THE CONCEPTUAL FRAMEWORK productive capacity in terms of its ability to replace

inventory and other assets out of revenues.

Any asset can be valued in a variety of different ways:

HISTORICAL How much did it cost?

COST The IASB Framework

CURRENT How much did it cost after The purpose of the framework is to set out the concepts
PURCHASING restating its historical cost for the that underlie the preparation and presentation of
POWER COST effects of inflation? financial statements.
REPLACEMENT How much would it cost to replace
The framework deals with the following issues:
(or current)
that asset if it were sold or
COST consumed?  Objective of financial statements
NET How much could the asset be sold  Underlying assumptions
REALISABLE for on the open market, after
 Qualitative characteristics of Financial
VALUE allowing for any costs that would
statements
have to be borne in the process?
 Elements of Financial Statements
NET PRESENT How much are the cash flows that
VALUE the asset will generate worth, after  Recognition of the elements of financial
allowing for the time value of statements
money?  Measurement of the elements of Financial
statements
 Concepts of capital, and capital maintenance
For example, a shop sells simple woodworking tools. On
1 January, at the start of the year, it purchased a The Objective of Financial Statements
hammer for 10.00. During the year, the general rate of
Users of Financial Statements:
inflation was 5%, but the price of the woodworking
tools increased by 8%. On 31 December, at the end of  Investors
the year, the hammer was sold for 11.00. That gives us  Employees
three potential profit figures on the sale of the hammer:  Lenders
HISTORICAL COST – the hammer cost 10.00 and was
 Suppliers and other trade creditors
sold for 11.00, so the profit was 1.00. That is of interest  Customers
of shareholders who are interested in stewardship  Governments and their agencies
(because they want to know that the directors have not  Public
stolen or lost the 11.00 from the sale of the hammer)
and to the tax authorities (because they will use that
series of transactions as the basis for charging tax) UNDERLYING ASSUMPTIONS

CURRENT PURCHASING POWER – the hammer cost  Accrual Basis

10.50 (December 31) and sold for 11.00 (December 31),  Going Concern
so the profit is 0.50 (December 31). That is of the
QUALITATIVE CHARACTERISTICS OF FINANCIAL
interest of shareholders who are interested in the real
STATEMENTS
returns that their investment can generate, after
allowing for the impact of inflation.  Understandability
Financial statements need to be
REPLACEMENT COST (or Current Cost) – the hammer
understandable or they will not be of any use.
cost 10.80 to replace at the time of its sale and was sold
The Framework states that users are expected
for 11.00, so the profit is 0.20. That figure is of interest
to have a reasonable knowledge of accounting
to management for pricing purposes, and also to
and business and should be prepared to read
shareholders who have invested in the long term and
the financial statements with reasonable care
are interested in whether the business can maintain its
 Relevance
 Relevance is judged in terms of decisions made THE ELEMENTS OF FINANCIAL STATEMENTS
by users. Arguably, most decisions involve
 ASSETS
looking ahead rather than backward. The
 LIABILITIES
framework states that historical information is
often a valid basis for predictions.  EQUITY
 Materiality  INCOME
Is an important aspect of judging relevance.  EXPENSES
Information is material if its omission or RECOGNITION OF THE ELEMENTS OF FINANCIAL
misstatement could influence the economic STATEMENTS
decisions of users. Materiality judgements
involve the nature of the information as well as Basic criteria:
quantitative factors such as size as a percentage -It must be probable that any future economic benefit
of profit or revenue. associated with the item will flow to or from the entity.
 Reliability
Information is reliable if it is free from material -The item must have a cost or value that can be
error and bias. measured reliably.
 Comparability
Comparability requires that figures are
comparable over time for any given company
and also between companies. That requires
consistency of accounting policies from year to
year and also clear disclosure of the major
policies in use.
 Faithful Representation
Is an important quality, but one that is often
compromised in accounting.
 Substance over form
Is an important basis for many standards. It
requires that the financial statements reflect
the economic substance of transactions or
relationships rather than their legal form.
 Neutrality
Implies that the financial statements are free
from bias.
 Prudence
Arguably contradicts neutrality by requiring a
degree of caution in preparing the financial
statements.
 Completeness
Requires that figures should be complete, but
only to the extent that is consistent with
materiality and cost.