CONCEPTUAL FRAMEWORKS

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CONCEPTUAL FRAMEWORKS
Standards Advisory Council meeting February 2005

James J. Leisenring IASB member
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CONCEPTUAL FRAMEWORKS

• In the areas I want to discuss, there are only
  small differences between the IASB and FASB
  framework
• Focus on the elements of financial statements and
  on recognition and not measurement as both
  frameworks are quite unresolved as to measurement
• FASB Conceptual Framework more expansive and I
  have selected it to describe several points also
  made in IASB Framework

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CONCEPTUAL FRAMEWORKS

• Purposes of the two frameworks are quite similar
• Both frameworks accept decision usefulness of
  information to a broad group of outsiders as the
  purpose of financial reporting (IAS paragraph 12)
• More expansive use of IASB framework as a result
  of IAS 8 hierarchy for establishing accounting
  policies

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CONCEPTUAL FRAMEWORKS
The FASB in Concepts Statement No. 1 concluded
. . . Financial reporting should provide
information to help investors, creditors, and
others assess the amount, timing, and uncertainty
of prospective net cash inflows to the related
enterprise. (paragraph 39) The IASB
framework The economic decisions that are
taken by users of financial statements require an
evaluation of the ability of an entity to
generate cash and cash equivalents and of the
timing and certainty of their generation.
(paragraph 15)
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CONCEPTUAL FRAMEWORKS
The primary focus of financial reporting is
information about an enterprises performance
provided by measures of earnings and its
components. Investors, creditors, and others who
are concerned with assessing the prospects for
enterprise net cash inflows are especially
interested in that information. (Con 1,
paragraph 43)
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CONCEPTUAL FRAMEWORKS
Furthermore, the Board said, Information about
enterprise earnings and its components measured
by accrual accounting generally provides a better
indication of enterprise performance than
information about current cash receipts and
payments. (Con 1, paragraph 44)
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CONCEPTUAL FRAMEWORKS
Financial statements prepared on the accrual
basis inform users not only of past transactions
involving the payment and receipt of cash but
also of obligations to pay cash in the future and
of resources that represent cash to be received
in the future. Hence, they provide the type of
information about past transactions and other
events that is most useful to users in making
economic decisions. (IAS, paragraph 22)
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CONCEPTUAL FRAMEWORKS
Information about the performance of an entity,
in particular its profitability, is required in
order to assess potential changes in the economic
resources that it is likely to control in the
future. Information about variability of
performance is important in this respect.
Information about performance is useful in
predicting the capacity of the entity to generate
cash flows from its existing resource base.
(IAS, paragraph 17)
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CONCEPTUAL FRAMEWORKS

• Accepting these conclusions focuses the debate
  on the items to be recognized in accrual basis
  earnings (profit and loss) and the measurement
  of those items.
• The fundamental nature of most accounting
  debates is that we dont agree on what should
  be considered earnings or profit and loss.

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CONCEPTUAL FRAMEWORKS

• Controversy sometimes over amount
• Controversy usually over timing and
  uncontrolled volatility
• Controversy over classification and display of
  items in earnings or profit and loss

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Source of the Early Debates
CONCEPTUAL FRAMEWORKS

• Assets, liabilities, or what-you-may-call-its
• Proper matching to avoid distorting periodic
  income
• Argument often used to avoid recognition of an
  item is that the result will distort income
  (earnings)

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APB STATEMENT NO. 4ASSETS
CONCEPTUAL FRAMEWORKS

• Assetseconomic resources of an enterprise that
  are recognized and measured in conformity with
  generally accepted accounting principles. Assets
  also include certain deferred charges that are
  not resources but that are recognized and
  measured in conformity with generally accepted
  accounting principles.

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APB STATEMENT NO. 4LIABILITIES
CONCEPTUAL FRAMEWORKS

• Liabilitieseconomic obligations of an enterprise
  that are recognized and measured in conformity
  with generally accepted accounting principles.
  Liabilities also include certain deferred credits
  that are not obligations but that are recognized
  and measured in conformity with generally
  accepted accounting principles.

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CONCEPTUAL FRAMEWORKS
Asset
Assets are probable future economic benefits
obtained or controlled by a particular entity as
a result of past transactions or events. (Con 6,
paragraph 25)
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CONCEPTUAL FRAMEWORKS
Liability
Liabilities are probable future sacrifices of
economic benefits arising from present
obligations of a particular entity to transfer
assets or provide services to other entities in
the future as a result of past transactions or
events. (Con 6, paragraph 35)
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CONCEPTUAL FRAMEWORKS
Asset
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. (IAS, paragraph 49a)
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CONCEPTUAL FRAMEWORKS
Liability
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 economic
benefits. (IAS, paragraph 49b)
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Assets
CONCEPTUAL FRAMEWORKS

• Three essential characteristics (Con 6,
  paragraph 26)
• (a) It embodies a probable future benefit that
  involves a capacity, singly or in combination
  with other assets, to contribute directly or
  indirectly to future net cash inflows
• (b) A particular entity can obtain the benefit
  and control others access to it
• (c) The transaction or other event giving rise to
  the entitys right to or control of the benefit
  has already occurred.

