Frequently asked questions
Due Process and about the Conceptual Framework project
What is objective of the conceptual framework project?
A common goal of the IASB and US FASB - a goal shared by their constituents - is for their standards to be clearly based on consistent and appropriate principles.
These principles must be rooted in fundamental economic concepts rather than based on a collection of arbitrary conventions. To provide the best foundation for developing principle based, common standards, the boards are undertaking a joint project to develop a common and improved conceptual framework.
How are you developing the common conceptual framework?
The new framework, which will deal with a wide range of issues, will build on the existing IASB and FASB frameworks and consider developments since those frameworks were created.
The boards are undertaking this project in eight phases, of which four are currently active (phases A to D). The boards decided that for every phase of the project, the initial consultative document will be a discussion paper.
This will enable interested parties will be able to get involved in the boards� thinking at an early stage.
Is the framework an accounting standard?
The boards� existing frameworks have different levels of authority:
- Within IFRSs, entities are required to consider the framework when no standard or interpretation specifically applies.
- Within US GAAP, there is no similar requirement; the FASB�s concepts statements are ranked alongside accounting textbooks, handbooks and articles and below widely recognised and prevalent practices.
The boards have not reached a common conclusion on the authoritative status of the common conceptual framework. However, both intend that it will not have the same status as financial reporting standards, and will not override standards.
How will the boards complete the framework?
Each board intends to update its own framework after each phase to incorporate the results of that phase. Thus, the boards will develop standards using up to date concepts that will have been through the boards� full due process. To ensure overall consistency, the boards will, throughout the life of the project, consider amendments to phases that were completed earlier.
How can I get involved?
The exposure draft and discussion paper are open for public comment. Interested parties are strongly encouraged to submit comment letters on the discussion paper by 29 September 2008.
Phase A Objective and Qualitative Characteristics: What we are proposing in the Exposure Draft on Phase A?
What is the objective of financial reporting? Why is it so important?
The boards propose that the objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions in their capacity as capital providers.
The objective of financial reporting is the foundation of the conceptual framework. Other aspects of the framework - qualitative characteristics, elements of financial statements, recognition and measurement - will build on that foundation with the aim of ensuring that financial reporting achieves its objective.
What are the qualitative characteristics of financial reporting? Why are they so important?
The qualitative characteristics are the attributes that make financial information useful. The exposure draft identifies:
- two fundamental qualitative characteristics � relevance and faithful representation
- four enhancing qualitative characteristics: comparability, verifiability, timeliness and understandability. They enhance the fundamental qualitative characteristics by distinguishing more useful information from less-useful information.
- two pervasive constraints that limit the information provided by financial reporting: materiality and cost.
In developing standards, the boards will consider the qualitative characteristics so that information reported in financial reports is useful to capital providers, thus meeting the objective of general purpose financial reporting.
The document is an exposure draft. What has changed from the discussion paper?
The boards published a discussion paper in November 2006. That discussion paper discussed the boards� preliminary views on the objective of financial reporting and the qualitative characteristics of financial reporting. The boards received 179 comment letters from all parts of the globe. Two of the main issues raised were the following:
- Some respondents argued that the objective of financial reporting should be broadened to encompass stewardship decisions made by capital providers.
- Some respondents asked why the boards proposed to replace the notion of reliability with the notion of faithful representation.
During 2007 and early 2008, the boards considered the issues raised and the exposure draft is a result of that process. Please refer below for more details on the boards� proposals.
How does the conceptual framework address the issue of management�s stewardship responsibility?
Several respondents to the discussion paper expressed a concern that the proposed objective was too narrowly focused on resource allocation decisions.
Although most respondents agreed that decision-usefulness was the appropriate objective, respondents argued that capital providers make other decisions that are aided by financial reporting information in addition to resource allocation decisions.
For example, shareholders must decide how to vote on whether to retain directors or replace them and how members of management should be remunerated for their services. Shareholders� decision-making process may include evaluating how management of the entity performed against management in competing entities in similar circumstances.
