Financial
Accounting Home Page
My Accounting Concepts Original Page
My Conflicts in Accounting Concepts Page
The ASB's Summary
of the requirements of FRS 18
My page on the Objectives of Accounting
My page on Transfer Pricing starts here
My Accounting Concepts and Conventions as posted by AccountingWEB
Accounting Concepts and Conventions:
An update to include FRS 18 and the IASB Framework
Introduction
I wrote the original version of this page several years ago, when Statement of Accounting Practice 2: Accounting Principles (SSAP 2) was in force. The idea behind that page was to introduce students and other interested parties to the basic underlying ideas behind the work of the accountant. After all, even students of accounting and business are not always clear about the role and work of the accountant, let alone Joe Public.
In addition to that original page, I recently added pages that concerned the objectives of accounting and some of the basic rules underlying the UK requirements for the publication of accounting statements.
Finally, my original Accounting Concepts and Conventions page was posted by AccountingWEB on their site on 17 January 2002 and it gave rise to a couple of comments: principally to the effect that I'd mentioned SSAP2 but neither Financial Reporting Standard 18 (FRS 18) nor the UK Accounting Standard Board's Statement of Principles for Financial Reporting.
This page brings my original page up to date and it cross references my other pages in this area. Furthermore, it adds a few comparisons with the IASB's Framework.
What www.duncanwil.co.uk Said Before
My introduction to my accounting concepts and conventions page included this:
In the United Kingdom, four of the following accounting concepts are laid down in SSAP 2 … that still remains true: they were introduced by SSAP 2! Those four concepts are:
- Going concern
- Accruals/matching
- Consistency
- Prudence
In addition to those four, I had added:
- Objectivity
- Duality
- Entity
- Cost
- Monetary measurement
- Materiality
- Realization
- Stable money
I felt, and still feel, that these twelve elements provide a good grounding for the starting point of the accountant's work.
SSAP 2 came into effect for accounting periods starting on or after 1 January 1972 and is superseded by FRS 18 for accounting periods ending on or after 22 June 2001.
Around the time that I prepared the concepts and conventions page, I prepared and posted a Conflicts in Accounting Concepts page that will probably also be of interest to readers of this page.
Financial Reporting Standard 18: Accounting Policies
FRS 18 has addressed additional aspects that accountants need to reflect on as they present their work to the world. FRS 18 addresses four more policies:
- Relevance
- Reliability
- Comparability
- Understandability
Whilst the ASB does include mention of timeliness in the context of FRS 18, I feel it ought to have been highlighted as a distinct policy: after all, there have been cases without number of accounting statements having had their publication delayed when to publish would have been both most appropriate and revealing (see below).
FRS 18 also discusses the entity concept and their ideas are highlighted here since they do possibly modify our view of the entity concept.
Has FRS 18 Really Introduced any new Accounting Concepts?
Anyone who has studied the presentation of information and data will already have come across the terms relevance, reliability, comparability, understandability and timeliness: they are at least parts of the foundations of the effective presentation of data: whether it is accounting data, statistical data, demographic data or whatever.
From the data presentation standpoint, therefore, FRS 18 is a side step rather than a forward step.
ASB Guidance on the Choice of Policies
The ASB has a get out clause for accountants who, let me be cynical, may not like these new ideas. In their summary of the requirements of FRS 18, the ASB says:
… the FRS requires an entity to select whichever of those accounting policies is judged to be most appropriate to its particular circumstances for the purpose of giving a true and fair view.
The constraints that an entity should take into account are the need to balance the different objectives, and the need to balance the cost of providing information with the likely benefit of such information to users of the entity's financial statements.
The ASB goes on to summarise further:
An entity's accounting policies should be reviewed regularly to ensure they remain the most appropriate to its particular circumstances. An entity should implement a new accounting policy if it is judged more appropriate to the entity's particular circumstances than the present accounting policy.
The FRS requires specific disclosures about the accounting policies followed and changes to those policies. It also requires, in some circumstances, disclosures about the estimation techniques used in applying those policies.
Source: http://www.asb.org.uk/publications/publication310.html
At the time of writing, I do not know of any company that has fallen foul of this aspect of FRS 18; but would simply make the cheap point that Enron and Maxwell Communications could both have cited such an approach to the choice and application of the accounting policies it chose to follow in their defence of their dreadful behaviour.
