This paper discusses the statement 'in a politically charged rulemaking environment, conceptual frameworks has only limited utility'.

Abstract

This paper discusses the statement ‘in a politically charged rulemaking environment, conceptual frameworks has only limited utility’. From this statement I will identify and explain the perceived functions of a Conceptual Framework (CF) and the role it plays. Following this will be an explanation of the history and the motivations of the accounting profession in persisting with attempts to develop a CF.

The existence of a CF is to serve as a guide for the standard setters to provide them with a set of objectives and constraints. Furthermore, CF provides a framework for setting standards, a basis for resolving accounting disputes and fundamental principles, which then do not have to be repeated in the Standards.

The CF has been developed over the years, and it is continually being developed due to the changing environment, especially in a politically charged rulemaking environment to pursue the appropriate structure for a ‘real’ CF designed to provide a base for the standards. Ultimately, the purpose is to provide “true and fair” financial reports for the users in making and evaluating decisions about the allocation of scare resources.

However from this paper, it is appropriate to conclude that accounting professions persist with attempts to develop a CF because of they trying to structure a CF designed to provide a base for the standards programme which is the accounting profession’s holy grail. Although it has its limitations, it is still playing a very important role in consistency and standardisation of standards setting and reviewing, furthermore it provides a quality and quantitative guideline in the preparation of financial reports.

Introduction

This paper discusses the statement ‘in a politically charged rulemaking environment, conceptual frameworks has only limited utility’. From this statement I identify and explain the perceived functions of a Conceptual Framework (CF) and a role a CF plays. Following this will be an explanation of the motivations by the accounting profession in persisting with attempts to develop a CF.

Definition

The Australian Accounting Research Foundation (AARF) CF has been described as:

Statements of Accounting Concepts set out the concepts which has been adopted by the AASB and PSASB in respect of the nature, subject, purpose and broad content of general purpose financial reporting in the private and public sectors (Para3, Policy Statement 5 (PS5)).

Nature and purpose of a CF

The CF is a body of interrelated objectives and fundamentals. The objectives recognise the goals and purposes of financial reporting and the fundamentals are the underlying concepts that help accomplish those objectives.

Those concepts provide guidance in selecting the transactions, events and circumstances to be accounted for, how the elements (i.e. assets, liability, equity, revenues and expenses) should be recognised, defined and measured, which cost or value should they be measured and how they should be summarised and reported. The CF itself does not describe the requirements on how financial reports should be prepared or presented, however it does describe the quality and requirements of elements that should be included in the financial reports (such as relevant, reliable and understandable, etc.) in order to support the financial reports are “true and fair”. To date, the Australian CF is equivalent to International Financial Reporting Standards (IFRSs).

Question 1: What are the perceived functions of a CF?

Horgren (1981) believes that a framework will help in the standard-setting process, which if successful can be used to help responsible practitioners in the preparation and audit of financial reports, reduce opportunities for creative accountants and establish a basis for regulators seeking to enforce compliance with financial reporting (McGregor, 1990).

It will also “help policymakers, making standard setting more efficient and effective, producing faster, more consistent and more defensible answers” (Horgren, 1981) as it serves as a ‘common’ language providing methods of analysis and constraints when dealing with complicated issues.

Essentially, these perceptions can be summed up by Horgren (1981) who states, “in many people’s mind, the framework is responsive to an axiomatic belief – that is, if we only had a foundation, deductive logic would lead us to the correct answer”.

But however true this statement may be, the process of formulating a CF and the perceived function it has is heavily influenced by a host of many factors based on individuals or groups ‘currently’ in power. The reason being is because the whole concept of policymaking often falls into the category of where one person’s improvement is often another person’s impairment.

As stated by Raymond Chambers (1973), “Policy-making is ‘choosing which’ when the choice is a matter of opinion or taste or some other personal or organizational criterion.”

As Albert Einstein once remarked, “Mathematics is hard ...

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As stated by Raymond Chambers (1973), “Policy-making is ‘choosing which’ when the choice is a matter of opinion or taste or some other personal or organizational criterion.”

As Albert Einstein once remarked, “Mathematics is hard enough, but political science is far too difficult for me”, which in this case holds true for formulating a CF.

The key criteria in the formulation of a CF and it perceived functions essentially boils down to ‘survival’. As Demski (1980) says “More precisely, in the view we define one financial reporting system as more valuable than another when some group unanimously regards the one as more valuable then the other in terms of individual value and has the power – socially speaking – to guarantee this choice.”