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Liabilities
CONCEPTUAL FRAMEWORKS

• Three essential characteristics (Con 6,
  paragraph 36)
• (a) It embodies a present duty or responsibility
  to one or more other entities that entails
  settlement by probable future transfer or use of
  assets at a specified or determinable date, on
  occurrence of a specified event, or on demand
• (b) The duty or responsibility obligates a
  particular entity, leaving it little or no
  discretion to avoid the future sacrifice
• (c) The transaction or other event obligating the
  has already happened.

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CONCEPTUAL FRAMEWORKS
Revenues
Revenues are inflows or other enhancements of
assets of an entity or settlements of its
liabilities (or a combination of both) from
delivering or producing goods, rendering
services, or other activities that constitute the
entitys ongoing major or central operations.
(Con 6, paragraph 78)
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CONCEPTUAL FRAMEWORKS
Expenses
Expenses are outflows or other using up of
assets or incurrences of liabilities (or a
combination of both) from delivering or producing
goods, rendering services, or carrying out other
activities that constitute the entitys ongoing
major or central operations. (Con 6,
paragraph 80)
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CONCEPTUAL FRAMEWORKS
Income
Income is 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. (IAS,
paragraph 70a)
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CONCEPTUAL FRAMEWORKS
Expenses
Expenses are 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.
(IAS, paragraph 70b)
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CONCEPTUAL FRAMEWORKS
IASB and FASB Framework

• Basic conclusion as to the conceptual primacy
  of assets and secondarily liabilities
• Thought to be a balance sheet approach
• Can there be an income statement view?

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CONCEPTUAL FRAMEWORKS
To me, the definitions were the missing
boundaries that were needed to bring the accrual
accounting system back under control. The
definitions have, I hope, driven a stake part way
through the nondistortion guideline. But I am
realistic enough to know, having dealt with the
subjects of foreign currency translation and
pension cost measurement, that the aversion to
volatility in earnings is so strong that the
notion of nondistortion will not die
easily. (Donald Kirk)
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CONCEPTUAL FRAMEWORKS
Some individual frameworks are sharply defined
and firmly held others are vague and weakly
held still others are vague and firmly
held. (Chuck HorngrenStanford University)
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CONCEPTUAL FRAMEWORKS
Accounting is more a process of allocating
transactions to accounting periods by reference
to the established conventions of matching and
prudence. . . . Assets and liabilities do not
form a natural starting point for devising
recognition rules the balance sheet is the
result of the accounting process, not the
starting point. (Ron PatersonErnst YoungUK)
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CONCEPTUAL FRAMEWORKS
Patersons balance sheet that is the result
of the accounting process is commonly the result
of debits and credits that have been created as
the necessary offsetting entries to achieve the
appropriate amount of revenue and expense.
Many of those debits and credits do not meet the
definitions of assets or liabilities but
nevertheless are identified as such on balance
sheets. Would it be acceptable to Paterson to
accurately describe those items as debit (or
credit) necessary to get net income to the
appropriate level? I doubt it. (James J.
LeisenringFASBUSA)
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CONCEPTUAL FRAMEWORKS
IASB Framework
. . .The application of the matching concept
under this Framework does not allow the
recognition of items in the balance sheet which
do not meet the definition of assets or
liabilities. (IAS, paragraph 95)
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CONCEPTUAL FRAMEWORKS
IASB Framework
Income is recognised in the income statement
when an increase in future economic benefits
related to an increase in an asset or a decrease
of a liability has arisen that can be measured
reliably. (IAS, paragraph 92)
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CONCEPTUAL FRAMEWORKS
IASB Framework
Expenses are recognised in the income statement
when a decrease in future economic benefits
related to a decrease in an asset or an increase
of a liability has arisen that can be measured
reliably. (IAS, paragraph 94)
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CONCEPTUAL FRAMEWORKS
For the income statement view to have any
intellectual rigor, proponents must either

• Define revenue and expense without regard to
  assets and liabilities.
• Accept that a balance sheet will contain a debit
  or credit necessary to achieve the appropriate
  amount of net income.
• Define or describe what is the appropriate
  amount of net income

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CONCEPTUAL FRAMEWORKS

• Cant define revenues, expenses, gains, and
  losses without reference to assets
• Absent independent definition of revenues,
  expenses, gains, and losses (not dependent on
  assets and liabilities), the income statement
  view is vacuous
• Measuring net income by the change in net
  assets provides an anchor for resolving
  difficult accounting questions

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CONCEPTUAL FRAMEWORKS
Asking the Right Questions
What is the asset? What is the liability? Did an
asset or liability or its value change? Increase
or decrease? By how much? Did the change result
from what we call Investment by
owners? Distribution to owners? Comprehensive
income? Revenue? Expense? Gain? Loss?
(Storey Storey)
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CONCEPTUAL FRAMEWORKS
Standards Advisory Council meeting February 2005

James J. Leisenring IASB member