The counter argument is one that I actually subscribe to: horses for courses. My current major areas of work bring me into contact with standard Charts of Account that I have precious little time for: entire countries tied to a very restricted Chart that makes no allowance for the obvious differences between companies that operate as manufacturers and companies that operate as a service provider and companies that operate in yet another aspect of business or commerce.
Consequently, the burden must fall on the Auditor and the various Management Committees to enforce FRS 18 and the choice and application of accounting policies.
The True and Fair View: another get out clause?
In line with just about anybody who writes about the meaning of the statement true and fair view, the ASB reveals:
The Statement does not, however, attempt to define the meaning of true and fair.
Source: An Introduction to the Statement of Principles for Financial Reporting.
Another get out clause? I have always found it incredible that whilst the phrase true and fair view was introduced into the UK accounting world just about two decades ago, accounting standard setters have almost always backed away from defining what it means … yet accountants have to apply it!
Having established the phrases True and Fair View; and I admit it is a difficult one to define in such as way that ALL accountants would be satisfied, at least the IASB has a crack:
… what is generally understood as a true and fair view of … information
Source: The IASB Framework, as quoted in IAS Explained page 88
Statement of Principles for Financial Reporting
In the same way that the International Accounting Standards Board (as it now is) has promulgated its Framework for the Preparation and Presentation of Financial Statements, in December 1999 the ASB has published a Statement of Principles for Financial Reporting.
The Statement of Principles is
An accounting standard-setter's conceptual framework or statement of principles describes the accounting model that it uses as the conceptual underpinning for its work ... The Statement is not, therefore, an accounting standard nor does it contain any requirements on how financial statements are to be prepared … it is only one of the factors that the ASB takes into account when setting standards. Other factors include legal requirements, cost benefit considerations, industry specific issues, the desirability of evolutionary change and implementation issues.
Source: An Introduction to the Statement of Principles for Financial Reporting.
The ASB recognizes that the Statement is a work in progress and is, therefore, subject to change. Moreover, they also admit that the Statement drew heavily on the IASB's Framework for the Preparation and Presentation of Financial Statements; and is similar in content to similar documents that standard setters in Australia, Canada, New Zealand and the USA have prepared and published.
The Statement's Main Points
The objectives of financial statements
My page on this subject is comprehensive: take a look and compare it with what the ASB has to say, in summary:
The reporting entity
As I said above, the ASB has reworked the entity concept to the extent that they now define single entities and consolidated entities:
Single entity financial statements … report on the activities and resources under the entity's control … the company is the reporting entity.
Consolidated financial statements report on the activities and resources under the entity's direct and indirect control … the group comprising the parent and its subsidiaries is the reporting entity.
Source: An Introduction to the Statement of Principles for Financial Reporting.
To be frank, I don't really see this as a rework of the entity concept: the traditional entity concept forces us to think in terms of the divorce of personal from business affairs. I don't see the reporting entity idea as contributing to any enhancement of the traditional entity concept: given the way it is presented, it probably never intended to be; but the use of the word entity may confuse or confound!
Relevant, reliable, comparable, understandable
Let me quote in full from the Introduction
Relevant - in other words, if it has the ability to influence the economic decisions of users and is provided in time to influence those decisions
Reliable - in other words, if:
Comparable - in other words, if it enables users to discern and evaluate similarities in, and differences between, the nature and effects of transactions and other events over time and across different reporting entities.
Understandable - in other words, if its significance can be perceived by users that have a reasonable knowledge of business and economic activities and accounting and a willingness to study with reasonable diligence the information provided.
Source: An Introduction to the Statement of Principles for Financial Reporting.
Under the heading of relevance we see the reference to timeliness in the definition of relevant: I think this definition clearly demonstrates why timeliness ought to be included as a separate policy. Any information that is relevant but that is provided late, can lose some or all of its relevance … there's nothing more useless than yesterday's news. Timeliness is much more of an imperative than the ASB is allowing for. The IASB Framework has this to day about timeliness:
If there is undue delay in the reporting of information it may lose its relevance. Management may need to balance the relative merits of timely reporting and the provision of reliable information. To provide information on a timely basis it may often be necessary to report before all aspects of a transaction or other event are known, thus impairing reliability. Conversely, if reporting is delayed until all aspects are known, the information may be highly reliable but of little use to users who have had to make decisions in the interim.
