL
　　REPORTING
　　MARCH 2011
　　Contingent Assets is consistent with the Framework's approach when
　　considering whether there is a liability for the future costs to decommission oil
　　rigs. As soon as a company has erected an oil rig that it is required to
　　dismantle at the end of the oil rig's life, it will have a present obligation in
　　respect of the decommissioning costs. This liability will be recognised in full,
　　as a non-current liability and measured at present value to reflect the time
　　value of money. The past event that creates the present obligation is the
　　original erection of the oil rig as once it is erected the company is responsible
　　to incur the costs of decommissioning.
　　Equity is defined as the residual interest in the assets of the entity after
　　deducting all its liabilities.
　　The effect of this definition is to acknowledge the supreme conceptual
　　importance of indentifying, recognising and measuring assets and liabilities, as
　　equity is conceptually regarded as a function of assets and liabilities, ie a
　　balancing figure.
　　Equity includes the original capital introduced by the owners, ie share capital
　　and share premium, the accumulated retained profits of the entity, ie retained
　　earnings, unrealised asset gains in the form of r*uation reserves and, in
　　group accounts, the equity interest in the subsidiaries not enjoyed by the
　　parent company, ie the non-controlling interest （NCI）。 Slightly more exotically,
　　equity can also include the equity element of convertible loan stock, equity
　　settled share based payments, differences arising when there are increases or
　　decreases in the NCI, group foreign exchange differences and contingently
　　issuable shares. These would probably all be included in equity under the
　　umbrella term of Other Components of Equity.
　　Income is defined as the increases in economic benefits during the accounting
　　period in the form of inflows or enhancements of assets or decreases of
　　liabilities that result in increases in equity, other than those relating to
　　contributions from equity participants.
　　Most income is revenue generated from the normal activities of the business in
　　selling goods and services, and as such is recognised in the Income section of
　　the Statement of Comprehensive Income, however certain types of income are
　　required by specific standards to be recognised directly to equity, ie reserves,
　　for example certain r*uation gains on assets. In these circumstances the
　　income （gain） is then also reported in the Other Comprehensive Income section
　　of the Statement of Comprehensive Income.
　　The reference to ther than those relating to contributions from equity
　　participants?means that when the entity issues shares to equity shareholders,
　　4THE IASB CONCEPTUAL FRAMEWORK FOR FINANCIAL
　　REPORTING
　　MARCH 2011
　　while this clearly increases the asset of cash, it is a transaction with equity
　　participants and so does not represent income for the entity.
　　Again note how the definition of income is linked into assets and liabilities.
　　This is often referred to as he balance sheet approach?（the former name for
　　the statement of financial position）。
　　Expenses are defined as decreases in economic benefits during the accounting
　　period in the form of outflows or depletions of assets or incurrences of
　　liabilities that result in decreases in equity, other than those relating to
　　distributions to equity participants.
　　The reference to ther than those relating to distributions to equity
　　participants?refers to the payment of dividends to equity shareholders. Such
　　dividends are not an expense and so are not recognised anywhere in the
　　Statement of Comprehensive Income. Rather they represent an appropriation
　　of profit that is as reported as a deduction from Retained Earnings in the
　　Statement of Changes in Equity.
　　Examples of expenses include depreciation, impairment of assets and
　　purchases. As with income most expenses are recognised in the Income
　　Statement section of the Statement of Comprehensive Income, but in certain
　　circumstances expenses （losses） are required by specific standards to be
　　recognised directly in equity and reported in the Other Comprehensive Income
　　Section of the Statement of Comprehensive Income. An example of this is an
　　impairment loss, on a previously r*ued asset, that does not exceed the
　　balance of its R*uation Reserve.
　　The recognition criteria for elements
　　The Framework also lays out the formal recognition criteria that have to be met
　　to enable elements to be recognised in the financial statements. The
　　recognition criteria that have to be met are that
　　that an item that meets the definition of an element and
　　it is probable that any future economic benefit associated with the item
　　will flow to or from the entity and
　　the item cost or value can be measured with reliability.
　　Measurement issues for elements
　　Finally the issue of whether assets and liabilities should be measured at cost or
　　value is considered by the Framework. To use cost should be reliable as the
　　cost is generally known, though cost is not necessary very relevant for the
　　users as it is past orientated. To use a valuation method is generally regarded
　　as relevant to the users as it up to date, but value does have the drawback of
　　not always being reliable. This conflict creates a dilemma that is not
　　satisfactorily resolved as the Framework is indecisive and acknowledges that　5THE IASB CONCEPTUAL FRAMEWORK FOR FINANCIAL
　　REPORTING
　　MARCH 2011
　　there are various measurement methods that can be used. The failure to be
　　prescriptive at this basic level results in many accounting standards sitting on
　　the fence how they wish to measure assets. For example IAS 40, Investment
　　Properties and IAS 16, Property, Plant and Equipment both allow the preparer the
　　choice to formulate their own accounting policy on measurement.
　　Applying the Framework
　　A company is about to enter into a three-year lease to rent a building. The
　　lease cannot be cancelled and there is no certainty of renewal. The landlord
　　retains responsibility for maintaining the premises in good repair. The
　　directors are aware that in accordance with IAS 17 that technically the lease is
　　classified as an operating lease, and that accordingly the correct accounting
　　treatment is to simply expense the income statement with the rentals payable.
　　Required
　　Explain how such a lease can be regarded as creating an asset and liability per
　　the Framework.
　　Solution ?lease
　　Given that it is reasonable to assume that the expected life of the premises will
　　vastly exceed three years and that the landlord （lessor） is responsible for the
　　maintenance, on the basis of the information given, the risks and rewards of
　　ownership have not passed. As such IAS 17 prescribes that the lessee charges
　　the rentals payable to the income statement. No asset or liability is recognised,
　　although the notes to the financial statements will disclose the existence of the
　　future rental payments.
　　However, instead of considering IAS 17 let us consider how the Framework
　　could approach the issue. To recognise a liability per the Framework requires
　　that there is a past event that gives rise to a present obligation. It can be
　　argued that the signing of the lease is a sufficient past event as to create a
　　present obligation to pay the rentals for the whole period of the lease. On the
　　same basis, while substantially all the risks and rewards of ownership have not
　　passed, the lessee does control the use of the building for three years and has
　　the benefits that brings. Accordingly, when considering the Framework, a
　　radically different potential treatment arises for this lease. On entering the
　　lease a liability is recognised, measured at the present value of the future cash
　　flow obligations to reflect the time value of money. In turn an asset would also
　　be accounted for. After the initial recognition of the liability, a finance cost is
　　charged against profit in respect of unwinding the discount on the liability. The
　　annual cash rental payments are accounted for as a reduction in the liability.
　　The asset is systematically written off against profit over the three years of the
　　agreement （depreciation）。
　　6 THE IASB扴 CONCEPTUAL FRAMEWORK FOR FINANCIAL
　　REPORTING
　　MARCH 2011
　　There is, at present, a conflict between IAS 17 and the Framework. The IASB is
　　currently reviewing IAS 17 because the current accounting treatment of lessees not recognising the future operating lease rentals as liabilities arguably amounts to off balance sheet financing. The Framework definition of a liability is at the heart of proposals to revise IAS 17 to ensure that the statement of financial position faithfully and completely represents all an entity liabilities. Accordingly this conflict should soon be resolved.Tom Clendon FCCA is a subject expert at Kaplan
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