2018 is looking to be a busy year as far as financial reporting changes are concerned. There will be two major new standards adopted this year — one for revenue recognition and another one for financial instruments. Furthermore, it is in 2018 that the International Accounting Standards Board (IASB), the accounting standard-setting body, issued a revised version of the Conceptual Framework for Financial Reporting.
Although the Conceptual Framework is not a standard by itself, and does not override the provisions of any standard, its importance nevertheless cannot be downplayed as it assists the IASB in developing the standards. It also helps the financial statement preparers and users better understand and interpret these standards. In addition, the Conceptual Framework can be used as a reference by preparers who are trying to develop accounting policies but cannot find any applicable standard currently in place.
Prior to these improvements, the last revisions to the Conceptual Framework were issued in 2010. However, the 2010 Conceptual Framework was criticized for various reasons. Some critics pointed out that it lacks clarity, while others said that it excludes certain important concepts and that it does not support the current thinking of the IASB. With these new changes, the IASB aims to underpin the key concepts of the Conceptual Framework with sufficient details, which the IASB can use to develop standards while at the same time, help others better interpret and apply the standards.
The revisions include several new concepts, provide clarifications on some key concepts and update the definitions and the criteria for recognizing assets and liabilities.
NEW CONCEPTS IN THE REVISED CONCEPTUAL FRAMEWORK
The following are brief descriptions of the new concepts introduced in the revised Conceptual Framework:
• Description of the reporting entity – Although the IASB has admitted that it is not in a position to dictate who is required to prepare financial statements, the revised Conceptual Framework provides general guidance on a reporting entity (i.e., an entity that is either required or has opted to prepare financial statements and is not necessarily a legal entity). Identifying a reporting entity (or its boundary) may be difficult particularly if it is not a legal entity. In such a case, the primary consideration should be the users of the financial statements and what information they need from the reporting entity. Thus, even if the Conceptual Framework does not dictate what entity should prepare financial statements, it does clarify that a reporting entity cannot be arbitrarily identified.
• Measurement – Similar to the 2010 Conceptual Framework, the revised one does not mandate any specific measurement basis. The new framework does, however, identify and describe two measurement bases: the historical cost measurement and the current value measurement (which includes current cost, value in use and fair value), as well as the factors to consider when selecting such basis.
• Presentation and disclosure – This revision reflects the IASB’s intention of ensuring better and more effective communication of financial statement information, since this will make the information more relevant to the financial statement users. The revised Conceptual Framework introduces new concepts and guidance on how information, specifically income and expenses, should be presented and disclosed in the financial statements.
• Derecognition – The revised Conceptual Framework defines derecognition as “the removal of all or part of a recognized asset or liability from an entity’s statement of financial position.” When an entity derecognizes an asset or a liability, the aim is to always faithfully represent which assets or liabilities (or parts thereof) were retained after the transaction that gave rise to derecognition occurred.
UPDATES AND CLARIFICATIONS IN THE REVISED CONCEPTUAL FRAMEWORK
Other than the new concepts, several sections or chapters were also revised that include:
• Definitions of an asset and a liability – Instead of the asset and liability being defined as the ultimate inflow and outflow (respectively) of economic benefits, assets are now considered economic resources while liabilities are now looked on as the “obligation to transfer economic resources.” The phrase ‘expected flow’ was also deleted, emphasizing the fact that assets and liabilities may be recognized even if future inflow or outflow of economic benefits are not certain or even likely. In addition, the IASB also included the criterion “no practical ability to avoid” in the definition of the liability.
• Recognition of assets and liabilities – This is a major change from the 2010 Conceptual Framework. The 2010 version was more focused on recognition based on the probability of future inflows or outflows of economic benefits. The revised version talks about the qualitative side of capturing or recognizing assets, liabilities, income and expenses and emphasizes that recognition of these elements should only be done if they will result in relevant information and faithful representation.
The IASB also reintroduced some concepts to ensure consistency and minimize confusion on their application. One such reintroduced concept is prudence, which is defined as “the exercise of caution when making judgments under conditions of uncertainty.”
Another reintroduced concept is “substance over form”, with the IASB reinstating an explicit reference to the need to “faithfully represent the substance of the phenomena that it purports to represent.” Still another is the concept of stewardship, which was reinstated in recognition of the fact that financial statement users need to assess management’s stewardship over the resources of the entities through the information contained in the financial statements.
Since the revisions are effective immediately for the IASB and its Interpretation Committee or IFRIC, we will start seeing these changes reflected on the IASB’s and IFRIC’s future discussions and projects. Preparers who have developed or will be developing accounting policies based on the Conceptual Framework should consider these changes effective Jan. 1, 2020 and should note that these will be applied retrospectively. While the impact may not be significant or immediately felt by the entities and the preparers of the financial statements, entities should familiarize themselves with these new concepts and revised definitions as these may result in future changes to accounting policies, measurement of assets, liabilities, income and expenses and recognition and derecognition of assets and liabilities.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.
Dhonabee B. Señeres and Ma. Emilita L. Villanueva are Partners of SGV & Co.