Horngren (1981) also agrees with this opinion by stating “So far, the key element of CF is the set of individuals or coalitions with sufficient power to force a choice.”

Evidence to support this is fact is the standard-setting bodies all with various life spans. The committee on accounting procedures lasted 22 years, then came the APB which lasted 13 years and currently in control is the FASB. The pivotal issue that defines the lifespan of these bodies is its ability to resolve conflicts among the various groups in a manner perceived to be acceptable to the ultimate group in power, the federal government (Horngren, 1981).

Horngren (1981) continues by stating, “Ultimate achievement rests on the capability of the FASB to set real, workable and sound standards, but at the same time to convince it constituents to accept its work as the reality they must be prepared to live with.” Essentially, by gaining greater support of diverse groups, the greater the chance the board has in retaining and enhancing it’s powers.

Therefore the perceived functions of a CF is dependent on it formulation based on the social economic setting that controls its policymakers at the current time.

However, for people with a non-accounting background or basic accounting knowledge their perceived function of a CF is as a standard or law which needs to be followed in any case when preparing a financial report. In general, functions of CF is dependent on the ‘eye of beholder’.

Question 2: What Role has the CF played, so far in the development of accounting regulations?

Previously, I have identified that the perceived functions of a CF is dependent on it’s formulation based on the social economic setting that controls its policymakers at the current time. Other than that, a CF for financial reporting can also have a variety of different roles.

The primary role of the CF can be concluded that as there is a need to provide direction and guidelines to financial accounting and reporting, it is also to provide conceptual input into the all the accounting standards board’s work on the development and review of accounting standards (PS5, Para6). It seems like the Board’s mission cannot be fulfilled without a conceptual underpinning that provides direction and the means for deciding whether one solution to a financial reporting issue is better than the other. Therefore, a CF provides the unity that is required, and with that, the direction and means to help in making those decisions (Johnson, 2004). I believe that without a set of unified concepts, standard setters are like a ship in a storm without an anchor.

In the APS1 outlined the role of statements of Accounting Concepts is reminded the member that Statements of Accounting Concepts have been approved by the Australian Accounting Standards Board (AASB) and the Public Sector Accounting Standards Board (PSASB) to establish the CF for the development and amendment to Accounting Standards. By the way, in the preparation, presentation or audit of a general purpose financial report, the Statements of Accounting Concepts are not necessary. However, Statements of Accounting Concepts are one of the sources of guidance to which members should make reference if there is no Accounting Standard or the Urgent Issues Group (UIG) Consensus View dealing with an accounting treatment or disclosure issue when prepare the financial report. (Para21)

That having been said, a number of the principles in the Statement play a fundamental role in existing accounting standards. For example, several standards (including FRS 5) draw on the Statement's definitions of assets and liabilities; FRS 2 reflects the Statement's discussion of the activities to be included in an entity's financial statements and the activities to be excluded; and the Statement's views on the presentation of information about financial performance are embodied in FRS 3.

The following discussion is going to identify what is the relationship between CF and accounting standards. The CF defines “the nature, subject, purpose and board content of general purpose financial reporting”. (Para3, PS5) Accounting Standards specify the ways in which accounting concepts are to be applied in particular circumstances. Their aim is to ‘standardise’ general purpose financial reporting and to improve the quality of financial reporting across the whole range of reporting entities.

Nevertheless, in the event of conflict, Accounting Standards take precedence over CF.

In ethical requirements, APS1 (Para10) states “Members are advised that in the context of the preparation and presentation of a general purpose financial report for a reporting entity or where an entity which is not a reporting entity elect to prepare a general purpose financial report, application of the standards set out in Accounting Standards in mandatory as are the Consensus Views set out in UIG Abstracts”. APS (Para12) to require members to ‘take all reasonable steps within their power to ensure that any departure from’ the CF are properly disclosed and explained. Since APS1 is part of the Code of Professional Conduct, the above means that it is an ethical requirement that members use their best endeavours to guarantee that the CF is practical.

