Conceptual Framework

Purpose of the Conceptual Framework

o Prescribes the concepts for general purpose financial reporting
oAssist the IASB in developing standards that are based on consistent concepts
oAssist preparers in developing consistent accounting policies when no standard applies to a particular transaction or when a
standard allows a choice of accounting policy
oAssist all parties in understanding and interpreting the standards

o Provides the foundation for the development of standards that

oPromote transparency by enhancing the international comparability and quality of financial information
oStrengthen accountability by reducing the information gap between providers of capital and the entity’s management
oContribute to economic efficiency by helping investors identify opportunities and risks around the world, thus improving
capital allocation. The use of single trusted, accounting language lowers the cost of capital and reduces international
reporting costs.
Status of the Conceptual Framework
o The conceptual framework is not a standard
o If there is a conflict between a standard and the Conceptual Framework, the requirement of the standard will prevail
o Authoritative status of the Conceptual Framework is depicted in the Hierarchy of Guidance:
1. PFRSs
2. Judgement
When making judgement:
 Management shall consider:
a. Requirements in other PFRSs dealing with similar transactions
b. Conceptual framework
 Management may consider
a. Pronouncements issued by other standard-setting bodies
b. Other accounting literature and industry practices
o Conceptual Framework may be revised from time to time based on the IASB’s experience working with it however revisions
do not automatically result to changes in the Standards not until the IASB goes through its due process of amending a standard

Scope of the Conceptual Framework

o The Conceptual Framework is concerned with the general purpose financial reporting

General purpose financial reporting

o Involves the preparation of general purpose financial statements

The 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”

o This objective is the foundation of the Conceptual Framework

Primary Users
1. Potential and existing investors
2. Lenders and other creditors
 Lenders – those who extend loans
 Other creditors – those who extend other forms of credit
 These users cannot demand information directly from reporting entities and must rely on general purpose financial reports
for much of their financial information needs.

 Conceptual Framework is concerned with General Purpose Financial Reporting

o General Purpose Financial Reporting
 Deals with providing information that caters to the common needs of primary users
 THEREFORE, the General Purpose Financial Reports DO NOT and CANNOT provide ALL information
needs of primary users
  They will have to find for other sources that would cater to their needs
 Meets the needs of maximum number of primary users
 Even though this can be used by the entity’s management and the public, these reports are not directed to these
users
 DO NOT directly show the value of a reporting entity, they just provide information that helps users in
estimating the value of the entity
o Providing useful information requires making estimates and judgements
o The Conceptual Framework establishes the concepts that underlie those estimates and judgements

Decisions About Providing Resources to the Entity

o Primary users’ decisions about providing resources to the entity involve decisions on:

a. Buying, selling, or holding investments

b. Providing or settling loans and other forms of credit
c. Exercising voting or similar rights that could influence management’s actions relating to the use of the entity’s
economic resources

o These decisions depend on the investor/lender/creditor’s expected returns

 (Expected returns sa income sa ilang investment or repayment sa loan)
o Expected returns
 Depend on assessment of the entity’s:
a. Prospects for future net cash inflows
b. Management stewardship
 to make these assessments, investors/lenders/creditors need info on:
a. the economic resources of the entity, claims against the entity, and changes
in those resources and claims (prospects for future net cash inflows)
b. how efficiently and effectively na utilize ang resources sa entity
(management stewardship)

Information on Economic Resources, Claims, and Changes

o General purpose financial reports provide information on a reporting entity’s:
o Financial Position
 Information on the economic resources (assets) and claims against the reporting entity (liabilities and
equity)

o Changes in economic resources and claims

 Information on the financial performance (income and expenses) and other transactions that lead to
changes in financial position

