1 CONCEPTUAL FRAMEWORK FOR

FINANCIAL REPORTING

FRANCIS H. VILLAMIN
2 CONCEPTUAL FRAMEWORK FOR
FINANCIAL REPORTING

Learning Objectives
• State the purpose, status, and scope of the Conceptual
Framework.
• State the objective of financial reporting.
• Identify the primary users of financial statements.
• Explain briefly the qualitative characteristics of useful
information and how they are applied in financial
reporting.
 CONCEPTUAL FRAMEWORK FOR
3 FINANCIAL REPORTING

Learning Objectives

• Define the elements of financial statements and state

their recognition criteria and their derecognition.
• State the measurement bases used in financial
reporting.
4 PURPOSE OF THE
CONCEPTUAL FRAMEWORK
• The Conceptual Framework prescribes the concepts for
general purpose financial reporting. Its purpose is to:
a. assist the International Accounting Standards Board
(IASB) in developing Standards that are based on
consistent concepts;
b. assist preparers in developing consistent accounting
policies when no Standard applies to a particular
transaction or when a Standard allows a choice of
accounting policy; and
c. assist all parties in understanding and interpreting the
Standards.
5
STATUS OF THE CONCEPTUAL FRAMEWORK

• The Conceptual Framework is not a PFRS. When there is a

conflict between the Conceptual Framework and a PFRS, the
PFRS will prevail.
• In the absence of a standard, management shall consider the
Conceptual Framework in making its judgment in developing and
applying an accounting policy that results in useful information.
 SCOPE OF THE CONCEPTUAL
6
FRAMEWORK

The Conceptual Framework is concerned with general purpose

financial reporting. General purpose financial reporting involves the
preparation of general purpose financial statements. The Conceptual
Framework provides the concepts regarding the following:
1. The objective of financial reporting
2. Qualitative characteristics of useful financial information
3. Financial statements and the reporting entity
4. The elements of financial statements
 SCOPE OF THE CONCEPTUAL
7
FRAMEWORK

The Conceptual Framework is concerned with general purpose

financial reporting. General purpose financial reporting involves the
preparation of general purpose financial statements. The Conceptual
Framework provides the concepts regarding the following:
5. Recognition and derecognition
6. Measurement
7. Presentation and disclosure
8. Concepts of capital and capital maintenance
8
OBJECTIVE OF GENERAL PURPOSE
FINANCIAL REPORTING

• The objective of general purpose financial reporting is

to provide financial information about the reporting entity
that is useful to primary users in making decisions about
providing resources to the entity.
• The objective of general purpose financial reporting forms the
foundation of the Conceptual Framework.
9 PRIMARY USERS

• Primary users – are those who cannot demand

information directly from reporting entities. The primary
users are:
(a) Existing and potential investors
(b) Lenders and other creditors.

• Only the common needs of primary users are met by the

financial statements.
10
QUALITATIVE CHARACTERISTICS

I. Fundamental qualitative characteristics

(1) Relevance
(a) Predictive value
(b) Feedback value
 Materiality – entity-specific aspect of relevance
11
QUALITATIVE CHARACTERISTICS

I (2) Faithful representation

(a) Completeness
(b) Neutrality
(c) Free from error
12
QUALITATIVE CHARACTERISTICS

II. Enhancing qualitative characteristics

(1) Comparability
(2) Verifiability
(3) Timeliness
(4) Understandability
13 FUNDAMENTAL VS.
ENHANCING

• The fundamental qualitative characteristics are the

characteristics that make information useful to users.
• The enhancing qualitative characteristics are the
characteristics that enhance the usefulness of information
14
RELEVANCE
• Information is relevant if it can affect the decisions of
users.
• Relevant information has the following:
a. Predictive value – the information can be used in making
predictions
b. Confirmatory value – the information can be used in confirming
past predictions

 Materiality – is an ‘entity-specific’ aspect of relevance.

