Financial Reporting: The New Conceptual Framework

FINANCIAL REPORTING: THE NEW CONCEPTUAL FRAMEWORK

The current framework was approved in July 1989, and was adopted in April 2001 by the IASB. It sets out the concepts concerning the "preparation and the presentation of financial statements" for users which are external to the company. However, during these last two decades, the market, the business practices, as well as the economic environment, have evolved. The current framework, no longer reflecting the business reality, is therefore being updated by the IASB and the FASB.

The first phase of this new "Joint Conceptual Framework Project", regarding the objectives of financial statements and its qualitative characteristics was completed on the 28th of December.

We will first determine the main strengths and weaknesses of these two sections, and then evaluate the changes that have been made.

THE STRENGTHS AND WEAKNESSES OF THE FISRT TWO CURRENT SECTIONS

A framework is "a statement of generally accepted theoretical principles [...] that provides the basis for both the development of new reporting practices and the evaluation of existing ones" (Ernst & Young, 2009).

STRENGTHS

Informed economic decisions

As we said before, the Framework governs published financial statements. These statements are intended to provide useful information to different external users, who have different information needs: it helps them make informed "economic decisions" based on reliable information. To enable the users to make these informed decisions, financial statements must show comparability and understandability, as well as faithful representation (relevance and reliability): these are the qualitative characteristics given by the Framework.

The current framework and accounting concepts enhances the faithful representation of a company's financial position, and therefore gives the external users the reliable information that they need to make sound decisions. The fist two sections allow external users to have a "wide view" of the company.

Protection of the different users interests

As we said before, the different external users have different information needs, for they have different interests: investors need reliable information to know where to put their money, employees need relevant information for raise bargaining, governments for taxation purposes, etc... Companies might be tempted to manipulate issued information to escape certain obligations: they can for example show less profit to pay less tax, or show more profit to attract investors.

The Framework is here to prevent the manipulation of financial statements to the company's advantage by giving regulations in the preparation and in the presentation of these statements: it allows a "true and fair view", thus the protection of user's interests.

However, the current regulatory Framework is not without weaknesses and is subject of debate.

WEAKNESSES

"Creative accounting" and subjectivity

The Framework is concept base. When accounting concepts are applied in companies, it is left to the judgement of the accountants, thus leading to high subjectivity, as every one may have they own interpretation: it is "creative accounting". There are therefore variations in accounting practices, and in the methods that can be used to prepare financial statements, even though the current Framework aims to reduce subjectivity.

The principle based approach enables flexibility and can lead to different professional judgement, because it means that its implementation is more subject to personal judgement than a rule-based approach.

Lack of common understanding and comprehension

The Framework's objective is also to assist in the development of IFRSs and IASs. Therefore, it assists in a worldwide harmonisation and standardization of international accounting standards and regulations. However, trying to apply the same concept to different accounting cultures can lead to misunderstanding, and