o Referred to the Conceptual Framework as Economic Phenomena

~~~Financial Position~~~
Economic Resources and Claims
o The information in the Financial Position of an entity can help users identify the entity’s financial strengths and
weaknesses
 Can help users in assessing the entity’s:
a. Liquidity and Solvency
 Liquidity – ability of the entity to settle short-term obligations
 Solvency – ability of the entity to meet long-term obligations
b. Needs for additional financing
c. Management stewardship on the economic resources
~~~Changes In Economic Resources and Claims~~~
Changes in Economic Resources and Claims
o Result from:
a. Financial Performance (income and expenses)
b. Other events and transactions
o Financial Performance
o Helps users assess the entity’s ability to produce return from its economic resources
 Return – provides indication on ‘management stewardship’ on resources
o Variability of return helps users in assessing the uncertainty of future cash flows
 information on past cash flows help users assess the entity’s ability to generate future cash flows by providing basis in
understanding the entity’s operating, investing, and financing activities, assessing its liquidity or solvency , and interpreting
other information about its financial performance

o Other events and transactions

o Economic resources and claims may also change for reasons aside from financial performance, such as issuing debt
instruments or equity instruments
 Debt instrument – muutang ka in order to raise money for the entity
 Equity instrument – mubaligya ka stocks to raise money for the entity

Information about use of the entity’s Economic Resources

o Information on how efficiently and effectively the entity’s management has discharged its responsibilities to use the entity’s
economic resources helps users assess the entity’s management stewardship
 This information also helps how the resources will be efficiently and effectively used in future periods, thus helping
in the assessment of the entity’s prospects for future cash inflow
 Example: safeguarding resources and ensuring entity’s compliance with laws

Qualitative Characteristics
o the qualitative characteristics of useful financial information identify the types of information that are likely to be most useful
to the primary users in making decisions using an entity’s financial report

1. Fundamental Qualitative Characteristics

o Make information useful to users
a. Relevance
b. Faithful Representation
2. Enhancing Qualitative Characteristics
o Enhance the usefulness of information
a. Comparability
b. Verifiability
c. Timeliness
d. Understandability

Fundamental Qualitative Characteristics

Relevance – information is relevant if it can affect the decision of users

a. Predictive Value – information can help users in making predictions about future outcomes
b. Confirmatory Value (feedback value) – information can help users in confirming their previous predictions
 Predictive value and confirmatory value are interrelated.
o Example: revenue in the current period can be used to predict revenue in a future period and at the same time can also
be used in confirming a past prediction

Materiality
o information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that
the primary users of a specific reporting entity’s general purpose financial statements make on the basis of those
financial statements
o entity-specific type of relevance
o meaning, materiality depends on the facts and circumstances surrounding a specific entity
o Conceptual Framework and Standards DO NOT specify a uniform quantitative threshold for materiality
o Matter of PROFESSIONAL JUDGEMENT

Making Materiality Judgements (IFRS practice statement 2)

o Provides a non-mandatory guidance that entities MAY follow in making materiality judgements

Materiality Process

1. Identify information that has the potential to be material

o Starting point in making the identification is the requirement of the Standards
IDENTIFY o This is because when developing Standards, the IASB identifies the information needs of a wide
range of primary users and considers the balance between the benefits to be derived from the
information and the cost of producing it
o Cost is NOT A FACTOR when making materiality judgements
 o the entity also considers the common information needs of its primary users, in addition to those
specified in the PFRS

2. Assess whether the information identified in step 1 is, in fact, material

o Entity considers the following:

a. Whether the information could influence the uses’ decision on the basis of financial
statements as a whole
ASSESS b. The item’s nature or size, or both
c. Quantitative and qualitative factors

 Quantitative Factors
o Include the size of impact of the item
o Size of an item can be assessed in relation to a percentage of another
amount or a threshold amount

 Qualitative Factors
o Are characteristics of an item or its context
a. Entity-specific qualitative factors
o Involvement of a related party or rarity of the item
b. External qualitative factors
o the entity’s industry sector or the state of the economy

3. Organize the information within the draft financial statements in a way that communicates the
information clearly and concisely to primary users
ORGANIZE o The entity exercises judgement on how to present information in a manner that maximizes
understandability to the primary users

4. Review the draft financial statements to determine whether all material information has been
identified and materiality considered from a wide perspective and in aggregate, on the basis of the
complete set of financial statements
REVIEW o The review allows the entity to ‘step-back’ and get a wider perspective of the information
provided
o Necessary because an item might not be material on its own, but it might be material if used in
conjunction with the other information in the complete set of financial statements

