Theory of the Financial Reporting Framework

This article describes the Theory of the Financial Reporting Framework.  A general purpose financial statement is a formal semantic structure.  That formal semantic structure of such a general purpose financial statement is described by the accounting equation and double entry bookkeeping model and a reporting framework.  It is that double entry bookkeeping model which differentiates "bookkeeping" from  general "recordkeeping".  This is part of the essence of accounting.

To the untrained eye, it might not look like it; but a financial reporting framework fundamentally prescribes where information from a set of business events must be reported within a financial statement. The Theory of Accounting and Control; Resources, Events, Agents (REA); and ISO/IEC Accounting and Economic Ontology each point this out.

A general purpose financial statement provides quantitative financial information and nonfinancial information, aggregations and disaggregations related to financial accounts, information about broad categories of financial transactions, policies, and qualitative disclosures, and other such disclosures.  Not all this information flows through a financial accounting system.

In order to achieve comparability across many different reporting economic entities with consistency in terms of applying a reporting framework; a financial reporting framework describes, currently in the form of a written text document of some sort, the predefined standard basic line items, the predefined standard subordinate categories, the predefined standard superordinate categories, and the permitted styles of organizing those superordinate categories. Per the formal rules of classification; the pattern of classification is made known and for such financial reporting frameworks; because they are "financial" they must comply with the double entry bookkeeping mathematical model and some version of the fundamental accounting equation; everything must fit into that well understood model.  A reporting economic entity effectively maps its chart of accounts and the results of its business events into this scheme. A set of journals and ledgers are used to record transactions to facilitate this process.

(An example helps one see.)

A financial statement is a navigable graph of meaning once you have the structural insight.  The double entry bookkeeping model, the accounting equation, and the financial reporting framework used to create the financial statement provides the details that make up that structural insight. An example of this structure is the intentional interconnected nature of the primary financial statements by design known as articulation.

Saying this another way; a financial statement has regularity which can be exploited. This regularity allows for the comparison of representations. It also enables assumptions to surface, interpretations to be exposed, and meaning to be negotiated explicitly.

Meaning isn't derived from a representation in a model such as a financial reporting framework. Meaning is interpreted, negotiated, and agreed to by a collective of humans. Understanding is individual; meaning is intersubjective. Financial reporting frameworks establish a feedback loop which improves the financial reporting framework. The result is unprecedented clarity.

Specifically, a general purpose financial statement explains the state (i.e. balance sheet) and changes in state (i.e. income statement, cash flow statement, statement of changes in equity) of the reporting economic entity.  That is the summary of information that resulted from business events.

The detailed information about business events is standardized into an organized set of financial statement line items that resolve to the accounting equation: "Assets = Liabilities + Equity" a.k.a. "Resources = Obligations to Third Parties + Obligations to Owners". Those Assets, Liabilities, and Equity are decomposable into standardized subordinate and superordinate subcategories and standardized basic line items to enable cross economic entity comparison of those business events with consistency.

Financial statement classification follows a pattern of classification: superordinate, basic, subordinate. Classifications for both state and changes in state work this way.  Information about business events is provided via financial statements created using standard reporting frameworks such as US GAAP or International Financial Reporting Standards (IFRS). 

A financial reporting framework provides a clear, mutually exclusive and collectively exhaustive set of line items which are used to represent "state" and "changes in state".

Information is traceable and trackable from source/origin to financial statement  line item destination; or financial line item statement location back to source/origin. Information forms a chain in order to track information provenance.  From journal to ledger to trial balance to report writer to financial statement to financial analysis model.  Techniques (i.e. Lean, Agile, Six Sigma) can be used to mistake proof the chain. Industrial processes can be created.

Rather than articulating a financial reporting framework as a book, a financial reporting framework can be articulated as a model.  That model has a controlled vocabulary of elements, connections between the elements, structures, conditions, and facts.

A financial reporting framework provides governance which minimizes epistemic risk. Financial reporting framework publishers such as the FASB and IASB coordinate this governance.

So, something that used to look like this: (here are more examples)

Would now look more like this: (this shows only a portion of the reporting framework model)

And so, creating models for a reporting framework allow for more unprecedented clarity. In fact, a virtuous cycle is possible. There are many different approaches to creating a model such as the competency question approach.

What will happen to the financial statement and other accounting, reporting, audit, and analysis artifacts is similar to what happened to blueprints in the 1980s with CAD/CAM and again in the 1990s with BIM.

The Theory of the Financial Reporting Framework is part of the Metatheory which describes Financial Statement Mechanics and Dynamics. Other theories such as the Theory of Information Blocks, Theory of Mathematical Integrity, Theory of Model Structure, Theory of Disclosures and Disclosure Mechanics, and Theory of Reportability also help to describe a reporting framework.

With this Theory of the Financial Reporting Framework, financial reporting frameworks can be created to enable the creation of digital financial statements.
  • Framework
    • Topic
    • Disclosure
      • Prototype
      • Exemplar
    • Style
    • Element
      • State
      • Change in State
    • Connection
    • Condition
    • Structure
    • Fundamental Accounting Concepts (FAC)
    • Disclosure Mechanics
    • Reportability Rule
Elements of financial statements are the building blocks with which financial statements are constructed; the classes of items that financial statements comprise. The items in financial statements represent in words and numbers certain entity resources, claims to those resources, and the effects of transactions and other events and circumstances that result in changes in those resources and claims.

Elements of financial statements are the building blocks with which financial statements are
constructed—the classes of items that financial statements comprise. Elements refers to broad classes,
such as assets, liabilities, revenues, and expenses. Particular economic things and events, such as cash
on hand or selling merchandise, that may meet the definitions of elements are not elements as the termis
used in this Statement. Rather, they are called items or other descriptive names. This Statement focuses
on the broad classes and their characteristics instead of defining particular assets, liabilities, or other items. Although notes to financial statements are described in some authoritative pronouncements as an integral part of financial statements, they are not elements. They serve different functions, including amplifying or complementing information about items in financial statements.

The items that are formally incorporated in financial statements are financial representations (depictions
in words and numbers) of certain resources of an entity, claims to those resources, and the effects of transactions and other events and circumstances that result in changes in those resources and claims. That is, symbols (words and numbers) in financial statements stand for cash in a bank, buildings, wages due, sales, use of labor, earthquake damage to property, and a host of other economic things and events pertaining to an entity existing and operating in what is sometimes called the “real world.”

Note that a financial reporting framework is a type of governance. Another type of governance is selecting from among allowed alternatives to determine how an enterprise chooses to report within permitted boundaries.

Additional Information:


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