Accountancy Department

CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS

(CONFRAS#1)

FINANCIAL REPORTING FRAMEWORK

Learning Objective:

Comprehensively understand the financial reporting framework and the various

standard-setting bodies, particularly:

a. Generally Accepted Accounting Principles

b. Purpose of accounting standards
c. Financial Reporting Standards Council
d. Philippine Interpretation Committee
e. International Accounting Standards Committee
f. International Accounting Standards Board
__________

What is accounting?

A
ccounting is a service activity. Its function is to provide quantitative information,
primarily financial in nature, about economic entities, that is intended to be useful
in making economic decisions.1

Accounting is the art of recording, classifying and summarizing in a significant

manner and in terms of money, transactions and events which are in part at least of a
financial character and interpreting the results thereof.2

Accounting is the process of identifying, measuring, and communicating

economic information to permit informed judgment and decision by users of the
information.3

Essential characteristics of Accounting

1. Quantitative information;
2. Financial in nature;
3. Useful in decision making.

1 The Accounting Standards Council

2 Committee on Accounting Terminology of the American Institute of CPAs
3 American Accounting Association

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COMPONENTS OF ACCOUNTING

IDENTIFYING

The analytical component of accounting. This is the process determining whether

or not a transaction is accountable.

Not all transactions that transpire in a business are accountable. The hiring of
employees or the death of the company President are business activities but such
events are not accountable because they cannot be quantified or expressed in terms of
a unit of measure.

An event is accountable or quantifiable when it has an effect on the assets,

liabilities, or equity, whether such events take place internally or externally.

MEASURING

The technical component of accounting. This is the process of assigning peso

amounts to the accountable economic transactions and events.

If accounting information is to be useful, it must be expressed in terms of a

common financial denominator. Financial statements without monetary amounts would
be largely unintelligible or incomprehensible.

The Philippine peso is the unit of measuring accountable economic transactions.

Measurement bases or financial attributes

1. Historical cost

The amount of cash or cash equivalents paid or the fair value of the
consideration given to acquire an asset at the time of acquisition. Also known as “past
purchase exchange price.”

2. Current cost

The amount of cash or cash equivalent that would have to be paid if the same or
equivalent asset was acquired currently. Also known as “current purchase exchange
price.”

3. Realizable value

The amount of cash or cash equivalent that could currently be obtained by selling
the asset in an orderly disposal. Also known as “current sale exchange price.”

4. Present value

The discounted value of the future net cash inflows that the item is expected to
general in the normal course of business. Also known as “future exchange price.”

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COMMUNICATING

The formal component of accounting. This is the process of preparing and

distributing accounting reports to potential users of accounting information.

ASPECTS OF COMMUNICATION

1. Recording

Also known as journalizing. This is the process of systematically maintaining a

record of all economic business transactions after they have been identified and
measured.

2. Classifying

Also known as posting. This is the process of sorting or grouping of similar and
interrelated economic transactions into their respective classes.

3. Summarizing

The actual preparation of the financial statement.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN THE PHILIPPINES

Generally accepted accounting principles represent the rules, procedure, practice

and standards followed in the preparation and presentation of financial statements.

FINANCIAL REPORTING STANDARDS COUNCIL

In the Philippines, the development of generally accepted accounting principles is

formalized initially through the creation of the Accounting Standards Council (ASC)
which promulgated the Philippine Accounting Standards (PAS).

The aforesaid body was later on replace by the Financial Reporting Standards
Council (FRSC) which promulgated the Philippine Financial Reporting Standards
(PFRS). The FRSC is the accounting standard setting body created by the Professional
Regulation Commission upon recommendation of the Board of Accountancy (BOA) to
assist the BOA in carrying out its powers and functions provided under the Philippine
Accountancy Act of 20044

PHILIPPINE INTERPRETATIONS COMMITTEE

The Philippine Interpretations Committee (PIC) was formed by the FRSC to

replace the Interpretations Committee (IC) formed by the ASC.

4The Philippine Accountancy Act (R.A. 9298) is the law regulating the practice of accountancy in the
Philippines.

