Conceptual Framework and o With the integration of capital markets, companies

Accounting Standards have expanded choices of where to raise capital,

Module 1: Financial Reporting and Accounting either equity or debt.
Standards o Adoption of global accounting standards.
Learning Objectives
1. Describe the global financial markets and their relation to Accounting
financial reporting. Accounting is the universal language of business.
2. Explain the objective of financial reporting.
3. Identify the major policy-setting bodies and their role in The essential characteristics of accounting are:
the standard-setting process. 1. Identification, measurement, and communication of
4. Discuss the challenges facing financial reporting. financial information about
2. economic entities to
Prelude to Module 1 3. interested parties.

Financial Accounting vs Managerial Accounting

Financial accounting is the process that culminates in
the preparation of financial reports on the enterprise for
use by both internal and external parties.
Managerial accounting is the process of identifying,
measuring, analyzing, and communicating financial
information needed by management to plan, control and
evaluate a company’s operations.
Financial statements are the principal means through
Revolution in International Financial Reporting which a company communicates its financial
o In the past, many countries used their own set of information to those outside it. These statements provide
financial reporting standards or followed standards a company’s history quantified in money terms.
set by larger countries such as those in Europe or in The financial statements mostly provided are:
the United States. 1. Statement of Financial Position,
o Free trade and interdependence of national economies 2. Income Statement (or statement of
is a reality in the global scenario which has brought a comprehensive income),
revolution in financial reporting. 3. Statement of Cash Flows, and
o A single set of rules called International Financial 4. Statement of Changes of Equity.
Reporting Standards (IFRS) is now being used by Note disclosures are an integral part of each financial
over 149 countries. statement.
NOTE: Free trade is defined as international trade left NOTE: Some financial information is better provided, or can
to its natural course without tariffs, quotas, or other restrictions. be provided only, by means of financial reporting other than
Interdependence of national economies means that formal financial statements. Examples include the president’s
companies can access not only their home capital letter or supplementary schedules in the company annual
markets but others as well. report, prospectuses, reports filed with government agencies,
news releases, management’s forecasts, and social or
environmental impact statements.
LEARNING OBJECTIVE 1
Global Markets Accounting and Capital Allocation
o World markets are now becoming increasingly Resources are scarce. Accountants must measure
intertwined. performance accurately and fairly on a timely basis so that
International consumers: the right managers and companies are able to attract
 drive Japanese cars, investment capital. Relevant financial information that
 wear Italian shoes and Scottish woolens, faithfully represents financial results allows investors and
 drink Brazilian coffees and Indian teas creditors to compare the income and assets employed by
o Tremendous variety and volume of both exported such companies.
and imported goods indicates the extensive Companies such as Nokia (FIN), McDonald’s (USA),
involvement in international trade for many Air China Ltd (CHN), and Toyota Motor (JPN).
companies, such that the world is their market.
The process of capital allocation is shown below:
o Due to technological advances and less onerous
regulatory requirements, investors are able to engage
in financial transactions across national borders and
to make investment, capital allocation, and financing
decisions involving many foreign companies.
o Many investors, in attempts to diversify their
portfolio risk, have invested more heavily in
international markets. As a result, an increasing
number of investors are holding securities of foreign NOTE: An effective process of capital allocation is critical to
companies. a healthy economy. It promotes productivity, encourages
innovation, and provides an efficient and liquid market for
o Capital markets are increasingly integrated and
buying and selling securities and obtaining and granting credit.
companies have greater flexibility in deciding where Unreliable and irrelevant information leads to poor capital
to raise capital. allocation, which adversely affects the securities market.
High-Quality Standards Stewardship.
To facilitate efficient capital allocation, investors need Management also is accountable to investors for the
relevant information and a faithful representation of all custody and safekeeping of the company’s economic
information to enable them to make comparisons across resources and for their efficient and profitable use.
borders.
Case: Where to Invest? Example: The management of Nestle has the
Scenario: You were interested in investing in a responsibility of protecting its economic resources from
telecommunications industry. Four of the largest unfavorable effects of economic factors, such as price
telecommunications companies in the world are Nippon changes, and technological and social changes.
Telegraph and Telephone (Japan), Deutsche Telekom NOTE: Because Nestle’s performance in discharging its
(Germany), Telefonica (Spain&Portugal), & AT&T responsibilities (referred to as its stewardship
(USA). responsibilities) usually affects its ability to generate net
Questions: cash inflows, financial reporting may also provide
1. How do you decide which, if any, of these decision-useful information to assess management
telecommunications companies you should invest in? performance in this role.
2. How do you compare the four companies?
NOTE: A single, widely accepted set of high-quality Entity Perspective
standards is a necessity to ensure adequate As part of the objective of general-purpose financial
comparability. Globalization demands a single set of reporting, an entity perspective is adopted.
high-quality international accounting standards.
Companies are viewed as separate and distinct from their
Here are some elements: owners (present shareholders) using this perspective.
1. Single set of high-quality standards established by a The assets of Nestle are viewed as assets of the company
single standard-setting body. and not of a specific creditor or shareholder. These
2. Consistency in application and interpretation investors have claims on Nestle’s assets in the form of
3. Common disclosures. liability or equity claims.
4. Common high-quality auditing standards and
The entity perspective is consistent with the present
practices.
business environment where most companies engaged in
5. Common approach to regulatory review and
financial reporting have substance distinct from their
enforcement.
investors (both shareholders and creditors).
6. Education and training of market participants.
7. Common delivery systems (e.g. extensible Business Thus, a perspective that financial reporting should be
Reporting Language ---XBRL). focused only on the needs of the shareholders, referred
8. Common approach to company governance and to as proprietary perspective is not considered
legal frameworks around the world. appropriate.