Faithful Representation
o Information provides a true, correct, and complete depiction of the economic phenomena that it purports to represent
o Requires the depiction of a substance (substance over form)
 Depicting only the legal form would not faithfully represent the economic phenomenon

a. Completeness
o All information (in words or numbers) necessary for users to understand the phenomenon being depicted is
necessary for users to understand the phenomenon being depicted is provided
b. Neutrality
o Information is selected or presented without bias
o Information is not manipulated to increase the probability that users will receive it favorably or unfavorably
o Supported by prudence
 Does not allow the understatement of assets or overstatement of liabilities because the financial statements
would not be faithfully represented
c. Free from error
o Means there are no errors in the description and in the process by which the information is selected and applied

Enhancing Qualitative Characteristics

Comparability
o Information is comparable if it helps users identify similarities and differences between different sets of information that are
provided by:
a. Intra-comparability – a single entity but in different periods
b. Inter-comparability – different entities in a single period
o Comparison is not uniformity
 Verifiability
o Information is verifiable if different users could reach a general agreement (consensus) as to what the information purports to
represent
o Can be:
a. Direct Verification – involves direct observation
b. Indirect Verification – involves checking the inputs to a model formula and recalculating outputs

Timeliness
o Information is timely if it is available to users in time to be able to influence their decisions

Understandability
o Information is understandable if it is presented in a clear and concise manner
o Does not mean complex matters should not be included because it would make the information incomplete

Applying the Qualitative Characteristics

 Fundamental Qualitative Characteristics are essential to the usefulness of the information
 Information must be relevant and faithfully presented for it to be useful
 Enhancing Qualitative Characteristics only enhance the usefulness of information that is both relevant and faithfully
presented but CANNOT make irrelevant or erroneous information to be useful

The Cost Constraint

 COST is a pervasive constraint on the entity’s ability to provide useful information
 Providing information entails cost and can be justified by the benefits expected to be derived from the information
 Costs should not outweigh the benefits

Financial Statements and the Reporting Entity

Objective of Financial Statements:
o To provide financial information about a reporting entity’s assets, liabilities, equity, income, and expenses that is
useful in assessing:
 The entity’s future net cash inflows
 Management’s stewardship over economic resources

o Information is provided in the:

a. Statement of financial position (assets, liabilities, equity)
b. Statement of financial performance (income, and expenses)
c. Other statement and notes

Reporting Period
o Financial statements are prepared for a specific period of time and provide information on assets, liabilities, and equity

Comparative Information
o To help users in evaluating changes and trends, financial statements provide comparative information for at least
ONE preceding reporting period

Forward-looking information
o Financial statements are designed to provide information about past events
o Information about possible future transactions and other events is included in the financial statements ONLY if it
relates to the past information presented in the financial statements and is deemed useful to users of financial
statements
o Financial statements DO NOT typically provide forward looking information about management's expectations and
strategies for the reporting entity

Perspective adopted in Financial Statements

o Information in financial statements is prepared from the perspective of the reporting entity

Going Concern Assumption

o Financial statements are normally prepared on the assumption that the reporting entity is going concern
o If this is not the case, the entity's financial statements are prepared on another basis
o Measurement at realizable value rather than a mixture of costs and values
The Reporting Entity
o The one that is required or chooses to prepare financial statements and is NOT necessarily a legal entity
o Can be a single entity or a group or combination of two or more entities
o Sometimes an entity controls another entity:
o Parent – the controlling entity
o Subsidiary – controlled entity
 Consolidated Financial Statements
- The financial statement if a reporting entity comprises both the parent and subsidiaries
 Unconsolidated Financial Statements
- The financial statement of a reporting entity that is the parent alone
 Combined Financial Statements
- The financial statement of two or more entities that are not linked by a parent-subsidiary
relationship
- Two or more subsidiaries
 Individual Financial Statements
- Financial Statement of an individual subsidiary

Consolidated and Unconsolidated Financial Statements

o Consolidated Financial Statements
 provide information on a parent and its subsidiaries viewed as a single reporting entity
 NOT designed to provide information on any particular subsidiary
o information is provided in the subsidiaries own financial statements (Individual Financial
Statements)
 enables users to better assess the parents prospects for future cash flows because the parents cashflows are
affected by the cash flows of its subsidiary
o Unconsolidated Financial Statements
 CANNOT be used as a substitute for consolidated financial statements