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The Role of the PIC is to prepare interpretations of PFRS for approval by the
FRSC and in the context of the Conceptual Framework, to provide time guidance on
financial reporting issues not specifically addressed in current PFRS.

Thus ..

Generally Accepted Accounting Standards in the Philippines are collectively

composed of:

1. Philippine Financial Reporting Standard (PFRS);

2. Philippine Accounting Standards (PAS); and
3. Philippine Interpretations (PI).

INTERNATIONAL ARENA

The International Accounting Standards Board (IASB) is an independent private

sector body, with the objective of achieving uniformity in the accounting principles which
are used by businesses and other organizations for financial reporting around the globe.

IASB replaced the International Accounting Standards Committee (IASC).

IASB is tasked to public accounting standards in a series of pronouncements

known as International Financial Reporting Standards (IFRS).

The IFRS is a global phenomenon intended to bring about greater transparency

and a higher degree of comparability in financial reporting, both of which will benefit the
investors and are essential to achieve the goal of one uniform and globally accepted
financial reporting standards.

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THE CONCEPTUAL FRAMEWORK FOR FINANCIAL

REPORTING5

Learning Objective:

Comprehensively understand the core principles of the Conceptual Framework

for Financial Reporting, particularly:

a. The Conceptual Framework for Financial Reporting

b. Its definition and purpose
c. Scope
d. Objective of financial reporting
e. Underlying assumptions
f. Qualitative Characteristics
g. Elements of Financial Statements
__________

T
he Conceptual Framework for Financial Reporting is a single document
promulgated by the IASB.

It is a summary of terms and concepts that underlie the preparation and

presentation of “general purpose financial statements6” for external users. It is the
underlying theory for the development of accounting standards and revisions of the
previously issued accounting standards.

The following are among the purposes of the Conceptual Framework for
Financial Reporting:

A. To assist the FRSC in developing accounting standards that will represent

Philippine GAAP;
B. To assist preparers of financial statements in applying accounting standards and
in dealing with issues not yet covered by GAAP;
C. To assist the FRSC in its review and adoption of IFRS;
D. To assist users of financial statements in interpreting the information contained
in the financial statements;
E. To assist auditors in forming an opinion as to whether financial statements
conform with Philippine GAAP;
F. To provide information to those interested in the work of the FRSC in the
formulation of PFRS.

If there is a standard or an interpretation that specifically applies to a

transaction, the standard or interpretation overrides the Conceptual Framework.

Nothing in this Conceptual Framework overrides any specific PFRS. In the

case of conflict between the two, the latter prevails.

5 Revised 2018
6General purpose financial reports are financial reports directed to the general information needs of a
wide range of users who are not in a position to demand reports tailored to their specific information
needs.

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SCOPE OF CONCEPTUAL FRAMEWORK

1. Objective of financial reporting;

2. Qualitative characteristics of useful financial information;
3. Definition, recognition, and measurement of the elements from which financial
statements are constructed;
4. Concepts of capital and capital maintenance.

OBJECTIVE OF FINANCIAL REPORTING

The objective of financial reporting is to provide financial information about the

reporting entity that is useful to existing and potential investors, lenders and other
creditors in making decisions about providing resources to the entity.

Financial reporting is directed primarily to the existing and potential investors,

lenders, and other creditors which compose the primary user group. Information that
meets the needs of the specified primary users is likely to meet the needs of other users
such as employees, customers. governments, and their agencies.

Existing and potential investors need general purpose financial reports in order to
enable them to make economic decisions whether to buy, sell, or hold on to their
investments. On the other hand, lenders and other creditors need general purpose
financial reports in their decision on whether or not to extend a loan to an entity, among
others.

General purpose financial reports do not and cannot provide all the information
that the users need. These users need to consider pertinent information from other
sources, such as general economic conditions, political events, and industry outlook.

General purpose financial reports are not designed to show the value of an
entity. They provide, however, the information to help the primary users estimate the
value of the entity.

QUALITATIVE CHARACTERISTICS

Qualitative characteristics are the qualities or attributes that make financial

accounting information useful to the users.

