Conceptual Framework: Advantages, Disadvantages & Measurement

Posted on Mar 10, 2025 in Business Administration and Innovation Management

What is a Conceptual Framework?

A conceptual framework for financial reporting is a statement of generally accepted theoretical principles, which form the frame of reference for financial reporting. Its theoretical principles provide the basis for:

  1. The development of accounting standards.
  2. The understanding and interpretation of accounting standards.

Advantages of a Conceptual Framework

  1. Accounting standards are developed on the same theoretical principles.
  2. The development of accounting standards is less subject to political pressure.
  3. Accounting standards use a consistent approach.
  4. A principles-based approach avoids the need for large volumes of ‘rules’ to address every scenario. Instead, the same underlying principles can be applied to any scenario.

Disadvantages of a Conceptual Framework

  1. Financial statements are intended for a variety of users.
  2. There may be a need for a variety of accounting standards, each produced for a different purpose.
  3. It is not clear that a conceptual framework makes the task of preparing and then implementing standards any easier than without a framework.

Measurement Bases: Historical Cost vs. Current Value

The Conceptual Framework specifically looks at two measurement bases: Historical cost and current value.

Historical Cost

Historical cost for an asset is the cost that was incurred when the asset was acquired or created. Historical cost for a liability is the value of the consideration received when the liability was incurred.

Advantages of Historical Cost

  1. Amounts used are objective, as it is more difficult to manipulate cost-based figures.
  2. Amounts are reliable; they can always be verified.
  3. The statement of financial position and statement of cash flows figures are consistent with each other.
  4. There is less possibility for manipulation by using ‘creative accounting’ in asset valuation.
  5. Cost is a measure that is readily understood.

Disadvantages of Historical Cost

  1. Overstatement of profit – it shows current revenues less out-of-date costs.
  2. Out-of-date asset values – based on their historical values.
  3. Holding gains/losses are not measured separately from operating results.
  4. Return on assets/capital employed is distorted by both overstatement of profit and out-of-date asset value.

Current Value

Current value measurement bases include: Fair value, value in use, and current cost.

  • Fair value: The price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date.
  • Value in use: The present value of the cash flows, or other economic benefits that an entity expects to derive from the use of an asset and from its ultimate disposal.
  • Current cost of an asset: The cost of an equivalent asset at the measurement date, comprising the consideration that would be paid at the measurement date.
  • Current cost of a liability: The consideration that would be received for an equivalent liability at the measurement date.

Advantages of Current Value

  1. Assets are valued after management has considered the expected benefits from their future use.
  2. It is relevant to the needs of information users.

Disadvantages of Current Value

  1. The discount factor used to calculate the present value of future cash flows requires subjective judgements by management.
  2. There may be problems in deciding how to provide an estimate of current costs for non-current assets which can only be purchased new.

Principle-Based vs. Rules-Based Approaches

IFRS Standards are written using a principles-based approach. This means that they are written based on the definitions of the elements of the financial statements, recognition and measurement principles, as set out in the Conceptual Framework for Financial Reporting. Other GAAP, for example US GAAP, are rules-based, which means that accounting standards contain rules that apply to specific scenarios.

Advantages of a Principle-Based Approach

  1. A principles-based approach based on a single conceptual framework ensures standards are consistent with each other.
  2. Rules can be broken and ‘loopholes’ found. Principles offer a ‘catch all’ scenario.
  3. Principles reduce the need for excessive detail in standards.

Disadvantages of a Principle-Based Approach

  1. Principles can become out of date as practices change.
  2. Principles can be overly flexible and subject to manipulation.