The FASB’s Conceptual Framework for
Financial Reporting: A CriticalAnalysis
American Accounting Association’s
Financial Accounting Standards Committee
George J. Benston (primary author); Douglas R.
Carmichael; Joel S. Demski; Bala G. Dharan; Karim Jamal;
Robert Laux; Shiva Rajgopal; George Vrana.
Group “J”
Name ID
19301035
Ovi Barua
Azmun Nahar 19301094
Conceptual Framework
Conceptual Framework is a system of principles set by
organizations like the FASB, which guides the development of
accounting standards. It aims to create a coherent foundation
for financial reporting that provides useful and reliable
information to investors, creditors, and other stakeholders.
Key Issues of
the paper
The paper addresses four main key issues:
1. Fair Value Accounting
2. Conservatism Bias
3. Balance-Sheet vs. Income-Statement Approach
4. Role of Standard Setters (FASB/IASB)
Fair Value
Accounting
Fair value accounting is an approach where companies record their assets and liabilities at
their current market value (what they’re worth today) rather than their historical cost (what they
were originally bought for).
Example: Purpose in the Framework
Imagine a company owns a piece of The Conceptual Framework, it refers that fair
land that it bought for $500,000. value accounting aims to provide information
Over time,the land’s estimated reflecting the current economic reality of a
market value rises to $1 million. business.
Fair value accounting would report it
at $1 million to reflect its current
market worth.
Criticisms of Fair Value Accounting
Unreliable Estimates
The authors argue that fair value often relies on
hypothetical or volatile market estimates,
which can mislead stakeholders.
Challenge for Auditors
Because fair values are sometimes based on market
assumptions rather than actual transactions, they can
be difficult for auditors to verify, which may weaken the
reliability of financial reports.
Reasons behind Criticism
Concern fo Financial Stability
1
Fair value can make a company
appear stronger or weaker than it is,
depending on market swings. The
authors are concerned that this
inconsistency can mislead investors
and cause instability.
2
Preference for Practical Standards
They believe that standards should be
practical and based on reliable data, not
hypothetical market values, to maintain trust
and accuracy in financial reporting.
Conservatism Bias
Conservatism bias refers to the accounting principle of being cautious in financial reporting,
often leading to the practice of recognizing expenses earlier and revenues later.
Example: Purpose in the Framework
Imagine a retail company that receives
The Conceptual Framework advocates for
$10,000 for a large order. Using
conservatism: neutrality, suggesting that financial reporting should
They wouldn’t report this $10,000 as not favor one outcome over another. However, the
revenue until they’re absolutely sure the authors argue that conservatism can protect
buyer has received and accepted the against managerial over-optimism.
products.However, they would report any
expenses for producing the goods
immediately.
Criticisms of Conservatism Bias
While neutrality is essential, the authors believe that a
Neutrality
vs.
degree of conservatism is necessary to counterbalance
Caution managers’ natural tendencies to project overly positive
outcomes.
Reasons behind Criticism %
The authors stress that without conservatism, financial
Risk of
reports might present an inflated picture of a company’s
Over-Optimism health, potentially misleading investors.
Balance-Sheet vs. Income-Statement Approach
The balance-sheet approach emphasizes listing assets and liabilities to measure
performance based on changes in their values, while the income-statement
approach focuses on reporting revenues and expenses directly.
Purpose in the Framework
The balance-sheet approach aims to provide a snapshot of
a company’s financial status. However, the authors argue
this can lead to distorted perceptions due to reliance on
estimates rather than realized transactions.
Criticisms of the Balance-Sheet Approach
This method can lead to values that
fluctuate widely based on market
Dependence perceptions rather than actual
on
Revaluation economic activity, which may
misrepresent a company’s true
financial condition.
Reasons behind Criticism
The authors argue for the
income-statement approach as
Need for Clarity a way to ensure that financial
reporting reflects actual
performance rather than
hypothetical valuations.
Role of Standard Setters (FASB/IASB)
The Financial Accounting Standards Board (FASB) and the International Accounting
Standards Board (IASB) are responsible for creating and updating accounting
standards.
Purpose in the Framework
Their goal is to develop standards that lead to
reliable and comparable financial reporting
across different entities and countries.
Criticisms of Standard Setting
Difficulty The authors highlight that it’s challenging to predict the
Measuring Costs impacts of new standards on various industries and
and Benefits: companies, which can lead to unintended consequences.
Reasons behind Criticism
They suggest implementing a trial phase for new standards
Need for Trial Runs to assess their impact before full adoption, similar to drug
testing, to minimize potential risks.
Conclusion
Here we can concluded that the authors
critique the current Conceptual Framework for
being too theoretical and lacking practical
applicability. They argue for a more detailed
framework that considers the motivations of
both financial report users and producers,
emphasizing the need for practical, reliable
standards to reflect true economic realities.
This paper raises important questions about the
standards we use in financial reporting. I’d be happy
to answer any questions or discuss these points
further.