Source: The IASB Framework, as quoted in IAS Explained page 87
At least the IASB has said something useful for the accountant to consider!
The IASB also introduce the idea of substance over form in their discussion of relevance (see The IASB Framework, as quoted in IAS Explained page 86. Again, a concept that was introduced into the UK accounting bear pit a short time ago; but which the ASB has not addressed: not on the parts of the web site that I have seen and not in its Introduction document.
I think the definition of understandable leaves a lot to be desired, too: in order to comply with this policy, we need a:
Plenty of scope for fudge here … apart from that, it's a breeze! The Introduction later says, in apparent contradiction to what I have just shown:
In presenting information in financial statements, the objective is to communicate clearly and effectively. Financial statements should be simple, straightforward and grief as possible while retaining their relevance and reliability. Good presentation avoids adding a mass of material and unnecessarily lengthening the statements.
Source: An Introduction to the Statement of Principles for Financial Reporting.
The ASB does appreciate that financial statements will be subjected to interpretation, simplification, abstraction and aggregation … but that if this is done properly, they will still be of benefit.
The Introduction usefully brings the materiality concept into the discussion. Money measurement is discussed at length and recognition/realization is well discussed too, although the ASB seems to have invented the word derecognised when they ought to have used extinguish or disposal; and later on they invented the word remeasurement when they were discussing revaluation.
Elements of financial statements
The Introduction clarifies what a financial statement should contain:
Assets - rights or other access to future economic benefits controlled by an entity as a result of past transactions or events
Liabilities - obligations to transfer economic benefits as a result of past transactions or events
Ownership interest - the residual amount found by deducting all of the entity's liabilities from all of the entity's assets
Gains - increases in ownership interest not resulting from transfers from owners in their capacity as owners
Losses - decreases in ownership interest not resulting from transfers to owners in their capacity as owners
Source: An Introduction to the Statement of Principles for Financial Reporting.
Measurement in financial statements
The Introduction discusses to measurement regimes for financial statements:
The Introduction also discusses arm's length transactions as being the basis of the acquisition, disposal and measurement in financial statements. As a matter of interest, my page on Transfer Pricing discusses arm's length transactions, albeit in the context of transfer pricing rather than measurement in financial statements.
IASB's Fundamentals discusses four measurement bases in their discussion of measurement of the elements of financial statements. In addition to
They have
Whether UK company law, taxation law and accounting standards accept these latter two options or not, and the ASB itself says that elements of the Statement may contradict current UK legislation, the Introduction could at least have discussed such alternatives; and maybe more.
Accounting for interests in other entities
Finally, the Introduction discusses the importance that the impact of reporting for other entities can have on the reporting entity's own financial statements. Key words here are:
Conclusions
The subject of accounting concepts and conventions is an important one: after all, such concepts really are at the heart of the work of the accountant. At the time of writing the Executives of Enron Inc are receiving subpoenas to appear before Congress in the USA: they and their Auditors, Arthur Andersen, seem to have fallen foul of accounting concepts and conventions if nothing else.
The concepts and conventions discussed here and in my other pages are the starting point for anyone who wants to become an accountant or bookkeeper.
The ASB's contribution to this debate in the form of FRS 18 and their Statement of Principles for Financial Reporting falls far short of a definitive contribution to the debate.
FRS 18 brings about a debate on the basic principles of the presentation of data and information; but not a great deal about the concepts and conventions that we might expect.
The Statement adds elements to the debate in this area; but the IASB Framework is more comprehensive in several areas; and the nature and tone of the Introduction to the Statement makes it difficult to take seriously.
I am pleased to have taken the opportunity to update my concepts and conventions pages and would recommend that anyone who has read so far, makes sure that they read all of my other pages in and around this area.
© Duncan Williamson
9 February 2002 revised August 2003
References
An Introduction to the Statement of Principles for Financial Reporting
The Accounting Standards Board
ASB Publications PO Box 939 Central Milton Keynes MK9 2HT United Kingdom
International Accounting Standards Committee (2000)
International Accounting Standards Explained
John Wiley & Sons
(NOTE: I have referred to the IASB throughout this page even though IAS Explained was published when they were still the IASC).
© Webmaster Duncan Williamson 2002