By the end of this week, you will be able to:

• Gain a better understanding of IASB organization;

• Familiarize IASB conceptual framework for financial reporting.

Week Three Learning Objectives

Prepare for FAT Week Three

• Alexander et al (textbook), Chapter 4.

• Deegan & Unerman (textbook), Chapter 6.

• IFRS Conceptual Framework Project Summary (March 2018). Conceptual Framework for

Financial Reporting.

FAT Lecture and seminar

Theories of accounting regulation

Case study: Accounting war on expensing stock options.

Reflection on previous week

Mike Zhao

IASB, and International Accounting

Conceptual Framework

FAT Week Three Lecture

Two main models of financial accountingAnglo-American model

• Accounting system is strongly influenced by professional accounting bodies rather than government.

• It emphasises the importance of capital markets. (most of companies long-term funds come from public sources of equity and debt finance).

• It relies on terms such as ‘true and fair’ or ‘presents fairly’, which in turn are based on considerations of economic substance over legal form.

Continental European model

• Relatively small influence from the accounting profession, little reliance on qualitative requirements such as true and fair, and stronger reliance on government.

• Accounting methods tend to be heavily associated with the tax rules, and the information tends to protect the interest of creditors rather than investors. (most of companies long-term funds come from family sources, governments or lenders, often banks).

Creation of IASC

IASC (International Accounting Standards Committee): predecessor of IASB. • Created in 1973 • Objective: formulate and publish, in the public interest, accounting standards to be observed

in the presentation of financial statements and promote their worldwide acceptance and observance; and work generally for the improvement and harmonisation of regulations, accounting standards and procedures relating to the presentation of financial statements.

Henry Benson • Elected president of Institute of Chartered Accountants of England and

Wales (ICAEW) • First chairman of IASC.

IASC to IASB

International Accounting Standards (IAS) permitted a wide range of accounting options. • Does not enhance comparability and understandability of financial statements. • Not accepted by Securities Exchanges as a basis for reporting.

International Organization of Securities Commissions (IOSCO) • The demand for a single set of rigorous international accounting standards. • IAS is expected to be more standardized. • A revised IAS was accepted by IOSCO in 1999.

IASC was replaced in 2001 by the IASB • Adopted all existing IAS • From 2001 has been publishing new regulations in the form of IFRS.

Organ Function

IFRS FoundationGovernance, funding; appoint members for IASB, IFRSIC and Advisory Council.

IASB Standard setting (10 of 16 members to approve IFRS).

IFRS Interpretations Committee Interpret the application of IAS and IFRS, and provide timely guidance on financial reporting issue.

The Monitoring BoardParticipate in the process for appointing the trustees and approve the appointment of the trustees.

The IFRS Advisory Council Give advice to IASB and trustees.

Within IASB

Due process

Due process.

The aim of this elaborate due process of standard setting is that all constituent parties from the different regions of the world participate in this process • “accountants, financial analysts and other users of financial statements, the business community,

stock exchanges, regulatory and legal authorities, academics and other interested individuals.”

Overriding its own due process during 2008 financial crisis.

• Political pressure from French government and European Commission forced the Board to bypass its own due process when making amendments to standards in relation to financial instruments.

• The amendment to IAS 39 to enable the reclassification - allow European financial institutions to reclassify their holdings as ‘held to maturity’ and back-date the change.

• Financial institutions would not have to report huge losses for their third quarter of 2008.

International Harmonisation of Accounting

• In 2002 EU agreed that from 1 January 2005 all companies whose shares were traded on any securities exchange in the EU would have to compile their consolidated accounts in accordance with IAS/IFRS. But each IAS/IFRS would have to be endorsed separately by the EU before becoming mandatory for listed companies in the EU.

• While the IASB develops standards, it does not have any power of enforcement of their use in particular jurisdictions.

• Despite the reforms to IASB and IFRS Foundation, IFRS/IAS have still not been accepted by the US Securities Exchange Commission as an adequate basis for the preparation by US companies.