LEARNING OBJECTIVE 2 Decision-Usefulness

Objective of Financial Reporting Investors are interested in financial reporting because it
The objective of general-purpose financial reporting is provides information that is useful in making decisions
to provide financial information about the reporting is referred to as the decision-usefulness approach.
entity that is useful to present and potential equity As indicated earlier, when making these decisions,
investors, lenders, and other creditors in making investors are interested in assessing:
decisions about providing resources to the entity. 1. The company’s ability to generate net cash inflows,
NOTE: Those decisions involve buying, selling, or 2. Management’s ability to protect and enhance the
holding equity and debt instruments, and providing or capital provider’s investments.
settling loans and other forms of credit. Information Financial reporting should therefore help investors assess
that is decision–useful to capital providers (investors) the amounts, timing, and uncertainty of prospective cash
may also be useful to other users of financial reporting inflows from dividends or interest, and the proceeds from
who are not investors. the sale, redemption, or maturity of securities or loans.
In order for investors to make these assessments, the
Equity Investors and Creditors economic resources of an enterprise, the claims to those
The objective of financial reporting identifies investors resources and the changes in them must be understood.
and creditors as the primary user group for general- NOTE: Financial statements and related explanations
purpose financial statements. Identifying investors and should be a primary source for determining this information.
creditors as the primary user group provides an important
focus of general-purpose financial reporting. QUESTION:
In assessing cash flow prospects, does this mean that the
Example: When Nestle issues its financial statements, its cash basis is preferred over the accrual basis of
primary focus is on investors and creditors because they accounting?
have the most critical and immediate need for information ANSWER:
in financial reports. Information based on accrual accounting generally better
NOTE: Investors and creditors need the financial indicates a company’s present and continuing ability to
information to assess Nestle’s ability to generate net generate favorable cash flows than does information
cash inflows and to understand management’s ability to limited to the financial effects of cash receipts and
protect and enhance the assets of the company, which payments. --- Under accrual accounting, a company
will be used to general future net cash inflows. As a generally recognizes revenues when it makes sales and
result, the primary user groups are not management, expenses when incurred.
regulators, or some other non-investor group.
LEARNING OBJECTIVE 3 Question:
Standard-Setting Organizations How much progress has been made toward the goal of
For many years, many nations have relied on their own one single set of global accounting standards?
standard-setting organizations. Answer:
Recent surveys indicate that there is almost universal
support (94 percent) for IFRS as the single set of global
accounting standards.

