The revised Conceptual Framework: new ground rules

in Regulatory/Compliance, 26.06.2018

Without a framework for preparing financial statements, accounting standards would develop in a random, haphazard way, in reaction to arising issues. In this context, the Conceptual Framework—though not itself a standard—serves as a common ideology by which the International Accounting Standards Board (IASB) interprets existing standards, develops new ones, and defines accounting positions in difficult cases. For instance, the Conceptual Framework assists national standard-setting bodies in developing national standards.

On 29 March 2018, the IASB released a revised Conceptual Framework for Financial Reporting. Effective immediately, it replaces the previous version issued in 2010.[1]

The main changes

The revision aims to update and clarify the existing Conceptual Framework, for example giving more guidance on the substance-over-form approach, measurement uncertainty, and other items. Additionally, some terms have been reintroduced, including stewardship and prudence (in the chapter on qualitative characteristics).

Two new chapters have also been added:

Financial statements and the reporting entity
This chapter summarises and determines the scope of financial statements, and offers a description of the reporting entity.

Presentation and disclosure
This chapter defines, conceptually, what information should be included in the financial statements and how it should be presented and disclosed.

Additionally, important developments have happened in the following areas:

Elements of financial statements
The terms asset and liability have been redefined. An asset is now specified as “a present economic resource controlled by the entity as a result of past events”. An economic resource, which previously had no definition, is defined as “a right that has the potential to produce economic benefits”.

For your reference, asset was previously defined as “a resource controlled by the entity as a result of past events and from which economic benefits are expected to flow to the entity”. So, in other words, the potential to produce economic benefits means that the flow of economic benefits no longer needs to be certain, or even likely (if it is not certain or likely, however, then the asset’s recognition and measurement may be affected). Indeed, all that is required is one circumstance (at least) in which it would produce economic benefits.

A liability is now defined as “a present obligation of the entity to transfer an economic resource as a result of past events.” An obligation is “a duty or responsibility that the entity has no practical ability to avoid”.

Previously, liability was defined as “a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits”. The new wording “no practical ability to avoid” must be specifically interpreted and justified case by case.

These new terms, interpretations, and definitions may require companies to reconsider their accounting approaches.[2]

Recognition criteria
The revised recognition criteria refer explicitly to the fundamental qualitative characteristics of “useful information”. In other words, recognition is now only appropriate if it results (1) in relevant information about assets, liabilities, equity, income, and expenses, and (2) in a faithful representation of those items. Cost remains a possible constraint to recognition decisions, and derecognition has been specified as the total removal of a recognised asset or liability from an entity’s statement of financial position (the IASB’s view is that both the control approach and the risk-and-rewards approach to derecognition are valid).

Measurement concepts
More guidance on measurement has been given. Namely, historical cost and current value measurement bases have been clearly distinguished into new categories: fair value, value in use (for assets) or fulfilment value (for liabilities), and current cost. The factors to consider when selecting a measurement basis are also given, i.e. how the asset contributes to future cash flows and what information that measurement basis will produce in the financial statements. Here, once again, we see that information provided by a particular measurement basis must be relevant and contribute to a faithful representation in order to be useful to the users of the financial statements. As previously, the benefits of a particular measurement need to justify the cost.

What’s next and how to prepare

The concept of “useful information” (i.e. that is relevant and faithfully representative) is the pivotal underlying point of the revision. In response, companies should review their accounting policies and identify any areas to be updated. And, moving forward, when a topic or transaction is not covered by any standard, companies will have to consider the revised Conceptual Framework when undertaking a new accounting approach. This could prove challenging, depending on the case, and take extra time or warrant the help of an IFRS specialist.

These amendments concerning the Conceptual Framework are effective for annual periods beginning on or after 1 January 2020 (except in cases where earlier application is permitted).[3] This means that the overall impact on standard-setting may take some time to crystallise. To assist companies with the transition, the IASB has issued a separate accompanying document: Amendments to References to the Conceptual Framework in IFRS Standards.

Visit our IFRS webpage for our latest insights regarding financial statement disclosures and other hot topics in IFRS.

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[1] Before 2010, the Framework for the Preparation and Presentation of Financial Statements (approved by the IASC Board in April 1989) was effective.
[2] The IASB has decided that IFRS 3 issuers, as well as issuers developing accounting policies for regulatory account balances using IAS 8, must continue to apply the 2010 definitions of asset and liability.
[3] The application will be retrospective, in accordance with IAS 8.

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