Elements of Financial Statements

1. Assets Financial Position

2. Liabilities
3. Equity
4. Income
5. Expenses
Financial Performance

ASSET
o present economic resource controlled by the entity as a result of past events
o Economic resources is a right that has the potential to produce economic benefits
o Three aspects:
 Right
- Asset is an economic resource and an economic resource is a right that has the potential to produce
economic benefits
a. Rights that correspond to an obligation of another party
i. right to receive cash goods or services
ii. right to exchange economic resources with another party on favorable terms
iii. Right to benefit from an obligation of another party to transfer an economic resource
if a specified uncertain future event occurs
b. Rights that do not correspond to an obligation of another party
i. Right over physical objects
ii. Right to use intellectual property
- Normally arise from law
- But rights could also arise from other means
- Not all rights are assets
 To be an asset, the right must have the potential to produce for the entity economic benefits that
are beyond the benefits available to all other parties and those economic benefits must be
controlled by the entity
- An entity CANNOT have a right to obtain economic benefits from itself
- The presence or absence of expenditure is NOT necessary in determining the existence of an asset
- An asset can be obtained for free from donation
  Potential to Produce Economic benefits
- Is the present Right that has the potential to produce economic benefits and not the future economic
benefits that the right may produce

 Control
- Means the entity has the exclusive right over the benefits of an asset and the ability to prevent others
from accessing those benefits
- If one party controls an asset no other party controls the asset
- DOES NOT MEAN that the entity can ensure that the resource will produce economic benefits in all
circumstances
 It only means that if the resource produces benefits, it is the entity who will obtain those benefits
and not another party
- Normally stems from legally enforceable rights (ownership or legal title)
- Ownership is NOT always necessary for control to exist because control can arise from other rights
- Physical possession is also NOT always necessary for control to exist

LIABILITY
o Present obligation of the entity to transfer an economic resource as a result of past events
o Three aspects:
 Obligation
- A duty or responsibility that an entity has no practical ability to avoid
- Either
 Legal Obligation
 An obligation that results from a contract legislation or other operation of law
 Constructive Obligation
 An obligation that results from an entity's actions that create a valid expectations and
others that the entity will accept and discharge certain responsibilities
- Always go to another party
- not necessary that the identity of that party is known
 An obligation for environmental damages may be owed to the society at large
- One party’s obligation normally corresponds to another party right
 This accounting symmetry is not maintained at all times
 A seller may be required to recognize a warranty obligation but the buyer would not
recognize a corresponding asset for that warranty

 Transfer of Economic Resources

- Is the obligation that has the potential to require the transfer of an economic resource to another party
and not the future economic benefits that the obligation may cause to be transferred
 Present Obligation as a result of past events
- The obligation must be a present obligation that exists as a result of past events
- a present obligation exists as a result of past events if:
a. The entity has already obtained economic benefits or taken an action
b. as a consequence the entity will or may have to transfer an economic resource that it
would not otherwise have had to transfer
 read examples page 60-61

Executory Contracts
o Is a contract that is equally unperformed - neither party has fulfilled any of its obligations or both parties have partially fulfilled
their obligations to an equal extent
o establishes a combined right and obligation to exchange economic resources
o To protect both parties if ever one party does not perform, Not performing of what is executed in the contract will be a subject
for case
o The contract ceases to be executory when one party performs its obligation
 If the entity performs first, the entity’s combined right and obligation changes to an asset
 if the other party performs first the entity’s combined right and obligation changes to a liability
Equity
o There is the residual interest in the assets of the entity after deducting all its liabilities
o The definition of equity applies to all entities regardless of form

Income
o Is the increases in assets or decreases in liabilities that result in increases in equity other than those relating to contributions
from holders of equity claims
Expenses
o Are decreases in assets or increases in liabilities that result in decreases in equity other than those relating to distributions
to holders of equity claims

 Contributions from, and distributions to the entity's owners, are NOT income and expenses but rather direct adjustments to
equity

