Financial statements are prepared to fulfill information needs of its users. In order to cater the needs at best a certain financial reporting framework is used considering the jurisdiction in which the entity and/or its users exist. For example two of the popular financial reporting framework are IFRSs and US GAAPs. However, talking about the nature of reporting frameworks, we can have to types of framework:
- Fair presentation framework (also known as conceptual framework)
- Compliance framework (also known as rule-based framework)
Fair presentation framework is such a framework that requires compliance with the provisions of framework but in addition that it acknowledges that:
- in achieving fair presentation management might have to make such additional disclosures that are not specifically required by the framework; and
- in extremely rare circumstances it might be necessary to depart from the requirements of the framework to achieve fair presentation of the entity’s financial position and performance in the financial statements
Compliance framework, as the name suggests, requires compliance with the provisions of the framework i.e. strict obedience of instructions is required and the ones preparing financial statements have no choice but to follow the requirements of framework. Compliance framework does not allow any room or flexibility as given under fair presentation framework.
In simple words, although fair presentation framework requires compliance but it still allows for the alternatives that can achieve better presentation of financial statements resulting in more relevant and reliable financial statements even if management has to make additions or go against the requirements of framework. Whereas, in compliance framework no such leverage is given and under this framework complete compliance is required under any condition.
While preparing financial statements those who are responsible to prepare financial statements needs to inform users regarding the financial reporting framework used and also in case of any departure, if fair presentation framework is used, disclosures shall be made with such prominence as required so that users can understand and also provide the reasons why departure was necessary and how the alternative treatment adopted by the management resulted in more relevant and reliable financial statements.
In audit engagements, auditor has to consider the framework used to prepare financial statements as it has bearing on the audit engagement down to the level of audit report.