International Accounting Standards Board (IASB)

NOTE: The standards issued by these organizations are The standard-setting structure internationally is composed of
sometimes principles-based, rules-based, tax-based, or the following four organizations:
business-based. In other words, they often differ in 1. IFRS Foundation provides oversight to the IASB,
concept and objectives. IFRS Advisory Council and the IFRS Interpretation
Committee.
The International Accounting Standards Board (IASB) is
2. International Accounting Standards Board
the main international standard-setting organization and (IASB) develops, in the public interest, a single set
is based in London, United Kingdom. of high-quality, enforceable, and global international
International Accounting Standards Board (IASB) financial reporting standards for general-purpose
IASB issues International Financial Accounting financial statements.
Standards (IFRS), which are used on most foreign 3. IFRS Advisory Council (the Advisory Council)
exchanges. IFRS is presently used or permitted in over provides advice and counsel to the IASB on major
149 jurisdictions (similar to countries) and is rapidly policies and technical issues.
gaining acceptance in other countries as well. 4. IFRS Interpretation Committee assists the IASB
IFRS has the best potential to provide a common platform through the timely identification, discussion, and
on which companies can report and investors can compare resolution of financial reporting issues within the
financial information. framework.
Two organizations that have a role in international NOTE: IFRS Foundation. In this role, it appoints members,
reviews effectiveness and helps in the fundraising efforts for
standard setting are: these organizations.
1. International Organization of Securities
Commission (IOSCO) In addition, as part of the governance structure, a Monitoring
2. IASB Board was created. The purpose of this board is to establish a
NOTE: The standards issued by these organizations are link between accounting standard-setters and those public
sometimes principles-based, rules-based, tax-based, or authorities (e.g. IOSCO) that generally oversee them. The
business-based. In other words, they often differ in Monitoring Board also provides political legitimacy of the
overall organization.
concept and objectives.
Due Process
International Organization of Securities Commission In establishing financial accounting standards, the IASB
(IOSCO) has a thorough, open, and transparent due process. The
IOSCO is an association of organization that regulate the IASB due process has the following elements:
world’s securities and future markets. Members are 1. An independent standard-setting board overseen by
generally the main financial regulator for a given country. geographically and professionally diverse body of
IOSCO does not set accounting standards, instead this trustees;
organization is dedicated in ensuring that the global 2. A thorough and systematic process for developing
markets can operate in an efficient and effective basis. standards;
The member agencies (such as from France, Germany, 3. Engagement with investors, regulators, business
New Zealand, and the United States) have resolved to: leaders, and the global accountancy profession at
o Cooperate together to promote high standards of every stage of the process;
regulation, in order to maintain just, efficient and 4. Collaborative effort with the worldwide standard-
sound markets. setting community.
o Exchange information on their respective Furthermore, the characteristics of the IASB, reinforce
experiences in order to promote the development of the importance of an open, transparent, and independent
domestic markets. due process.
o Unite their efforts to establish standards and an  Membership. The Board consists of 13 full-time
effective surveillance of international securities members. Members are appointed for five-year
transactions. renewable terms, and come from different
o Provide mutual assistance to promote the integrity of countries.
the markets by a rigorous application of the  Autonomy. The IASB is not part of any other
standards and by effective enforcement against professional organization. It is appointed by and
offenses. answerable only to the IFRS Foundation.
IOSCO supports the development and use of IFRS as the  Independence. Full-time IASB members must
single set of high-quality international standards in cross- sever all ties from their past employer. The
border offerings and listings. It recommends that its members are selected for their expertise in
members allow multinational issuers to use IFRS in cross- standard-setting rather than to represent a given
border offerings and listings, as supplemented by country.
reconciliation, disclosure, and interpretation where  Voting. Seven of 13 votes are needed to issue a new
necessary to address outstanding substantive issues at a IFRS.
national or regional level.
NOTE: With these characteristics, the IASB and its members LEARNING OBJECTIVE 4
will be insulated as much as possible from the political Financial Reporting Challenges
process, favored industries, and national or cultural bias. NOTE: One of the reasons of the success of IFRS is that
Types of Pronouncements financial statements and related disclosures capture and
The IASB issues three major types of pronouncements: organize financial information in a useful and reliable
fashion.
1. International Financial Reporting Standards.
2. Conceptual Framework for Financial Reporting. 1. IFRS in a Political Environment