FUNDAMENTAL QUALITATIVE CHARACTERISTICS

RELEVANCE

Relevance is the capacity of the information to influence a decision. Information

that does not bear an influence on any economic decision is useless.

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Financial information is capable of making a difference in a decision if it has

predictive value7 and confirmatory value8.

Illustration 01

If the interim income statement for the first quarter is P2,000,000

(confirmatory value), and this trend continues for the entire year, it is logical to
assume that the net income after four quarters or one year would be P8,000,000
(predictive value).

Inherent in the concept of relevance is the practical rule of MATERIALITY. This

rule dictates that strict adherence to GAAP is not required when the items are not
significant enough to affect evaluation, decision and fairness of the financial statements.
This concept is also known as the doctrine of convenience. The materiality of an item
depends on its relative size rather than absolute size. What may be material for one
entity may be immaterial for another.

Illustration 02

An omission of P1,000,000 in the financial statements of a multi-billion

dollar entity like Apple may not be important to it but may be so critical for small
start-up entities.

When is an item material then? There is no hard and fast rule in determining
whether an item is material or not. Very, often, this is dependent on sound judgment,
professional expertise and common sense honed by years of experience.

Information is material if its omission or misstatement could influence the

economic decision that the users make on the basis of the financial information
about an entity.

FAITHFUL REPRESENTATION

A financial report is faithfully represented when it represents the actual effects of

the transactions that transpired during the accounting period.

To be a perfectly faithful representation, a depiction should have three

characteristics, being:

1. COMPLETENESS;

Completeness requires that all relevant information should be presented in a way

that facilitates understanding and avoids erroneous implication. Completeness is the
result of the adequate disclosure standard or the principle of full disclosure.

However, keep in mind the previously discussed concept of materiality.

Completeness and materiality must be harmonized for a faithfully represented financial

7 Financial information has predictive value if it can be used as an input to processes employed by users
to predict future outcome.
8Financial information has confirmatory value when it enables users to confirm or correct earlier
expectations.

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report. Completeness, in this context does not mean the disclosure of all possible date
but merely the substantial disclosure of all RELEVANT data, setting aside the immaterial
items. Too much data often leads to complicated and incomprehensible reports.

2. NEUTRALITY;

A neutral depiction is without bias in the preparation or presentation of financial

information. The financial information should not enrich one party at the expense of
another.

Information contained in the financial statements must be free from bias. It is well
to remember, that general purpose financial statements are directed to the common
needs of many users, and not to the particular desires of specific users.

3. FREEDOM FROM ERROR.

A report that is free from error does not connote a perfectly infallible report. This
principle is substantially complied with with the clear, reasonable, and good faith
disclosure of items in the financial reports.

Implicit to this is the principle of “substance over form.” A faithfully represented

report inherently represents the substance of an economic phenomenon or transaction
rather than merely representing its legal form.

Illustration 03

A lease contract which bears a provision of a transfer of ownership at the

termination of the lease period may be a hint that in substance the contract is
really that of an installment sale rather than a contract of lease. Thus, in
disclosing this fact in a financial report, it is wise to present it as a sale contract
rather than a lease contract.

ENHANCING QUALITATIVE CHARACTERISTICS

Enhancing qualitative characteristics, as contrasted with the fundamental

qualitative characteristics, relate to the form rather than the substance of the financial
reports.

COMPARABILITY

Comparability is the enhancing qualitative characteristic that enables users to

identify and understand similarities and dissimilarities among items in the financial
reports.

Comparability may be made horizontally9 or dimensionally10.

9 Horizontal comparability is the quality of information that allows comparisons within a single entity
through time or from one accounting period to the next.
10Dimensional comparability is the quality of information that allows comparisons between two or more
entities engaged in the same industry.

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For information to be comparable, like things must look alike and different things
must look different. Comparability is not enhanced by making unlike things look alike or
making like things look different.

Implicit in the concept of comparability is the principle of consistency. This

principle prescribes that accounting methods and practices should be applied on a
uniform basis from period to period.

Comparability is the goal and consistency is the means to achieve that goal.

