The Evolution of Conceptual Framework

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Conceptual Framework generally serves as the keystone against which detailed accounting standards and financial elements are set up or qualified. In terms of establishing a well-grounded conceptual framework, coherence is one of the purposes required to be achieved, which would facilitate to diminish the distinctions when different sectors are dealing with similar accounting issues. To be more professional, as defined by FASB (Financial Accounting Standard Board), conceptual framework is a coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function and limits of financial accounting and financial statements. (Lecture-4)

In the light of the above, it is believed that when developing conceptual framework, regulatory bodies basically aim at generating a widely accepted principle system of financial and accounting concepts to which different parts within economic relationship will agree. Normally, when developing a system, the priority is to figure out the basic objectives and then go specifically to cover the issues by giving exact definition, measurement and evaluation. And the development of conceptual framework obviously follows the rule by first determining the objectives it seeks to achieve. Following that is to make proper alternatives and give clear definitions to basic accounting items in accordance with the set objectives. Since the second step only accomplishes qualitative identification and classification for different accounting items, final step for authorities is to apply an integrated quantitative measurement system.

Obviously, FASB follows an ex ante manner on the way to develop the conceptual framework.

Objective →Definition (Recognition) →Measurement →Real number

However, as objectives are normally set by users of accounting information, we should first identify the users and their requirements.

The process goes as follows:

User→ Objective→ Definition (Recognition) →Measurement→ Real number

Users of financial information vary, including present investors, creditors, potential investors and etc. And their expectations from the financial statements naturally differ. As IASB (International Accounting Standards Board) indicates, shareholders generally focus on the dividends and the appreciation ability of a company while venture capital providers are more concerned about the risk inherent in the return (Lecture-4). Besides, creditors normally care about the repayment ability of a company to avoid default. Also, the usefulness of the information can be judged from the following aspects, namely relevance, understandability, reliability, completeness, objectivity, timeliness and comparability (Bromwich, 1992). Overall, the objective of conceptual framework is to provide financial information that satisfies the users' decision-making purposes.

Following that, conceptual framework focuses on what to include in financial statements and how much. For one part, the recognition involves the decision that whether an item should be recorded and incorporated in financial statements (Bromwich, 1992). Basically, balance sheet is made up of three parts-assets, liabilities and equity equal to the excess value of assets over liabilities. Income statement consists of revenues, expenses, gains, losses and comprehensive income which will be mentioned later in Part 3. In this sheet, comprehensive income equals to the sum of revenues and gains minus the sum of expenses and gains. After that, we have definitions for assets, liabilities, equity, revenue, expenses and etc. according to different objectives. For the other part, measurement is mainly about the choice from historic value, fair value or a mix of them to record a financial item with a certain numerical value.

Part Two

Income valuation under different circumstances

IASB/FASB approach, as a joint conceptual framework, gives income an economic definition that the income of an individual or an entity is objectively determined by the changes in capital value in a certain period plus the cash flow received or the amount consumed during that period (M. Bromwich, R. Macve, S. Sunder, 2008).

As looking back to Hicks' version income measurements, Hick No.1 is based on the assumption of maintaining the capital value intact at the end of a period as at the beginning. As to maintain intact the value of an asset, the closing value should be no less than the opening value in terms of present value of future cash flows. And the income under Hicks' No.1 is, as a result, the maximum of consumption an individual could have during a certain period with the expectation that the asset won't depreciate. Put into the situation of an entity, income is the maximum amount that can be distributed to the shareholders at the end of a period while the closing price won't fall below the opening price at the beginning of that period. In this way, we see that the income under joint of FASB/IASB is the identical to that under Hick No.1.

However, the other aspect of economists' opinion about income is Hick No.2, which defines income as the amount of money that could be consumed during one period in the expectation of receiving the same amount at the end of each of the following periods. Hick No.2 measures the income of one period with the consideration of sustained purchasing power in the long run. The main difference is that IASB/FASB approach doesn't take into account the possibility of interest rate changes. It is based on the assumption of constant interest rate. And if the interest rate changes from period to period, the closing value (in terms of the amount of future cash flows) of an asset cannot be assured to be as well off as the opening price, especially when the interest rate increases. (Lecture-1)

As both income-measurement systems involve the evaluation of opening value and closing value or even future cash flows, the results of choosing different value measurement systems vary. Basically, the issue of valuation system most relevant to the conceptual framework focuses on the influence of value relevance research to financial standard setting. According to FASB, relevance and reliability are the two main criteria that identify if a certain accounting setting is capable enough to fully reflect the relevant changes in equity value (Barth, M.E., Beaver, W. H., Landsman, W.R., 2001). Normally, more relevant of an accounting figure to the real changes in capital value, more possible its effort will be reflected in capital pricing and thus used by financial statement users. Given to the high relevance of income and capital value under both Hicks' and the joint FASB/IASB system, the manner that accounting standards are set could be influential to parts of financial statements. An example of value relevance is the implementation of fair value measurement system in which fair value can be defined as a price at which an asset could be sold or a liability could be transferred between market anticipants at a certain measurement time point (FASB, 2006).

Part Three

Contribution of various conceptual frameworks to comprehensive income

Comprehensive income statement is a model that incorporates the change in equity attributive to events or transactions irrelevant to owners' investments into traditional net income. Therefore, comprehensive income consists of two parts, namely net income and other comprehensive income. Other comprehensive income normally includes noncommercial gain and loss out of foreign exchange, changes in market value of future contracts, unrealized loss and gain on available-for-sale securities and etc.

IASB Reporting Performance

Intending for a combination of the two measurements of FASB in the expectation of using comprehensive income

Here, I invited what Newberry included in "Reporting Performance: Comprehensive Income and its Components". In FASB, one conceptual framework is cost-based, that begins with income being treated as a measuring tool for the performance of one or more specific projects. As for depreciation of an asset, it could be viewed as the cost of keeping an asset or having the right to keep others from this asset. As the depreciation is a quantitative loss in term of the value of the asset, it should be deducted from the corresponding income. In this concept, changes in the quantitative value of an economic object should be eliminated from the income. Generally speaking, this measurement concept focuses on match the costs with corresponding value input and this is relevant to historical cost evaluation systems, which evaluate the value input and output of an item accordingly.

Another conceptual framework set by FASB as tabulated above treats income as the increment in capital value, which in other words is the deviation from the investment to the distribution the investor can attain in the future. Under this circumstance, the change in equity attributive to the shareholders should be incorporated into the total income. However, notably, revenues can hardly match with the relevant costs, as it is always unclear how the profits will be generated. So the key point under this framework is capital valuation based on future cash inflows and outflows.

As indicated by Newberry in his article, IASB was attempting to build up a concept framework then by a combination of the two frameworks from FASB, in accordance with the comprehensive income method. So far as I am concerned, the principles of enhancement concept set by FASB is of the highest relevance with comprehensive income statement. And the reason goes into three aspects. Firstly, both these two principles focus on the effect of variation in ownership to real income. Secondly, the difference of investment and dividends in FASB's framework includes both the changes from owners' investment and irrelevant abnormal events. Thirdly, performance measurement concept indicates clearly that unrelated losses and gains should not be included by the income under that principle, that makes comprehensive income statement system hardly feasible.