Recognition and Derecognition

The Recognition Process

o Recognition is the process of including in the statement of financial position or statement of financial performance an item
that meets the definition of one of the financial statement elements
 Involves recording the item in words and in monetary amount and including that amount and the totals of either of
those statements
o Carrying amount is the amount at which an asset a liability or equity is recognized in the statement of financial position
o Sometimes the recognition of income results in the simultaneous recognition of a related expense
 this is called matching of costs and income (matching concept)
o Recognition Criteria:
a. It meets the definition of an asset, liability, equity, income, or expense
b. recognizing it would provide useful information (relevant and faithfully presented information)

 Both the criteria must be met before an item is recognized

 items that meet the definition of a financial statement element but do not provide useful information are NOT RECOGNIZED
and vice versa

 Providing information as well as using that information entails cost

 Thus an entity should consider the cost constraint (cost benefit principle) when making recognition decisions such that the
usefulness of the information justifies its cost
 Even if an item that meets the definition of an asset or liability is not recognized, information about that item may still need to
be disclosed in the notes
o the item is referred to as unrecognized assets or unrecognized liability

Relevance
o The recognition of an item may not provide relevant information if:
a. it is uncertain whether an asset or liability exists
b. an asset or liability exists but the probability of an inflow or outflow of economic benefits is low
 If one or both of the foregoing factors result to nonrecognition, information about the unrecognized asset or liability may still
need to be provided in the notes
 Despite the presence of one or both of the foregoing factors, an asset or liability may nonetheless be RECOGNIZED if this
provides relevant information

Faithful Representation
o The recognition of an item is appropriate if it provides both relevant and faithfully represented information
o the level of measurement uncertainty and other factors (such as presentation and disclosure) affect and items faithful
representation

Measurement Uncertainty
o An asset or liability must be measured for it to be recognized
o Often, measurement requires estimation and thus subject to measurement uncertainty
o The use of reasonable estimates is an essential part of financial reporting and DOES NOT necessarily undermine the
usefulness of information
o An exceptionally high measurement uncertainty can affect the faithful representation of an item
o measurement uncertainty can lead to the non-recognition of an asset or a liability if making an estimate is exceptionally
difficult or exceptionally subjective

Derecognition
o Opposite of recognition
o the removal of a previously recognized asset or liability from the entity’s statement of financial position
o Occurs when the item ceases to meet the definition of an asset or liability
 Such as when the entity loses control of all or part of the asset, or no longer has a present obligation for all or part of the
liability
o The entity:
 a. Derecognizes the assets or liabilities that have expired or has been consumed, collected, fulfilled, or transferred, and
recognizes any resulting income and expenses
b. Continues to recognize any assets or liabilities retained after the derecognition. No income or expense is normally
recognized on the retained component unless there is a change in its measurement basis. After derecognition, the retained
component becomes a unit of account separate from the transferred component

Unit of Account
o Is the right or group of rights, the obligation or the group of obligations, or the group of rights and obligations, to which the
recognition criteria and measurement concepts are applied
o Can be:
 An account title (cash, accounts receivable)
 A group of similar assets (property, plant, and equipment)
 A group of assets and liabilities (cash-generating unit)
o Is selected for an asset or liability when determining how that asset or liability, and the related income or expense, will be
recognized and measured
 Cash is recognized when it is either on hand or deposited in the bank and is measured at face amount, while accounts
receivable is recognized when a sale occurred and is measured at the transaction price, adjusted for any uncollectible
amount
o If an entity transfers part of an asset or part of a liability, the unit of account may change at that time, so that the transferred
component and the retained component become separate units of account\

Transfers
o Derecognition is not appropriate if the entity retains substantial control of a transferred asset
 In such case, the entity continues to recognize the transferred asset and recognizes any proceeds received from the
transfer as a liability
 If there is only partial transfer, the entity derecognizes only that transferred component and continues to recognize
retained component

Measurement
o Recognition requires quantifying an item in monetary terms, thus necessitating the selection of an appropriate measurement
basis

Measurement Bases
1. Historical Cost
2. Current Value
a. Fair value
b. Value in use and fulfilment value
c. Current cost