15
FAITHFUL REPRESENTATION
• Faithful representation means the information provides a true, correct
and complete depiction of what it purports to represent.
• Faithfully represented information has the following:
a. Completeness – all information necessary for users to
understand the phenomenon being depicted is provided.
b. Neutrality – information is selected or presented without bias.
c. Free from error – there are no errors in the description and in
the process by which the information is selected and applied.
16 ENHANCING QUALITATIVE
CHARACTERISTICS
1. Comparability – the information helps users in identifying
similarities and differences between different sets of
information.
2. Verifiability – different users could reach consensus as to
what the information purports to represent.
3. Timeliness – the information is available to users in time
to be able to influence their decisions.
4. Understandability – users are expected to have:
a. reasonable knowledge of business activities; and
b. willingness to analyze the information diligently.
17 FINANCIAL STATEMENTS AND
THE REPORTING ENTITY

Objective and scope of financial statements

• The objective of general purpose financial statements is to
provide financial information about the reporting entity’s
assets, liabilities, equity, income and expenses that is useful in
assessing:
a. the entity’s ability to generate future net cash inflows;
and
b. management’s stewardship over economic resources.
18 FINANCIAL STATEMENTS AND
THE REPORTING ENTITY
Reporting period
• Financial statements are prepared for a specific period of time (i.e.,
the reporting period) and include comparative information for at
least one preceding reporting period.

Going concern
• Financial statements are normally prepared on the assumption that
the reporting entity is a going concern, meaning the entity has
neither the intention nor the need to end its operations in the
foreseeable future.
19 FINANCIAL STATEMENTS AND
THE REPORTING ENTITY

Reporting entity
• A reporting entity is one that is required, or chooses, to
prepare financial statements, and is not necessarily a legal
entity. It can be a single entity or a group or combination of
two or more entities.
20
ELEMENTS OF FINANCIAL STATEMENTS
21 ASSET

• Asset is “a present economic resource controlled

by the entity as a result of past events. An
economic resource is a right that has the
potential to produce economic benefits.”
22 THREE ASPECTS IN THE DEFINITION
OF AN ASSET

1. Right – asset refers to a right, and not necessarily to a physical object,

e.g., the right to use, sell, lease or transfer a building.
2. Potential to produce economic benefits – the right has a potential
to produce economic benefits for the entity that are beyond the
benefits available to all others. Such potential need not be certain or
even likely – what is important is that the right already exists and that,
in at least one circumstance, it would produce economic benefits for
the entity.
3. Control – means the entity has the exclusive right over the benefits of
an asset and the ability to prevent others from accessing those benefits.
23 LIABILITY

• Liability is “a present obligation of the entity to

transfer an economic resource as a result of past
events.”
24
THREE ASPECTS IN THE DEFINITION OF A
LIABILITY

1. Obligation – An obligation is “a duty or responsibility that an entity

has no practical ability to avoid.” (CF 4.29) An obligation can be either
legal obligation or constructive obligation.

2. Transfer of an economic resource – the obligation has the

potential to require the transfer of an economic resource to
another party. Such potential need not be certain or even likely
– what is important is that the obligation already exists and
that, in at least one circumstance, it would require the transfer
of an economic resource.
 THREE ASPECTS …… LIABILITY
25 (CONTINUATION)

3. Present obligation 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; and
b. as a consequence, the entity will or may have to transfer an
economic resource that it would not otherwise have had to
transfer.
26
EXECUTORY CONTRACTS

• An executory contract “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.”
• An executory contract establishes a combined right
and obligation to exchange economic resources.
 27 EXECUTORY CONTRACTS

• 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.
28
EQUITY
• “Equity is the residual interest in the assets of the
entity after deducting all its liabilities.”
(Conceptual Framework 4.63)
• Equity equals Assets minus Liabilities
29 INCOME AND EXPENSES

• Income
Income is “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
Expenses 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.”
30 RECOGNITION &
DERECOGNITION
The recognition process
• Recognition is the process of including in the statement of
financial position or the statement(s) of financial
performance an item that meets the definition of one of the
financial statement elements (i.e., asset, liability, equity,
income or expense). This involves recording the item in
words and in monetary amount and including that amount
in the totals of either of those statements.
31 RECOGNITION &
DERECOGNITION
Recognition criteria
• An item is recognized if:
a. it meets the definition of an asset, liability, equity,
income or expense; and
b. recognizing it would provide useful information, i.e.,
relevant and faithfully represented information.
32 RECOGNITION &
DERECOGNITION
Relevance
• The recognition of an item may not provide relevant information if,
for example:
a. it is uncertain whether an asset or liability exists; or
b. an asset or liability exists, but the probability of an inflow or
outflow of economic benefits is low. (Conceptual Framework
5.12)