Moreover, in legal requirements, unlike Accounting Standards application of the CF is not mandatory for entities subject to the Corporations Law. Nevertheless, APS1 (Para21) reminds members that they should refer to the CF for guidance on an accounting treatment or a disclosure issue in the absence of an Accounting Standard or UIG Consensus View on the matter concerned. PS5 (Para6) support the use of the CF as guidance in the absence of other pronouncements. It should also be noted that CF is mandatory for certain Australian Reporting entitles such as Public Sector entitles which is not subject to the Corporations Law are required by legislation or ministerial directive to apply the CF. In particular, concepts statements will continue to guide the setting of accounting standards and will also provide guidelines when no standards exist. Moreover, government entities, not subject to the corporation law are required to apply the framework.

Essentially, a CF provides a framework for setting accounting standards, a basis for resolving accounting disputes and fundamental principles which then do not have to be repeated in accounting standards. And once again, in the event of conflict, Accounting Standards take precedence over CF.

Although it may be argued that the role of the framework becomes further complicated by the periodic introduction of new members. Some major difficulties may arise as the CF moves into the area of earnings recognition and as the board membership changes. And the main drawback of the role of a CF is that it can be too general in natural and the principles may, as a result, does not help when actually producing the financial statements.

Based on the identification and analysis, a CF therefore plays a very important role in the standard-setting process, although it is only one of the factors that the accounting standard board takes into account when setting standards. Other factors include legal requirements, cost-benefit considerations, industry-specific issues, and the desirability of evolutionary change and implementation issues.

Question 3: Why does the accounting profession persist with attempts to develop a CF?

Over the years, numerous accounting professions persist with attempts to develop a CF to define the nature and purposes of financial reporting in order to achieve consistency of Standards.

Much has been said and written about a CF for accounting, as stated by Muller (1985), ‘so the focus on the three paramount reasons to establish one: to describe existing practice, to prescribe future practice and to define key terms and fundamental issues.’ However, there is no single framework can satisfy more than one these three objectives. In fact, there are barriers to setting up a framework that will meet even one of them. The reason is because it is difficult to establish a CF as not everyone agrees about what actually exits and what is currently in practice (Miller, 1985).

History and motivation of a CF

First of all, the professional accounting bodies in USA, the UK and Canada have taken an opportunity to issue statements about the nature, purposes and limitations of published financial statements of companies, but none of them ever seriously suggest that any of these statements should be merited the title ‘CF’ (Peasnell, 1982).

In a sense, the motivation for the FASB to develop its framework grew out of observations about the difficulties that its predecessor, the Accounting Principles Board (APB), had experienced. From its inception, the APB was urged to develop a conceptual basis for its decisions delegated by the AICPA in the 1958 report, and required to work on both concepts and standards on the grounds that such concepts would provide a meaningful foundation for standards. In response, the APB commissioned two research studies on the “postulates” and “broad principles” of accounting. However, after reviewing the studies, the APB concluded that the recommendations contained therein were “too radically different” from existing generally accepted accounting principles for acceptance at that time (Peasnell, 1982).

The study resulted in a third force for change which is included Moonitz and Sprouse-Moonitz monographs. These publications questioned the foundations of the traditional historic cost model and suggested alternative approaches (Peasnell, 1982).

The APB seemed to abandon hope that fundamental research might provide a logical foundation for pronouncements on accounting principles. In 1970, the board approved APB Statement No.4 (APBS4). However, APBS4 was “primarily descriptive, not prescriptive” focusing on what financial accounting was at the time rather than what it ought to be. Since it was backward looking, it did not provide robust guidance to the APB in setting standards (Peasnell, 1982).

Soon afterward, due to the criticism the APB was receiving, the AICPA appointed two study groups- Wheat Report and the Trueblood Report to consider the establishment of accounting principles and the objectives of financial statements. The recommendations of those groups laid the foundation for the FASB and for its CF project (Peasnell, 1982).

In 1973, the FASB’s project was the one that embraced the objectives of financial reporting called Trueblood Study Group, which focused on what might be thought of as “first principles,” that is the objectives of financial statements. The FASB laid a sound foundation on which to develop the subsequent concepts that constitute the CF (Peasnell, 1982).

In 1975, the Accounting Standards Committee (ASC) developed a discussion paper- The Corporate Report, with emphasis placed in the discussion paper on greater disclosure, including statements of ‘future prospects’ and ‘corporate objectives’. Also, the publication of the Sandilands Report drew attention away from The Corporate Report to the contribution of both documents to ‘the fundamental problem of measurement of profit’. The ‘great inflation accounting debate’ has occupied the centre of the stage ever since, and the far more fundamental issues concerning the scope and nature of financial reporting dealt with in The Corporate Report has received scant attention. The discussion paper has faded away into history- one suspect to the profession’s great relief (Peasnell, 1982).