In developing the exposure draft, the boards clarified that the objective of general purpose financial reporting is to provide information that is useful to capital providers (eg shareholders and lenders) for:
- decisions about whether and how to allocate their resources to a particular entity.
- decisions about whether and how to protect or enhance their investments. These matters are sometimes viewed as relating to management�s stewardship or accountability of the entity.
Why do the boards propose to change the existing notion of reliability to the new notion of faithful representation?
In considering reliability, the boards observed that there are a variety of views of what the notion means. For example, some focus on verifiability or free from material error to the virtual exclusion of the faithful representation aspect of reliability. And to some, reliability apparently refers primarily to precision. Those considerations led the boards to consider how they could convey better what reliability means.
Accordingly, the boards propose that faithful representation encompasses all of the qualities that the previous frameworks included as aspects of reliability. Faithful representation�the depiction in financial reports of the economic phenomena they purport to represent�is essential if information is to be decision useful. To represent real world economic phenomena faithfully, accounting representations must be complete, neutral and free from error.
Why is verifiability not a component of the proposed notion of faithful representation?
Including verifiability as a component of faithful representation could result in some information being excluded from financial reporting. For example, an entity can faithfully depict a piece of information that represents management�s opinion or intentions and this information may be useful for decision-making. This information may not necessarily be directly or indirectly verifiable. Given this argument, the boards concluded that verifiability is not a component of faithful representation.
However, information that is verifiable is generally more decision useful than information that cannot be independently verified; therefore, the boards propose that verifiability should be an enhancing qualitative characteristic.
Phase D Reporting Entity: What are the boards� preliminary views in the discussion paper?
Why do we need a reporting entity concept?
General purpose financial reports provide information about a particular reporting entity. Therefore, the reporting entity phase (phase D) of the boards� joint project to develop a common conceptual framework deals with what a reporting entity is and other relevant issues such as how to determine the composition of a group reporting entity.
What is a reporting entity?
The discussion paper proposes: A reporting entity is a circumscribed area of business activity of interest to present and potential equity investors, lenders and other capital providers. It includes, but is not limited to, business activities that are structured as legal entities. Examples include a sole proprietorship, corporation, trust, partnership, association and a group of entities.
Does the discussion paper discuss how to determine the composition of a group reporting entity? Should the composition be based on control or on risks and rewards?
The discussion paper discusses three different models for how to determine the composition of a group reporting entity: the controlling entity model, the common control model and the risks and rewards model.
The boards� preliminary view is that the composition of a group reporting entity should be based on control, using the controlling entity model as the primary basis. The common control model may also provide useful information, but the boards would determine in one or more specific standards when to apply that model, rather than in the framework.
Although the boards� preliminary view is that the risks and rewards model should not be used to determine the composition of a group reporting entity, there is a link between control and risks and rewards. The control concept includes both power over another entity and the ability to obtain benefits (or to reduce the incidence of losses). Considering the benefits element of control typically involves considering who bears risks and/or who receives the rewards.
Does the discussion paper discuss how to assess whether an entity has control over another?
Yes, the boards� preliminary views on how to assess whether an entity has control over another include the following points:
- All the existing facts and circumstances should be considered when assessing whether an entity has control over another entity.
- Control includes situations in which control currently exists but might be temporary.
- The control concept should not be limited to circumstances in which the entity has majority voting rights or other legal rights (sometimes referred to as de facto or effective control).
- In some cases, an entity holds enough options over voting rights that exercise of those options would give the entity control over a second entity. That fact is not sufficient, in itself, to establish that the first entity currently controls the second entity.
- Power must be held by one entity only.
In phase A of the conceptual framework project, the boards propose to adopt the entity perspective - what does this mean for the parent company approach to consolidated financial statements?
The boards� preliminary view is that consolidated financial statements should be presented from the perspective of the group reporting entity�not from the perspective of the parent company�s shareholders.
However, that does not mean that the information needs of the parent company�s shareholders are ignored under the entity perspective. The boards may later require extra information that is primarily directed to this group of capital providers in projects on individual standards.