The Conceptual Framework of Financial Reporting and Its Roles

This article discusses the Conceptual Framework of Financial Reporting, its roles, benefits, and gaps. It also covers the importance of prudence and substance over form concepts in financial reporting. The article cites various sources to support the arguments presented.

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Question 1
Financial reporting is an important part of organization that requires standards in preparations for
informed financial decisions. Financial statements need to be prepared using generally accepted
accounting principles and theories that form conceptual framework basis. Conceptual
Framework refers to a system of objectives and ideas that form basis for development of
consistent standards and rules in financial reporting (Weil, Schipper, and Francis, 2013). The
Conceptual Framework of 2010 amendments is proposed by the International Accounting
Standards Board (IASB).
The Conceptual Framework has several roles in financial accounting and financial reporting.
First, the conceptual framework was to assist the IASB in developing future International
Financial Reporting Standards (IFRS) and reviewing existing IFRSs (Deegan, 2012). Secondly,
the Conceptual Framework of 2010 has a role to assist IASB in promoting rules and standards
that set nature, functions, and limits of financial statements and financial accounting. The
objective was to harmonize accounting standards, regulations, and procedures that enhance the
usefulness of financial reports in making economic decisions (Shortridge, and Smith, 2009).
Thirdly, the Conceptual Framework of 2010 was to assist financial preparers in developing
accounting policies where a transaction has no existing standards. Another role of Conceptual
Framework of 2010 was to assist individual countries in developing their national standards for
financial reporting. Lastly, the Conceptual Framework was to assist auditors form opinion on
financial statements if they comply with IFRS and users of financial reports in interpreting
financial information.
The Conceptual framework of 2010 has lead to several benefits in financial reporting. The
benefits have been realized by different stakeholders who have interests in the financial reports
of companies. These stakeholders include accounting policy makers, investors/shareholders,
management, lending institutions, and auditors. One of the benefits of the Conceptual
Framework is that it has offered a guideline to formulating accounting policies. It has enabled
countries develop national based accounting standards and companies’ board of management
develop policies that enhance consistent financial reporting. Secondly, Conceptual Framework
has enabled standardization of accounting standards (Deegan, 2012). It has formed basis within
which accounting standards are developed enhancing standard financial reporting. Another

benefit of Conceptual Framework of 2010 is that it has improved usability of financial reports. It
outlines of foundations to be used for developing standards and generally accepted principles of
accounting has enabled financial information users to make better and informed financial
decisions. Auditors have also benefited has their work was made easier when giving their
opinion on financial statements of a company.
The 2010 Conceptual Framework had gaps that caused problems in the accounting conceptual
framework. These problems have lead to Conceptual Framework being criticized and has
prompted need for it revision. One of the problems with the 2010 Conceptual Framework is that
it was not comprehensive. The conceptual framework did not cover or offered little guidance in
some areas such as on measurement, disclosure, presentation, or identification of a reporting
entity. Another problem is that some of the Conceptual Framework areas were unclear. For
instance, some definitions were not well explained and needed clarification.
The Conceptual Framework 2010 was criticized because it failed to capture some aspects that are
important in financial reporting. One of the criticisms was that the Conceptual Framework had
some aspects that were out of date. These aspects failed to reflect the IASB current thinking. For
instance, the Conceptual Framework stated that liability or asset should be recognized in the
financial statements only when they are probable that there is economic resources flow
(Langmead, and Soroosh, 2009). This is contrary to IABS that states all assets or liabilities
should be recognize whether there is economic resource flow or not because they provide useful;
financial information for financial decisions.
Question 2
(a). We all recognized the importance of financial reporting. According to our group, the
objective of general purpose financial reporting is to communicate financial performance of an
entity within a specific period of time. Financial reports comprehensively show all transactions
that an entity undertook in a certain accounting period and their economic resource flow. This
means that financial reports do capture all activities and other decisions that are made by a
company. For instance, financial reports show acquisition, expenses, and revenues that are as a
result of decisions made by management and actions undertaken by employees. Financial reports
also outline profit and earnings per share achieved by a company in a financial year. This is

