What is the purpose of the Conceptual Framework?
If there were no framework for preparing financial statement, accounting standards would be developed in a random, haphazard way to deal with issues as they arise. This would result in standards which would be inconsistent with each other or legislation.
By having a single conceptual framework, preparers and users of financial statements understand that accounting practices and accounting standards are based on this common ideology.
A framework also provides guidance for unusual transactions, which may be otherwise open to interpretation. Some people believe that by having a conceptual framework, it improves the credibility of the accounting profession overall.
Advantages and disadvantages of an Alternative System (rules based)
An alternative system to using a conceptual framework is a rules based one, whereby detailed rules govern and guide the preparation of financial statements.
This type of system is open to abuse as management may try ‘creative accounting’ methods to provide biased information whilst still complying with the relevant accounting standards and regulations. It is more difficult to evade wide-ranging principles than detailed rules.
Another disadvantage of having a rules-based system is that the creation of accounting rules may be influenced by certain parties, such as large companies or lobby groups. Influence is harder to exert when using a principles-based system guided by a conceptual framework.
Despite these problems, some countries prefer to use a rules-based system as it allows for less management judgement, which may result in mistakes.
Following a conceptual framework can be difficult and lead to overly complex accounting standards which may be hard for the end users to understand and apply. That said, a system of overly complex and detailed rules is also hard to apply.
The IASB Conceptual Framework
Many parts of financial statements are based on judgement, models and estimates rather than exact positions. The IASB Conceptual Framework provides the concepts underlying those judgements, estimates and models.
The Conceptual Framework sets out the concepts and ideas that underline the preparation and presentation of financial statements for external users.
The Conceptual Framework addresses:
- The objective of financial reporting;
- the qualitative characteristics of useful financial information;
- the reporting entity
- the definition, recognition and measurement of the elements from which financial statements are constructed; and
- concepts of capital and capital maintenance.
7 points to know about the purpose of the IFRS Conceptual Framework
The purpose of the Conceptual Framework is:
- to assist the IASB in the development of future accounting standards and in its review of existing accounting standards, ensuring consistency across standards
- to assist the IASB in promoting harmonisation of regulations, accounting standards and procedures relating to the presentation of financial statements by providing a basis for reducing the number of alternative accounting treatments permitted by accounting standards,
- to assist national standard-setting bodies in developing national accounting standards;
- to assist preparers of financial statements in applying international financial reporting standards and in dealing with topics that have yet to form the subject of an accounting standard.
- to assist users of financial statements in interpreting the information contained in financial statements prepared in compliance with international financial reporting standards;
- to assist auditors in forming an opinion on whether financial statements comply with international accounting standards; and
- to provide those who are interested in the work of the IASB with information about its approach to the formulation of accounting standards.
Keep in mind this Conceptual Framework is not an accounting standard itself, and it doesn’t override the requirements of any existing accounting standard.
Occasionally, an accounting standard may conflict with the Conceptual Framework, although this is rare. When this happens the requirements of the accounting standard override the requirements of the Conceptual Framework.