Conceptual Framework and General Purpose Financial Reporting in Accounting

This document discusses the importance of conceptual framework and general purpose financial reporting in accounting. It explores the benefits and criticisms of conceptual framework, the relevance of providing relevant information to external users for decision making, the concept of prudence in financial statement reporting, the concept of substance over form, and the concept of faithful representation.

ACCOUNTING
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Question 1
Conceptual framework has been framed with the underlying objective of achieving
consistency with regards to accounting standards particularly with regards to underlying
principles of recognition, measurement and disclosure. This in turn would ensure that there is
neutrality of financial reporting from standards. The key benefit of conceptual framework is
that it provides the key theoretical underpinnings on which the financial statements preparers
can base their financial reporting. Besides, it also leads to harmonisation of standards which
is convenient for the various stakeholders in financial reporting (Elliot and Elliot, 2017). The
key problem and criticism with regards to the conceptual framework of 2010 is that it tends to
focus only on defining the basis of the key terms such as asset and liability but does not tend
to answer with regards to the application of these to the emerging issues such as leases
(Deegan, 2014).
Question 2
The key objective of the general purpose financial reporting is to provide relevant
information to the external users so that prudent decision making with regards to allocation of
scarce resources can be undertaken. In this regards, it is imperative to indicate that users have
informational needs such as information about performance of the business, financial position
on a given data along with compliance related data. This data is extremely relevant to users
such as shareholders, creditors, lenders and regulators as these stakeholders engage in
decision making with regards to their relationship with the business based on the financial
reporting (Dunn, 2010).
Also through the general purpose financial reporting the underlying accountability that
management owes to the users is discharged. This is primarily because various users tend to
have certain expectations from the firm which the management is expected to fulfil. For
instance, the shareholders would expect improved financial performance, lenders would
expect compliance with the debt covenants, creditors would expect a robust financial position
while regulators would expect compliance with the relevant regulations. Financial reporting
thereby allows the various users to access whether the business is meeting their respective
expectations and hence take decisions with regards to allocation of scarce resources (Deegan,
2014).

Question 3
Prudence is a concept in financial reporting which typically implies that the management and
accountants should be conservative with regards to reporting of financial statements.
Typically financial statements preparation requires a host of management assumptions which
as per prudence concept need to be conservative so that the financial statements do not
project any optimistic scenario. Similarly, on part of the accountants it is expected that the
revenues are not overestimated while ensuring that expenses are not underestimated. Hence,
prudence concept essentially is required to lead to conservative financial statement reporting
(Elliot and Elliot, 2017).
Asymmetric prudence essentially refers to having a lower threshold for liability and expense
recognition while a higher threshold for asset and revenue recognition. This idea seems to be
loggerheads with the neutrality principle whereby it is expected to be neutral rather than
being conservative. Asymmetric prudence can potentially lead to understatement of income
in a given period owing to overestimation of expenses and underestimation of revenues.
However, the same would be reflected in the future periods as overstatement of income as the
expenses would be under-reported while revenues would be over-reported. This potentially
leads to the risk of ensuring misrepresentation of financial statements both in the present and
the future, therefore requiring to be careful while adhering to asymmetric prudence (Deegan,
2014).
Question 4
a) Substance over form is an accounting concept as per which for fair and accurate
representation of the entity affairs, it is imperative that the events and transactions should be
recorded in a manner so as to reflect their economic substance rather than focusing on their
legal form. This therefore requires the financial statement prepares to ensure that financial
statements tend to reflect the implications of various transactions to the underlying business
rather than reporting in isolation to the underlying business.
For instance, IAS 17 with regards to leases requires that financial statement preparers
consider the lease substance when determining if the lease is operating or finance. Hence, a
situation may arise where asset lease in favour of lessee may be done without provision of
title transfer at the end of the asset life. In such cases, substance based recognition would lead

to classification of lease as finance especially if the asset is leased for a significant portion of
asset useful life. An additional example could relate to the sale and buyback of inventory
which in legal terms would lead to realisation of revenue and cost but in substance no
revenue should be realised (Finch, 2008).
b) Yes, I agree with the assertion that faithful representation would imply substance rather
than only legal. This is because the focus of faithful representation is top highlight the
implication of various events and transactions for the business rather than highlighting only
the legal form. For instance, with regards to mining, it makes sense to disclose contingent
liabilities and any implications of the current or likely future lawsuits. While for certain
businesses, there may not be material but for certain businesses, these are highly relevant. In
this light, faithful representation requires the substance of various events to the captured by
the financial statements (Melville, 2011).

References
Deegan, C. (2014). Financial Accounting Theory, 4th ed. Sydney: McGraw-Hill
Dunn, J. (2010) Financial Reporting and Analysis. 3rd ed. London: John Wiley and Sons.
Elliott, B. and Elliott, J. (2017) Financial Accounting and Reporting, 18th ed., Harlow :
Financial Times Prentice Hall
Finch, C. (2008) A student’s guide to International Financial Reporting Standards.
Wokingham: Kaplan Publishing.
Melville, A. (2011) International Financial Reporting. 3rd ed. Harlow: Financial Times
Prentice Hall