The latest attempt to develop a CF comes from Canada (CICA, 1980) which produced Corporate Reporting. Corporate Reporting attempts to deal with the subject of what a CF is for and how it is intended to assist standard setters. If this case holds true, Corporate Reporting opts for an evolutionary approach and sees the function of a CF as providing objectives and criteria which CICA’s Accounting Research Committee can use not in a strictly deductive fashion but as tools in developing standards in a manner similar to common law (Peasnell, 1982).

In fact, the key motivators of why accounting profession persist with attempts to develop a CF over the years is because there are several benefits from the CF in developing and reviewing of the Standards. In Australia, the benefits which the AARF originally thought would emanate from successful framework are outlined in the Para7 of Policy Statement 5:

…more consistent and logical…
Increased international compatibility…
…more accountable for its decisions…
…communication…be enhanced…more apparent when the AASB seeks public comment on them

…more economical…for the AASB and the UIG in their decision-making

Although the Board continues to utilise the framework in making decisions, most of the framework was developed 20 or more years ago and has not been kept up with changing business practices, hence it needs to be updated and refined. Moreover, certain aspects of the framework are inconsistent with other aspects of Standards, and those inconsistencies are currently being review, for example some of the Standards are based on the matching approach, such as AASB120, however it is contradicted with the CF as it is based on the balance sheet approach (Para95, the Framework). Furthermore, some parts of the framework that originally were not ultimately completed, even though conceptual guidance in those areas continues to be needed. For those reasons, the framework is gradually becoming less helpful in providing guidance to the board for making standard-setting decisions.

It is appropriate to conclude in this question that the existing CF is to serve as a guide for the standard setters, which provide them with a set of objectives and constraints, and it serves as a basis for resolving accounting disputes when standard-setters and the preparers encounter any difficulties which the Standards do not serve. Moreover, the CF provides the fundamental principles, so that they do not have to repeat in the Standards.

Currently, the accounting professions persist with attempts to develop a CF as in order to meet the changing world and to pursue the appropriate structure for a ‘real’ CF designed to provide a base for the standards. Ultimately, the purpose is to provide a ”true and fair” view in financial reports for the users in making and evaluating decisions about the allocation of scare resources.

Conclusion

Many believe that a framework will help in the standard-setting process but cautions that because of the complexity of accounting policymaking, the framework alone is not enough. The framework is desirable but it is not sufficient.

Reflecting back to the statement ‘In a politically charged rulemaking environment, conceptual frameworks have only limited utility’, it is appropriate to conclude that accounting professions persist with attempts to develop a CF because of they trying to structure a CF designed to provide a base for the standards programme which is the accounting profession’s holy grail. Although it has its limitations, it is still playing a very important role in consistency and standardisation of standards setting and reviewing, furthermore it provides a quality and quantitative guideline in the preparation of financial reports.

References

Australian Society of Certified Practising Accountants and the Institute of Chartered Accountants in 2005, Accounting Handbook. Volume 1, latest Edition, Prentice Hall, Sydney.

APS 1: 'Conformity with Accounting Standards' and 'UIG Consensus Views', paragraphs 10–19.

Godfrey, J, Hodgson, A, & Holmes, S, 2003, Accounting Theory, 5th Edition, Wiley, Milton.

Hoggett, J & Edwards, L, 2000, Accounting in Australia, 4th Edition, Wiley, Milton.

Horngren, Charles T. April 1981. “Uses and Limitations of a CF”. Journal of Accountancy.

Johnson, L.T. December 2004. “The Project to Revisit the Conceptual Framework”.

McGregor, Warren, December 1990. “The CF for General Purposes Financial Reporting: Its Nature and Implications”.

Miller, Paul B.W, March 1985. “The CF: Myths and Realities”. Journal of Accountancy, pp. 62-71.

Peasnell, K.V, 1982. “The Function of a CF for Corporate Financial Reporting”.

Policy Statement 5: 'The Nature and Purpose of Statements of Accounting Concepts'.

Urgent Issues Group Abstract 11, Accounting for Contributions of, or Contribution for the Acquisition of, Non-Current Assets, 1996, Australian Accounting Research Foundation.