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BAO 3309 Research Assignment Footscray Park

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Course Code: BAO 3309
University: Victoria University

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Country: Australia

Question:
With reference to the IFRS (IASB) website and associated resources, as well as the relevant accounting literature, explain the objectives and purpose of the conceptual frameworkWith reference to the IASB Conceptual Framework Project website and associated resources, as well as the relevant accounting literature, explain why the IASB decided to revise the conceptual framework with specific reference to:a. Measurement, presentation and disclosure;b. Definitions of an asset and liability and recognition criteria; and c. The roles of stewardship and prudence in financial reportingIdentify and explain, according to the IASB, the following main improvements which have been made to the conceptual framework:a. Factors to be considered when selecting a measurement basis;b. The classification of income and expenses in other comprehensive income; and c. Guidance on when assets and liabilities are to be removed from financial statements;4. How does the revised conceptual framework update:a. The definitions of an asset and a liability; andb. The criteria for including assets and liabilities in financial statementsExplain how and why, with reference to the IASB Conceptual Framework Project website and associated resources, information used in assessing stewardship is needed to achieve the objective of financial reporting
Answer:

Why IASB Made a Decision of Revising the Conceptual Framework

Measurement, Presentation and Disclosure

IASB decided to revise the conceptual framework since it did not cover some of the important areas. The existing framework gave a very shallow guidance regarding measurement, presentation and disclosure, as well as identification of a reporting entity (Barker and McGeachin 2013, pp. 601). For instance, the existing framework gives a very little guidance on measurement as well as when specific measurement should be used. With regard to this, IASB recognized the need to revise the conceptual framework in order to provide a more detailed guidance which helps in development of requirements of measurement in relation to discussing cost based measurements, current prices of the market such as fair value, as well as other measurements based on cash flows (Barker 2010, pp. 147).
Furthermore, the existing framework fails to give adequate guidance on presentation and disclosure. Therefore, IASB decided to revise the framework so that it may provide a more detailed guidance that could help in development of useful requirements of presentation and disclosure (Chen, Tang, Jiang and Lin 2010, pp. 222). Particularly, the objective of IASB in revising the framework was to discuss presentation with regard to the objective or purpose of financial statements, concepts of classification, aggregation and offsetting, as well as discussing how financial statements are related (Barth, Landsman and Lang 2008, pp. 468).

Definitions of An Asset And Liability and Recognition Criteria

IASB revised the existing framework because it sought to make improvements in how liabilities and assets were defined, in addition to updating the criteria for their recognition. For instance, the existing framework defines assets as “resources which are controlled by an entity due to past transactions or events, as well as from it is expected that there will be a flow of economic benefits in future”. A liability, on the other hand, is defined by the conceptual framework as “the entity’s current duty or obligation resulting from past transactions or events, which when settled must lead to a flow of resources from the entity”. However, IASB recognized the need of making a clarification to these definitions, thus causing the need to revise the conceptual framework. The aim of this revision was to avoid any misunderstandings by confirming more explicitly that an asset or a liability refers to the underlying resource or obligation of the entity, but not just the mere inflow or outflow of economic benefits as set out by the existing framework (Henry and Holzmann 2011, pp. 91).
Furthermore, according to the existing framework, recognition of assets and liabilities takes place only when there is an inflow or outflow of economic resources. This threshold of probability of assets reflects prudence, which has a significant conflict with neutrality thus causing an urgent need for IASB to make a revision on the criteria for recognizing liabilities and assets (International Accounting Standards Board 2008, pp. 78).

Roles of Stewardship and Prudence In Financial Reporting

The current framework offers management of an entity a discretion to report uncertain economic gains, a matter which is an undermining factor to the credibility of financial reporting. In response to this concern, IASB made a decision of removing or eliminating the prudence concept from the existing framework as well as downplaying stewardship concept and reliability concept, which are significantly related to the concept of prudence (Henry and Holzmann 2011, pp. 92). The framework was revised by IASB with relation to prudence since by allowing the financial statement preparers to be prudent, they will their own judgment in disclosing uncertainties such as estimation of useful life of a depreciable asset, which may interfere with neutrality of financial statements, thus causing them to be biased (Epstein and Jermakowicz 2010, pp. 48).
Key Improvements Made to the Conceptual Framework

Factors Taken into Account during Selection of a Basis for Measurement

In accordance with chapter 6 of revised conceptual framework, IASB suggests that during selection of a measurement basis, preparers of financial statements must select a basis which helps them in presenting fairly the relevant information regarding the entity’s resources and the claims against the entity as well as changes which have occurred in the resources and claims as well. The basis must also seek to present fairly the efficiency and the effectiveness of the management of the entity as well as the board of governance on discharging their roles and duties in the use of the entity’s resources (Macve 2014, pp. 78). The revised framework also sets out that one basis of measurement for all liabilities and assets may not give information which is most relevant and useful to the financial statement users. Furthermore, the revised framework has established that while selecting a basis for measurement for a certain item, the information produced by the measurement in the financial position statement and financial performance statement must be considered. Besides, the benefits of a certain basis for measurement to financial statement users must be adequate enough for justifying the cost. All these factors are various improvements made by IASB with regard to selection of a measurement basis (International Accounting Standards Board 2008, pp. 108).