However, the presence of one or both of the foregoing does not

automatically lead to the non-recognition of an item. Other factors
should also be considered.
33
RECOGNITION & DERECOGNITION

Faithful representation
• The level of measurement uncertainty and other factors
can affect an item’s faithful representation, but not
necessarily its relevance.
34
RECOGNITION & DERECOGNITION

Measurement uncertainty
• Measurement uncertainty exists if the asset or liability needs to be
estimated. A high level of measurement uncertainty does not
necessarily lead to the non-recognition of an asset or liability if the
estimate provides relevant information and is clearly and accurately
described and explained.
• However, measurement uncertainty can lead to the non-recognition of
an asset or a liability if making an estimate is exceptionally difficult
or exceptionally subjective.
35 RECOGNITION &
DERECOGNITION
Derecognition
• Derecognition is the removal of a previously recognized asset
or liability from the entity’s statement of financial position.
• Derecognition occurs when the item ceases to meet the
definition of an asset or liability.
36 UNIT OF ACCOUNT

• Unit of account is “the right or the group of rights,

the obligation or the group of obligations, or the
group of rights and obligations, to which
recognition criteria and measurement concepts
are applied.”
37 MEASUREMENT BASES

1. Historical cost
2. Current value
a. Fair value
b. Value in use and fulfilment value
c. Current cost
38 HISTORICAL COST

• The historical cost of:

a. an asset is the consideration paid to acquire the asset
plus transaction costs.
b. a liability is the consideration received to incur the
liability minus transaction costs.
• Historical cost is updated over time to depict the following:
 Depreciation, amortization, or impairment of assets
 Collections or payments that extinguish part or all of
the asset or liability
 Unwinding of discount or premium when the asset or
liability is measured at amortized cost
39 FAIR VALUE

• Fair value is “the price that would be received to sell an

asset, or paid to transfer a liability, in an orderly transaction
between market participants at the measurement date.”
40 VALUE IN USE AND FULFILMENT
VALUE

• Value in use is “the present value of the cash flows, or other

economic benefits, that an entity expects to derive from
the use of an asset and from its ultimate disposal.”

• Fulfilment value is “the present value of the cash, or other

economic resources, that an entity expects to be obliged to
transfer as it fulfils a liability.”
41 CURRENT COST

• The current cost of:

a. an asset is “the cost of an equivalent asset at the
measurement date, comprising the consideration that
would be paid at the measurement date plus the
transaction costs that would be incurred at that date.”
b. a liability is “the consideration that would be received
for an equivalent liability at the measurement date minus
the transaction costs that would be incurred at that
date.”
42 ENTRY VALUES VS. EXIT
VALUES
• Current cost and historical cost are entry values (i.e., they
reflect prices in acquiring an asset or incurring a liability),
whereas fair value, value in use and fulfilment value are exit
values (i.e., they reflect prices in selling or using an asset or
transferring or fulfilling a liability).
 43
CONSIDERATIONS WHEN SELECTING A MEASUREMENT BASIS

• When selecting a measurement basis, it is important to consider the

following:
a. The nature of information provided by a particular
measurement basis (e.g., measuring an asset at historical cost may
lead to the subsequent recognition of depreciation or impairment,
while measuring that asset at fair value would lead to the
subsequent recognition of gain or loss from changes in fair value).
b. The qualitative characteristics, the cost-constraint, and other
factors (e.g., a particular measurement basis may be more
verifiable or more costly to apply than the other measurement
bases).
44 MEASUREMENT OF EQUITY

• Total equity is not measured directly. It is simply equal to

difference between the total assets and total liabilities.
• Because different measurement bases are used for different
assets and liabilities, total equity cannot be expected to be
equal to the entity’s market value nor the amount that can be
raised from either selling or liquidating the entity.
• Equity is generally positive, although some of its components
can be negative. In some cases, even total equity can be
negative such as when total liabilities exceed total assets.
45

END