Concepual framework

Sarah sets the scene The other day a student asked me: “Why do you we need the Conceptual Framework, when we have IFRSs which perfectly prescribe how we must account for things?” Over the years, this question has been asked of me a lot, and I can see why – it’s a good question! Do you also hear this question often, Tom?

Tom agrees Absolutely, Sarah! It’s a common query. The first thing I tell my students is that being tasked with the job of creating a high-quality set of IFRSs which is respected worldwide for its consistency and robustness is not easy. And that is why the IASB, the international standard-setting body, needs a kind of ‘road map’, the Conceptual Framework, to help them accomplish this unenviable task.

The Framework sets out key definitions, such as assets and liabilities, it states when these elements are to be recognised (and derecognised) and provides a consensus which identifies the purpose of financial reporting and articulates how the financial statements can be made useful.

Sarah interjects It’s not that the Framework replaces IFRS – on the contrary! The Framework is meant to sit alongside the accounting standards. The rules set out in IFRS should be backed up by definitions and principles in the Framework. And it’s worth noting that where there is a conflict between IFRS and the Framework, IFRS takes precedence.

In an ideal world, this wouldn’t happen but on rare occasions the two don’t quite see ‘eye to eye’. But remember, over time IFRS is being refined and the Framework gets the occasional update too – so I think it’s true to say that the two are actually becoming more aligned, which has to be a good thing.

Tom goes further What I find particularly helpful about the Framework is its use of definitions of elements, such as assets and liabilities. I tell my students that if they come across a scenario in their exam which they have not seen before, identifying which accounting issue you are dealing with is paramount. Is it an asset, for example? And the way to answer this is to ask yourself, “does it meet the definition of an asset, per the Framework?” That is, is it a present economic resource controlled by the entity as a result of past events? (an economic resource is a right that has the potential to produce economic benefits).

Sarah casts her mind back I couldn’t agree more, Tom. I remember one particular ACCA SBR question where a football club was buying a player’s registration (contracts) so the football player could play for that club. The question was all about intangible assets: as we know a football player’s contract is an intangible asset because it is without physical substance.

The question went on to test students’ knowledge of recognition and measurement of these intangibles and required knowledge of IAS 38 Intangible Assets. But first and foremost, what was essential was that the student could identify that it was all about assets. And if anyone was in any doubt about that, they could have turned to the Framework’s definition of an asset for confirmation. The club signing the contract with the player created an asset because for the period of the contract (and to the extent of the contract), the club had control of the player and thereby had the potential to earn revenue from this player. Tom ponders this further That’s right. I remember this question too, and it was one of the factors that inspired me to record the Football Finance 101 edition for the Accrual World YouTube series I am doing with Ben Wilson, where we discuss accounting and audit issues in the context of interesting situations: https://youtu.be/ jWeodXH4rg8

I must say that many students tell me that under the pressure of the exam environment, a key challenge is to identify what the accounting issue is in the first place. And I cannot overestimate how helpful a starting point the Framework can be. It can be the first stepping-stone!

In much the same way, I like to remind my students how helpful the IASB’s definition of a liability is: it is a present obligation of the entity to transfer an economic resource as a result of past events. What I love about the way it is defined is how robust it is – to be liable (and therefore to show a liability on your statement of financial position) you have to be obligated to pay someone.

In other words, payment is unavoidable – you cannot get out of it. This shows up in several IFRSs but the one that springs to mind is IAS 37 Provisions, Contingent Liabilities and Contingent Assets - and specifically, accounting for restructuring provisions.

Sarah chips in Oh, yes – that is a great example of the Framework’s definition of a liability in action! The very act of a company announcing that there is going to be a restructure creates a constructive obligation (and therefore a liability) because it results in the company having no realistic alternative but to go ahead and therefore incur the restructuring costs: the affected people have been told and so the company has gone ‘past the point of no return’. Management cannot realistically change its mind so the company must immediately recognise the expected cost of the restructure in profit or loss and a corresponding liability.

Tom concludes And once again, the IFRS has taken its form from a definition (of a liability in this last instance) set out in the Framework. You can’t say fairer than that! And I hope that ACCA students reading this article can turn to the Framework as a useful starting point when working FR and SBR questions. • Sarah Ardiles is an online ACCA FR lecturer – www.sarahardiles.com • Tom Clendon is an online ACCA SBR lecturer and podcaster – www.tomclendon.co.uk