important to investors and future investors of the company. From this argument, financial
reporting is a communicator and indicator of performance. This means that financial reports have
an ability to communicate decisions and activities undertaken in an organization when accurately
transactions are accurately recognized, measured, and recorded Van (Greuning, Scott, and
Terblanche, 2011). Therefore, the objective of general purpose financial reporting should be
communicating an entity performance through financial performance.
(b) We agree with the board decision to change formal description of the objective of financial
reporting to include an explicit reference to stewardship. The stewardship objective recognizes
the role that the management has to the performance of an entity. The management makes
decisions on how resources are allocated hence determining optimization of investment returns
in a company. Efficient allocation of resources means that the company will minimize cost and
maximize profit. Efficient allocation enhances financial performance of an organization by
ensuring expenses are minimal and revenue is maximized. Secondly, stewardship explicit
description by the board enhances management assessment in terms of ability to increase wealth
of the company. Styles and qualifications of one organization management are different to
another organization that affects performance. This entails that different management team are
capable of performing better than others. This therefore means that understanding the
management is an important aspect to making decisions either to invest or not to invest. The
decision to include explicit description of stewardship by the IASB recognize that financial
statements are indictors of management accountability, ability to make economic decision and
can be used by investors to make decisions on investment (Zimmerman and Yahya-Zadeh,
2011). Therefore, we agree with the board decision to change the formal description of the
objective and include stewardship because it is in line with the board mission of providing useful
information to financial information users.
Question 3
(a) Prudence in accounting is recognizing future losses but not gain. Prudence is an
accounting principle that is conservative and aim to underestimate gains and overestimate
losses. The ideas of prudence put forward that it safe to overestimate losses and
underestimate gains for the purpose of management. The management is able to make
better financial decisions when they overestimate spending and losses than when they are

underestimated (Măciucă, Hlaciuc, and Ursache, 2015). On the other side, the
management prefers to underestimate assets and income than overestimate them realize
the actual value is below estimate in a future date. Therefore, prudence is an idea of
“playing safe” when recording financial amount while anticipating future uncertainty of
the actual value.
Asymmetrically prudent leads to understatement of an entity’s income in one accounting
period but leads to overstatement in future accounting periods. Asymmetric prudence
recognizes losses earlier than gains. This principle put forward that losses are included in
the current financial statements while gains are recognized in a future date (Beest, Braam,
and Boelens, 2009). The anticipated losses are then recognized early in the current
financial year reducing the current income that lead to understatement. The recognition of
gains in a future gain after they were earned in a previous accounting period leads to
overstatement of an entity’s income in the following year (Weygandt et al., 2010).
Therefore, applying asymmetric prudence to record uncertainty leads to understatement
of the current financial year income and overstatement of income in the future financial
periods.
(b) We agree with the board decision to reintroduce prudence in the Conceptual Framework.
Prudence concept will ensure no estimates done on revenues are overestimated or
expenses underestimated in financial statements (Kieso, Weygandt, and Warfield, 2010).
This means that revenue transactions or assets will be recorded when an entity is certain
while expense transactions or liabilities will be recorded when it probable. The concept
will ensure profits are not recognized until the transaction is certain. We agree that
prudence concept is useful for making decisions that are under uncertain conditions. The
prudence concept removes false optimism to users of financial information. The concept
ensures that no gains are recognized in the financial statement that the company is not
certain and recognize all expenses that are uncertain. This makes the financial
information to be very conservative representing the financial pessimistic performance
for an entity (Pronobis and Zülch, 2010). Prudence concept therefore considers the aspect
of risk when reporting financial information. Risk is important to financial information n

users who use on financial statement to make informed decisions (Măciucă, Hlaciuc, and
Ursache, 2015). Therefore, we agree with the board decision to reintroduce prudence
because it considers uncertainty when recording financial information that enable
financial information users to be more informed when making financial decisions.
Question 4
Substance of over form concept is an accounting principle that is used when preparing
financial statements by ensuring they are accurate, relevant and complete reality of
transactions and events. This means that financial statements shows overall financial
realty rather than legal for of an event or transaction. The substance over form principle
requires financial statements and disclosures of an entity to reflect underlying accounting
transactions. The financial statements should not just comply with legal forms as they
appear. The substance over form therefore means that transactions are recorded when
they have financial or economic impact to an entity and not necessary when they have
legal form. The concept aim is to ensure no information is withheld or introduced in
financial statement with legal form without an accounting transaction that can mislead
users of financial information (Schroeder, Clark, and Cathey, 2011). For example, a
company can create bills and have paperwork for a customer whose products have not
been exchange. In this case the paperwork legitimizes the process but the product have
not been transacted thereby the transaction cannot be recorded because no accounting
transaction has taken place. Another example is where a company can acquire a lease
property without legal documents. In this case the transaction will be recognized in the
financial statements because there is an accounting transaction (financial realty) that is
involved in the event.
(c) We agree with the board on the decisions to state that faithful representation of a
transaction represents substance of an economic phenomenon instead of legal form.
Faithful presentation ensures all financial realities in an entity are recorded. Legal form
can exist in paperwork without affecting an entity financial reality. This means that only
faithful representation has economic phenomenon and should be recognized in financial
statements. Substance over form principle ensures the conceptual framework capture the

economic reality of a transaction instead of legal write-up that can cause misstatements
(Power, 2010). The board decision will therefore enhance completeness, accuracy, and
relevancy of financial information prepared. The users of financial information will make
better informed decisions using financial statement prepared in compliance with IFRS
standards. They will be able to get the true financial position of a company before they
make a financial decision. Therefore, we agree with substance over form concept being
stated by the board because it will enhance the reliability of financial information.

References
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