Present thinking of the IASB and FASB

in relation to liabilities
• According to the exposure draft released in 2008 the IASB and FASB
believe that the existing liability definition has limitations:
– Some users misinterpret the terms 'expected' (IASB definition) and 'probable'
(FASB definition) to mean that there must be a high likelihood of future
outflow of economic benefits for the definition to be met; this excludes
liability items with a low likelihood of a future outflow of economic benefits
– The definitions place too much emphasis on identifying the future outflow of
economic benefits, instead of focusing on the item that presently exists, an
economic obligation
– The definitions place undue emphasis on identifying the past transactions or
events that gave rise to the liability, instead of focusing on whether the entity
has an economic obligation at the reporting date
Present thinking of the IASB and FASB
in relation to liabilities (cont.)
• The IASB and FASB proposed the following draft
definition of a liability:
– A liability of an entity is a present economic obligation
that is enforceable against the entity.
• As with the proposed definition of assets, the
suggested change in the liability definition could
potentially have significant implications for
financial reporting. For example:
– The above definition could act to exclude constructive
or equitable obligations that are not enforceable
against the entity. This would be a major departure
from existing practice
– Would this be a good change?
 Approaches to determining profit
• Two common approaches to determining
profits
– asset/liability approach links profit to changes in
assets and liabilities
– revenue/expense approach relies on concepts
such as the matching principle

• The definition of expenses and revenues in

the CF based on asset/liability perspective
 Definition of expenses
• '… decreases in economic benefits during the
accounting period in the form of outflows or
depletions of assets or incurrences of
liabilities that result in decreases in equity,
other than those relating to distributions to
equity participants' (IASB Framework,
para.70(b))
 Recognition of expenses
• An expense shall be recognised when
– it is probable that the consumption or loss of
future economic benefits resulting in a reduction
in assets and/or an increase in liabilities has
occurred, and
– the consumption or loss of economic benefits can
be measured reliably
 Definition of income
• '… increases in economic benefits during the
accounting period in the form of inflows or
enhancements of assets or decreases of
liabilities that result in increases in equity,
other than those relating to contributions
from equity participants' (SAC 4, para.70(a))
 Definition of income (cont.)
• Income can be recognised from normal trading
relations, as well as from non-reciprocal transfers
such as grants, donations, bequests or where
liabilities are forgiven
• IASB Framework further subdivides income into
revenues and gains
– revenue arises in the course of the ordinary activities
of an entity
– gains represent other items that meet the definition
of income and may, or may not, arise in the ordinary
activities of an enterprise
– not clear why there is a need to break income into
two components
 Recognition of income
• As with the other elements of accounting,
income is recognised when:
– it is probable that the inflow or other
enhancement or saving in outflows of future
economic benefits has occurred; and
– the inflow or other enhancement or saving in
outflows of future economic benefits can be
measured reliably.
 Definition of equity
• Equity is defined as 'the residual interest in
the assets of the entity after deducting all of
its liabilities' (IASB Framework, para.49(c))

• As a residual interest it ranks after liabilities in

terms of claims against the assets

• Definition is a direct function of the

definitions of assets and liabilities
 Measurement principles
• To date there is very little prescription in
relation to measurement provided by CFs

• FASB statement provides description of

various approaches to measuring elements
without providing prescription
 Current IASB and FASB work on measurement issues

• In 2005 the IASB and FASB stated:

– Measurement is one of the most underdeveloped areas
of the two frameworks . . . Both frameworks (the IASB
and FASB Frameworks) contain lists of measurement
attributes used in practice. The lists are broadly
consistent, comprising historical cost, current cost, gross
or net realizable (settlement) value, current market
value, and present value of expected future cash flows.
Both frameworks indicate that use of different
measurement attributes is expected to continue.
However, neither provides guidance on how to choose
between the listed measurement attributes or consider
other theoretical possibilities. In other words, the
frameworks lack fully developed measurement concepts.
 Current IASB and FASB work on measurement issues
(cont.)
• Phase C of the joint IASB and FASB Conceptual
Framework Project is to address measurement
issues. In this work the IASB and FASB have
identified nine potential measurement bases,
these being: past entry price, past exit price,
modified past amount, current entry price,
current exit price, current equilibrium price, value
in use, future entry price, and future exit price
• It is expected that it will be a number of years
before any conclusion is reached about the most
appropriate measurement basis for assets and
liabilities
 Benefits associated with conceptual
frameworks
• Accounting standards should be more consistent
and logical

• Increased international compatibility of

accounting standards

• Standard-setters should be more accountable for

their decisions

• Communication between standard-setters and

their constituents should be enhanced
Benefits associated with CFs (cont.)
• The development of accounting standards should
be more economical

• Where conceptual frameworks cover a particular

issue, there might be a reduced need for
additional standards

• Emphasise the 'decision usefulness' role of

financial reports rather than restricting concern
to stewardship
 Disadvantages of conceptual
frameworks
• Smaller organisations may feel overburdened by
reporting requirements

• Typically economic in focus, so ignore

transactions that have not involved market
transactions or exchange of property rights
– further reinforces the importance of economic
performance relative to social performance

• Represent a codification of existing practice

 CFs as a means of legitimising
standard-setting bodies
• Some (e.g. Hines and Solomons) have
suggested that CFs have been used as devices
to help ensure the ongoing existence of the
accounting profession

• Increase the ability of the profession to self-

regulate, thus counteracting government
intervention