Conceptual Framework: Accounting Theory and Analysis

Accounting methods and reporting of financial statements must be applied in a consistent manner throughout all the accounting periods in the future. This regular application of financial accounting and reporting is stipulated under the concept of consistency. The concept prohibits businesses from changing their accounting policies unless there is justifiable and reasonable ground for such change and if a change is made then the change must be reported in addition to its nature and effect on the financial statements.  

The concept of consistency allows for comparability of an entity’s financial statements by the information users, auditors, stakeholders, accountants and investors for a precise and easy comparison. A company that uses the straight line method of depreciation for its plant and equipment, is supposed to stick to that method in all the subsequent financial periods. A change to reducing balance method of depreciation has to be reported in the statements. This also calls for the reason and effect of the change to also be communicated to the users of the financial statements in the financial report following the change.

However, when accountants are preparing the accounting statements of their entities, inconsistencies arise, for example inconsistencies occurring between relevant resource allocation information, fair value measurement and fair value inconsistencies in accounting arising from the inability to provide verifiable knowledge. In addition, the International Financial Reporting Standards, IFRS has inconsistencies of recognition and measurement of liabilities for both accounting standards and conceptual framework for financial reporting.

The conceptual framework and accounting standards provide inconsistency with regard to recognition and measurement of liabilities in IFRS. The reason for the inconsistency is due to the International Accounting Standards Board, IASB makes no conceptual distinction between the measurement process, which necessitates an observable measurement attribute, as well as the process of subjective estimation. Entities are required by the IASB to report both estimates and measurements in financial statements by using language and logic of measurement. The goal of conceptual framework is to identify and interpret the inconsistency arising thereof to show its relevance to accounting for liabilities and the implications arising out of measurement, recognition and conservatism. Moreover, conceptual framework also provides a basis for developing future accounting standards.   

The conceptual framework is crucial in the identification of concepts that must be applied consistently in the creation and revision of IFRSs by prompting the development of new and revised standards. Conceptual framework further clarifies the definitions of assets and liabilities that solve issues occasioned by the accounting standards. The accounting standards provide a definition of assets and liabilities as the eventual inflow or outflow of economic benefits rather than the underlying resource or obligation.

The purpose of financial reporting is give financial reporting of an entity for use by the existing and potential stakeholders of the entity, for instance equity investors, suppliers, lenders and capital providers. This extends the scope of financial reporting with regard to the existing framework for the common needs of the users to provide them with information that is more than the financial statements. However, relevance and faithful representation of financial reporting determines the usefulness of such financial information. Relevant information provides for a difference in decision as well as predictive value. Faithful representation on the other hand provides that the reported financial information be of substance to the economic phenomena instead of its legal form. 

The conceptual framework therefore works to represent the economic phenomenon in a faithful manner, with complete and neutral financial information that is material error-free. This accounts for all the key qualities included in the existing framework with regard to reliability but not conservatism or prudence. In financial reporting, prudence is in inconsistency with neutrality thus making conceptual framework omit it as a desirable quality. The conceptual framework incorporates all the fundamental objectives and concepts giving the functions, limits and nature of financial reporting and reporting thereby providing a consistent guide to accounting reporting. Further, there is a provision to the public with a structure and direction for reporting and accounting for unbiased financial and related information that allows the capital and markets for efficient allocation of scarce resources in the economy. While the accounting objectives provide the direction for accountants to solve financial accounting and reporting problems, concepts act as efficient tools for solving such problems. 

Conceptual framework enhances the qualitative characteristics to boost the financial information’s usefulness.  The qualitative characteristics include, comparability, verifiability, timeliness, and understandability. Understandability allows financial information users to grasp the underlying meaning of the statements. Timeliness allows the information users to influence decision about the financial statements while comparability is useful to users in the identification of similarities and differences between two economic phenomena. Verifiability provides users with an affirmation that the financial information faithfully represents the economic phenomena it signifies. 

Materiality and cost are the constraints that prevent useful financial reporting. The conceptual framework broadly gives the description of a reporting entity though not limited to the legal entities. Conceptual framework determines the group reporting entity’s composition and consolidated financial statements must be prepared from the group reporting entity’s perspective instead of the parent company’s perspective. The conceptual framework excludes the presentation of parent-only financial statements as long as they are included with the consolidated financial statements.

Moreover, the concept of control under conceptual framework includes situations where it might be present albeit temporarily. However, control should be limited to circumstances where the entity has voting rights over to provide direction for operating and financial policies of another entity. Further, conceptual framework helps financial information users to firmly understand and interpret the IFRSs thereby assisting them develop accounting policies without transactions or events as applied by IFRS. When an accountant is developing accounting policies, the conceptual framework should a guiding principle. 

However, conceptual framework is not without loopholes thereby calling for significant judgement. Since the conceptual frameworks are not accounting standards, it is difficult to ascertain whether accountants would adhere to them. Moreover, there is concern that true and fair view is not included in the conceptual framework though it is an essential aspect in all accounting information. Conceptual framework is crucial for the future consistent application and development of financial accounting standards on an international level. Inconsistencies can only be eliminated if a conceptual framework is established.

The inconsistencies present in the accounting practice raise doubts about the framework as IFRS’s robust conceptual basis. The transition from the conceptual framework should to be an exceptional decision requiring an explanation in special circumstances for the change. Conceptual framework therefore assists the Board to promote accounting procedure, regulation harmonization, as well as regulation of standards concerning the presentation of financial statement through provision of a basis for the reduction in the number of alternative accounting management as directed by the IFRS.


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