IASB Conceptual Framework - 2018

Purpose of the Conceptual Framework for Financial Reporting

The three main purposes of the 2018 IASB Conceptual Framework are:

• To assist the Board in the development of individual IFRS Standards while making sure that IFRS as a body of financial reporting standards is coherent and based on a consistent logic and set of principles.

• To assist preparers of financial statements in applying IFRS Standards when no individual standard applies to a transaction or recordable event, or when IFRS Standards allow a choice of accounting policy.

• To assist all parties in understanding and interpreting IFRS Standards.

Chapter 1 - The objective of general purpose financial reporting

Primary users of general purpose financial reports are existing and potential investors, lenders and other creditors who cannot require reporting entities to provide information directly to them and must rely on general purpose financial reports for much of the information they need. • Other parties, such as regulators and the general public, may find general

purpose financial statements useful, but the Board does not consider them primary users.

Chapter 1 - The objective of general purpose financial reporting

The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions relating to providing resources to the entity. Those decisions involve decisions about: • buying, selling or holding equity and debt instruments; • providing or settling loans and other forms of credit; or • exercising rights to vote on, or otherwise influence, management’s actions that

affect the use of the entity’s resources.

Decision-usefulness theory

Particular information is for particular classes of users on the basis of decision-making needs. • Decision-makers emphasis: ask what information users want. • Decision-model emphasis: researcher’s perception of what is necessary for

efficient decision making.

The aim of general purpose financial reporting must be to provide information that is useful to users.

Chapter 1 - The objective of general purpose financial reporting

According to the 2018 IASB Conceptual Framework, investors require information about the financial reporting entity’s:

• financial position

• financial performance on an accruals basis

• financial reporting as past cash flows

• the changes in economic resources and claims not resulting from financial performance.

Chapter 2 - The qualitative characteristics of useful financial information

If financial information is to be useful, it must be relevant and faithfully represent what it purports to represent. The usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable.

Fundamental qualitative characteristics Enhancing qualitative characteristics

Relevance Comparability

Faithful representation Verifiability

Timeliness

Understandability

• The cost constraint on useful financial reporting.

Chapter 3 - Financial statements and the reporting entity

Underlying assumption: going concern • an entity is a going concern and will continue in operation for the foreseeable

future. • the entity has neither the intention nor the need to liquidate or curtail materially

the scale of its operations in the foreseeable future.

Chapter 4 - The elements of financial statements

• Asset: a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits.

• Liability: a present obligation of the entity arising to transfer an economic resource as a result of past events.

• Equity: the residual interest in the assets of the entity after deducting all its liabilities. • Income: increases in assets or decreases in liabilities, other than those relating to

contributions from holders of equity claims. • Expenses: decreases in assets or increases in liabilities, other than those relating to

distributions to holders of equity claims.

Chapter 5 - Recognition and derecognition

Recognition: The process of capturing, for inclusion in the statement of financial position or the statement(s) of financial performance, an item that meets the definition of one of the elements of financial statements – an asset, a liability, equity, income or expenses.

Derecognition: The removal of all or part of a previously recognized asset or liability from an entity’s statement of financial position.

Not all items that meet its definition will be recognized in financial statements.

Chapter 6 - Measurement

The 2018 IASB Conceptual Framework introduces four measurement bases: • Historical cost. • Fair value. • Value in use • Current cost.

Elements recognised in financial statements are quantified in monetary terms. This requires the selection of a measurement basis. A measurement basis is an identified feature – for example, historical cost, fair value or fulfilment value – of an item being measured. Applying a measurement basis to an asset or liability creates a measure for that asset or liability and for related income and expenses.

Chapter 6 - Presentation and disclosure

The statement of profit or loss is the primary source of information about an entity’s financial performance for the reporting period. All income and expenses are classified and included in either: • the statement of profit or loss, or • outside the statement of profit or loss, in other comprehensive income.

Recycling: In principle, income and expenses included in other comprehensive income in one period are recycled to the statement of profit or loss in a future period when doing so results in the statement of profit or loss providing more relevant information or a more faithful representation.