User groups are possibly the most powerful force
3. International Financial Reporting Standards
influencing the IFRS. User groups consist of those most
Interpretations.
NOTE: With these characteristics, the IASB and its members interested in or affected by accounting rules.
will be insulated as much as possible from the political These user groups often target the IASB, to pressure it to
process, favored industries, and national or cultural bias. change the existing rules and develop new ones.
2. The Expectation Gap
Types of Pronouncements Expectation gap occurs when what the public thinks
International Financial Reporting Standards. accountants should do and what accountants think they
Financial accounting standards issued by IASB are can do are not the same or cannot be reconciled/closed.
referred to as International Financial Reporting 3. Ethics in the Environment of Financial
Standards (IFRS). The IASB has issued 17 of these Accounting
standards to date, covering such subjects as business In accounting, as in other areas of business, we frequently
combinations, share-based payments and leases. encounter ethical dilemma. Some of these dilemmas are
simple and easy to resolve. However, many are not,
Prior to the IASB (formed in 2001), standard-setting on
requiring difficult choices among allowable alternatives.
the international level was done by the International
Companies that concentrate on “maximizing the bottom
Accounting Standards Committee, which issued
line”, ”facing the challenges of competition”, and
International Accounting Standards (IAS). The
“stressing short-term results” place accountants in an
Committee issued 41 IAS, many of which have been
environment of conflict and pressure. Sometimes
amended or superseded by the IASB. Those still
technical competence is not enough when encountering
remaining are considered under the umbrella of IFRS.
ethical decisions.
Doing the right thing is not always easy or obvious. The
Conceptual Framework for Financial Reporting pressures to “bend the rules”, “to play the game”, or “To
Conceptual Framework for Financial Reporting sets forth
just ignore it” can be considerable. The decision is more
the fundamental objective and concepts that the Board
difficult because there is no comprehensive ethical system
uses in developing future standards of financial reporting.
to provide guidelines.
NOTE: As part of a long-range effort to move away from the
NOTE: Time, job, client, personal and peer pressures can
problem-by-problem approach, the IASB uses as IFRS
complicate the process of ethical sensitivity and selection
conceptual framework.
among alternatives.
The intent of the document is to form a cohesive set of
interrelated concepts, a conceptual framework that will serve 4. International Convergence
as tools for solving existing and emerging problems in a Convergence to a single set of high-quality financial
consistent manner. Conceptual Framework will be discussed reporting standards is desirable. Convergence is now
in Module 2. occurring in:
1. China is reforming its financial reporting system
International Financial Reporting Standards
through an approach called a continuous convergence
Interpretation process. The goal is to eliminate differences between
Interpretations issued by the IFRS Interpretations
its standards and IFRS.
Committee are also considered authoritative and must be
2. Japan now permits the use of IFRS for domestic
followed. This interpretations cover:
companies. The number of companies electing to use
1. Newly identified financial reporting issues not
IFRS is expected to increase substantially in the near
specifically dealt with in IFRS, and
future.
2. Issues where unsatisfactory or conflicting
3. The IASB and FASB (of the United States) have
interpretations have developed or seem likely to
spent the last 16 years working to converge their
develop, in the absence of authoritative guidance.
standards. The two Boards just issued new standards
The IFRS Interpretations Committee has issued over 20
on revenue recognition, financial instruments, and
of these interpretations to date.
lease accounting. Although the IASB and FASB
standards in these areas are similar, there are
Hierarchy of IFRS significant differences as well.
The following hierarchy is used to determine what
4. Malaysia was instrumental in helping amend the
recognition, valuation, and disclosure requirements:
accounting for agricultural assets.
1. International Financial Reporting Standards (IFRS),
International Accounting Standards (issued by the 5. Italy’s standard-setting group has provided advice
predecessor to the IASB), and IFRS interpretations and counsel on accounting for business
originated by the IFRS Interpretations Committee combinations under common control.
(and its predecessor, the IAS Interpretation Committee. In addition, U.S. and European regulators have agreed to
2. Conceptual Framework for Financial Reporting, recognize each other’s standards for listing on the various world
3. Pronouncements of other standard-setting bodies securities exchanges. As a result, costly reconciliation
that use similar conceptual framework (e.g. US GAAP). requirements have been eliminated and hopefully will lead to
NOTE: Any company indicating that it is preparing its greater comparability and transparency.
Reference:
financial statements in conformity with IFRS must
Kieso, D. et al. (2019), Intermediate Accounting: IFRS Edition. MA,
comply with all these standards and interpretation. USA, John Wiley & Sons, Inc.