Illustration 04

An entity that has adopted the straight-line method of depreciation in the

year 2000 is advised to use the same method of depreciation in the subsequent
year for more comparable reports. The usage of another depreciation method,
such as the sum-of-years-digits method, for the subsequent years may result in
the distortion of data leading to erroneous comparisons and ultimately erroneous
decisions.

However, consistency does not mean that no change in accounting method can
be made. If the change would result to a more useful and meaningful information, then
such change may be allowed. In doing so, the entity may be required to disclose the
effects of the change and the reasons therefor.

UNDERSTANDABILITY

Understandability requires that financial information must be comprehensible or

intelligible if it is to be most useful. Accordingly, the information should be presented in a
form and expressed in a language that a user understands.

However, complex economic activities make it impossible to reduce the financial

information to the simplest terms. Financial statements cannot realistically be
comprehensible to everyone.

Understandability simply means that users who have reasonable knowledge on

business, economic activities, and accounting in general, who review and analyze the
financial reports, should understand such report.

VERIFIABILITY

Verifiability means that different knowledgeable and independent observers could

reach consensus, although not necessarily complete agreement, that a particular
depiction is a faithful representation.

Verifiable financial information provides results that would be substantially

duplicated by measurers using the same measurement method.

TIMELINESS

Timeliness requires that financial information must be available or communicated

early enough when a decision is to be made.

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Information no matter how relevant or faithfully represented furnished after a

decision has already been made is useless and of no value. Generally, the older the
information, the less useful.

However, some information may continue to be relevant despite the end of the
reporting period as some users may need to identify and assess trends of the future.

COST CONSTRAINT

Distinct and separate from the fundamental and enhancing qualitative

characteristics of financial information is the concept of COST. Cost is a pervasive
content on the information that can be provided by financial reporting. Reporting
financial information imposes cost and it is important that such cost is justified by the
benefit derived from the financial information.

Benefits derived from the financial information should exceed the costs incurred
in obtaining such information.

THE ELEMENTS OF FINANCIAL STATEMENTS

The elements of financial statements refer to the quantitative information that

make up the statement of financial position and the statement of comprehensive

income. These elements are the so-called building blocks from which financial
statements are constructed.

The Statement of Financial Position is composed of:

a. Assets

Assets are resources controlled11 by the entity as a result of past transaction or

events and from which future economic benefits are expected to flow to the entity.

An asset is recognized12 when it is probable13 that future economic benefits14 will

flow to the entity and the asset has a cost or value that can be measured reliably.

11Control is an essential element of an asset. Ownership, on the other hand, is not a requirement for the
recognition of an item as an asset.
12 Recognition is the process of incorporating an item in the financial statements.
13The term probable means that the chance of the future economic benefit arising is more likely rather
than less likely. (More than 50% chance of occurrence)
14 Future economic benefits embodied in an asset is the potential to contribute directly or indirectly to the
flow of cash and cash equivalents to the entity.

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b. Liabilities

Liabilities are present obligations15 of the entity arising from past transactions16 or
events the settlement of which is expected to result in an outflow from the entity of
resources embodying economic benefits.

A liability is recognized when it is probable that an outflow of resources

embodying economic benefits will be required for the settlement of a present obligation
and the amount of the obligation can be measured reliably.

c. Equity

Equity is the residual interest in the assets of the entity after deducting all of its
liabilities

The Statement of Comprehensive Income is composed of:

a. Income17;

Income is an increase in economic benefit during the accounting period in the

form of inflow or increase in asset or decrease in liability that results in increase in
equity, other than contribution from equity participants.

Income is recognized when it is probable that an increase in future economic

benefits related to an increase in an asset or a decrease in a liability has arisen and that
the increase in economic benefits can be measured reliably.

In other words, income is recognized when it is earned, regardless of the flow of

cash.

b. Expense18

Expense is the decrease in economic benefit during the accounting period in the
form of an outflow or decrease in asset or increase in liability that results in decrease
in equity, other than distribution to equity participants.

Expenses are recognized when it is probable that a decrease in future economic

benefits related to a decrease in an asset or an increase in liability has occurred and
that the decrease in economic benefits can be measured reliably.