The Classification of Expenses and Income In OCI

According to section (chapter) 7 of the revised conceptual framework, new improvements have been introduced regarding classification of income and expenses in OCI. The profit or loss and OCI statement gives key information regarding the financial performance of the entity for the financial period being reported on. This section provides that the board may, in exceptional circumstances, make a decision to make an exclusion of expenses or income which arise from a change in current valuation of a liability or an asset, and consider including of those expenses and income in other comprehensive income. This decision may be made by the board if it is considered that the statement of profit or loss will provide information which is more relevant and represented more faithfully. According to chapter 4 of the revised conceptual framework, income is defined as increases in assets or reductions in liabilities in equity, with an exception to those that relate to contributions from equity claims holders. Expenses are defined as increases in liabilities or reductions in assets, except those that relate to distributions made to equity claims holders (International Accounting Standards Board 2008, pp. 89).

Guidance on When to Remove Assets And Liabilities From Financial Statements

Chapter 5 of revised or new conceptual framework provides a fresh guidance on derecognition of liabilities and assets in the financial statements. According to this chapter, derecognition an asset takes place when control of all or part of a recognized asset is lost by the entity. Similarly, a liability is derecognized when there is no present obligation by the entity for either all or part of a liability which had been earlier recognized (Gebhardt, Mora and Wagenhofer 2014, pp. 110). The new framework establishes that the aim of derecognition is to represent fairly, both:

Any liabilities and assets which are retained after the transaction or event which caused them to be derecognized.
The change in the liabilities and assets of the entity due to the transaction or event.

Updates of the Revised Conceptual Framework on the Following

How a Liability and an Asset is Defined

Chapter 4 of revised or new conceptual framework provides main updates on how a liability and an asset are defined. The new framework defines an asset as “a present economic resource which is controlled by the entity due to past transactions or events”. According to the new framework, an economic resource refers to a right with a potential of producing economic benefits (Bauer, O’Brien and Saeed 2014, pp. 211). The following is a summary of the main updates in an asset’s definition, according to the new framework:

An asset is defined as an economic resource, rather than just an inflow of economic benefits.
“Expected flow” is removed or deleted. Economic benefits do not need to be certain or likely to arise.

Decisions on measurement and recognition may be affected by a low probability of economic benefits.

On the other hand, a liability is defined by the new framework as “an entity’s present obligation of transferring an economic resource resulting from past transactions or events (Deegan 2013, pp. 69). An obligation is defined as a responsibility or duty that cannot be practically by the entity (Gebhardt, Mora and Wagenhofer 2014, pp. 109). The following is a summary of the main updates regarding definition of an asset:

A liability is clarified as an entity’s obligation of transferring economic resource, instead of the ultimate outflow of an economic benefit.
“Expected flow” is removed or deleted just like for the above case of an asset.

The criterion of “not being able to be avoided practically” is introduced with regard to the definition of an obligation.

The Criteria For Inclusion of Liabilities and Assets In Financial Statements

The existing criteria for recognition of a liability or an asset were that the item was supposed to be recognized if “it was certain that there would be an inflow of economic benefits to the entity or if the value or cost of the item could be reliably determined”. However, criteria for recognition under the revised framework explicitly refers to the various characteristics of useful information (International Accounting Standards Board 2008, pp. 88). These characteristics include:

Relevance

Whether or not recognition of the item of asset or liability would lead to relevant information is influenced by uncertainty of existence and low probability of economic benefits flow (Gebhardt, Mora and Wagenhofer 2014, pp. 107).

Faithful representation

This is affected by uncertainty of measurement, inconsistency in recognition of the asset or liability, as well as presentation and disclosure (Whittington 2008, pp. 140).
List of References
Barker, R., 2010. On the definitions of income, expenses and profit in IFRS. Accounting in Europe, 7(2), pp.147-158.
Barker, R. and McGeachin, A., 2013. Why is there inconsistency in accounting for liabilities in IFRS? An analysis of recognition, measurement, estimation and conservatism. Accounting and Business Research, 43(6), pp.579-604.
Barth, M.E., Landsman, W.R. and Lang, M.H., 2008. International accounting standards and accounting quality. Journal of accounting research, 46(3), pp.467-498.
Bauer, A.M., O’Brien, P.C. and Saeed, U., 2014. Reliability makes accounting relevant: a comment on the IASB Conceptual Framework project. Accounting in Europe, 11(2), pp.211-217.
Chen, H., Tang, Q., Jiang, Y. and Lin, Z., 2010. The role of international financial reporting standards in accounting quality: Evidence from the European Union. Journal of international financial management & accounting, 21(3), pp.220-278.
Deegan, C., 2013. Financial accounting theory. McGraw-Hill Education Australia.
Epstein, B.J. and Jermakowicz, E.K., 2010. WILEY Interpretation and Application of International Financial Reporting Standards 2010. John Wiley & Sons.
Gebhardt, G., Mora, A. and Wagenhofer, A., 2014. Revisiting the fundamental concepts of IFRS. Abacus, 50(1), pp.107-116.
Henry, E. and Holzmann, O.J., 2011. Conceptual framework revisions: Say goodbye to “Reliability” and “Stewardship”. Journal of Corporate Accounting & Finance, 22(3), pp.91-94.
International Accounting Standards Board, 2008. An Improved Conceptual Framework for Financial Reporting: Chapter 1, the Objective of Financial Reporting; Chapter 2 Qualitative Characteristics and Constraints of Decision-useful Financial Reporting Information: Exposure Draft. The Board, pp. 78-188.
Macve, R., 2014. What should be the nature and role of a revised Conceptual Framework for International Accounting Standards? China Journal of Accounting Studies, 2(2), pp.77-95.
Whittington, G., 2008. Fair value and the IASB/FASB conceptual framework project: an alternative view. Abacus, 44(2), pp.139-16

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