15Obligations may be legally enforceable of a consequence of a legally enforceable contract or law (legal)
and practice (constructive).
16 Past transactions are sometimes referred to as “Obligating Events”
17Income encompasses both revenue that arise from the ordinary course of business (sales, interest,
dividends) and gains that arise from auxiliary activities of the business (disposals of assets not held for
sale)
18 Expense encompasses both expenses that arise from the ordinary course of business (cost of sales,
wages, and depreciation) and losses that arise from the auxiliary activities of the business (losses from
fire, flood or war, disposal of assets not held for sale).

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In other words, expense is recognized when incurred, regardless of the flow of

cash.

The expense recognition principle is the application of the matching

principle. Under the matching principle, the costs and expenses incurred in earning a
revenue shall be reported in the same period the latter is earned.

APPLICATION OF THE MATCHING PRINCIPLE

1. Cause and effect association;

Expense is recognized when the related revenue is recognized. The reason is

the presumed direct association of the expense with the specific items of income. This
is an application of the strict matching concept.

Illustration 05

When a merchandise inventory is sold, the cost of sale is simultaneously

recognized with the revenue (sales).

2. Systematic and rational allocation;

Costs are expensed by allocating them over the periods benefited by such costs.
The reason is that the cost incurred will directly benefit future periods and that there is
an absence of a direct or clear association of the expense with specific revenue.

Illustration 06

A company constructs a new building with total cost of P10,000,000. The

company estimates that the total economic life of the building is 10 years. Under
the straight-line method of depreciation, the company must recognize P100,000
annually as depreciation expense.

The depreciation expense represents the allocated expense, from the total
cost of P10,000,000, to each year the building is expected to be used.

3. Immediate recognition.

The cost as incurred is expensed outright because of the uncertainty of future

economic benefits or the difficulty of reliably associating certain costs with future
revenue. The expenditure is expensed outright when no future economic benefits are
expected from the expenditure.

CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE

The financial performance19 of an entity is determined using two approaches:

19 Financial performance is the income of the company.

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1. The transaction approach

The transaction approach is the traditional preparation of an income statement

wherein an entity recognizes each accountable transactions as they occur and
summarizes the ultimate result thereof by comparing the total accumulated revenue and
total accumulated expense during a specific accounting period.

2. The capital maintenance approach.

The capital maintenance approach is the process of determining the income of

an entity by simply comparing the capital at the beginning of the accounting period and
the end of the same period. If the latter exceeds the former, then there is income. If
otherwise, there is a loss.

Two concepts of capital maintenance approach:

a. Financial capital - the absolute monetary amount of the net assets

contributed by the shareholders and the amount of the increase in net assets
resulting from earning retained by the entity. This is based on historical cost.

b. Physical capital - the quantitative measure of the physical productive capacity

to produce goods and services. This concept requires that productive assets
shall be measured at current costs rather than historical costs.

This concept will be further discussed in the subsequent chapters.

-end-

ADVISORY: It is strongly suggested that a careful reading of the entire book and
reference cited below is to be done for concept reinforcement.

REFERENCES USED:

Conrado T. Valix, Jose E. Peralta, and Christian Aris M. Valix, FINANCIAL

ACCOUNTING VOLUME ONE.

The Conceptual Framework for Financial Reporting (Revised 2018)

ASSESSMENT

Answer the following:

1. What is accounting?
2. When is a transaction accountable or quantifiable?
3. What is the basic objective of accounting?
4. What constitute GAAP in the Philippines?
5. What is the purpose of accounting standards?

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6. What are the purposes of the Conceptual Framework of Financial Reporting?

7. What economic decisions are made by investors and lenders or creditors in relation
to general purpose financial reports?
8. Among all the qualitative characteristics of useful financial information, what would
you consider as the most important? Explain.

II

1. Prepare a comprehensive, clear, and concise narrative on the nature of generally

accepted accounting principles, and financial reporting standards as you understand
it.
2. Prepare a concept web of the Conceptual Framework for Financial Reporting with
the corresponding narrative explaining such.

-end-

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