CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

Conceptual Framework for Financial Reporting

The Conceptual Framework for Financial Reporting (Conceptual Framework) is a complete, comprehensive and single
document promulgated by the International Accounting Standards Board (IASB). It is a summary of the terms and
concepts that underlie the preparation and presentation of financial statements for external users, which means it
describes the concepts for general-purpose financial reporting.

The Conceptual Framework is intended to guide standard-setters, preparers and users of financial information in the
preparation and presentation of statements. It is the underlying theory for the development of accounting standards
and revision of previously issued accounting standards.

The Conceptual Framework provides the foundation for Standards that:

a. Contribute to transparency by enhancing international comparability and quality of financial information.
b. Strengthen accountability by reducing information gap between providers of capital and the people to whom
they have entrusted their money.
c. Contribute to economic efficiency by helping investors to identify opportunities and risks across the world.

You can find a summary of the Conceptual Framework here: https://www.ifrs.org/-/media/project/conceptual-framework/fact-sheet-project-summary-and-feedback-

statement/conceptual-framework-project-summary.pdf

Purposes of Revised Conceptual Framework

The Revised Conceptual Framework was issued last March 2018.

The purposes of the Revised Conceptual Framework are as follows:

a. To assist IASB to develop IFRS Standards based on consistent concepts.
b. To assist preparers of financial statements to develop consistent accounting policy when no Standard applies to
a particular transaction or other event or where an issue is not yet addressed by an IFRS.
c. To assist preparers of financial statements to develop accounting policy when a Standard allows a choice of an
accounting policy.
d. To assist all parties to understand and interpret the IFRS Standards.

Authoritative Status of Conceptual Framework

If there is a standard or an interpretation that specifically applies to a transaction, the standard or interpretation
overrides the Conceptual Framework.

It is to be stated that the Conceptual Framework is not an International Financial Reporting Standard (IFRS). Nothing in
the Conceptual Framework overrides any specific IFRS.

In case where there is conflict, the requirements of the IFRS shall prevail over the Conceptual Framework.

Users of Financial Information

Under the Conceptual Framework, the users of financial information may be classified into two parts, namely:
a. Primary users
b. Other users

The primary users include the existing and potential investors, lenders, and other creditors.

The other users include all other parties, which are not classified as primary users, that may use the financial
information. Some examples of other users include:
 Employees
 Customers
 Suppliers
  Government and their agencies
 Public

Scope of Revised Conceptual Framework

a. Objective of financial reporting
b. Qualitative characteristics of useful financial information
c. Financial statements and reporting entity
d. Elements of financial statements
e. Recognition and derecognition
f. Measurement
g. Presentation and disclosure
h. Concepts of capital and capital maintenance

Objective of Financial Reporting

The objective of financial reporting forms the foundation of the Conceptual Framework.

Financial reporting is the provision of financial information about an entity to external users that is useful to them in
making economic decisions and for assessing the effectiveness of the entity’s management.

The overall 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.

The specific objectives of financial reporting are as follows:

a. To provide information useful in making decisions about providing resources to the entity.
b. To provide information useful in assessing the cash flow prospects of the entity.
c. To provide information about entity resources, claims and changes in resources and claims.

Limitations of Financial Reporting

a. General purpose financial reports do not and cannot provide all of the information that existing and potential
investors, lenders, and other creditors need.
b. General-purpose financial reports are not designed to show the value of an entity, but the reports provide
information to help the primary users estimate the value of the entity.
c. General-purpose financial reports are intended to provide common information to users and cannot
accommodate every request for information.
d. To a large extent, general-purpose financial reports are based on estimate and judgment rather than exact
depiction.

Qualitative Characteristics
Qualitative characteristics are the qualities or attributes that make financial accounting information useful to the users.
In deciding which information to include in financial statements, the objective is to ensure that the information is useful
to the users in making economic decisions.

Under the Conceptual Framework, qualitative characteristics are classified into:

a. Fundamental qualitative characteristics; and
b. Enhancing qualitative characteristics.

The fundamental qualitative characteristics relate to the content or substance of financial information; the enhancing
qualitative characteristics relate to the presentation or form of the financial information.

I. Fundamental Qualitative Characteristics

The fundamental qualitative characteristics are:
a. Relevance; and
b. Faithful representation
a. Relevance
In the simplest terms, relevance is the capacity of the information to influence a decision. To be relevant, the financial
information must be capable of making a difference in the decisions made by users. In other words, relevance requires
that the financial information should be related or pertinent to the economic decision.

Information that does not bear on an economic decision is useless.

Ingredients of Relevance
Financial information is capable of making a difference in a decision if it has:
a. Predictive value; and
b. Confirmatory value

Financial information has predictive value if it can be used as an input to processes employed by users to predict future
outcome.

Financial information has confirmatory value if it provides feedback about previous evaluations.

Often, information has both predictive and confirmatory value. The predictive and confirmatory roles of information are
interrelated.

Materiality
Materiality is a practical rule in accounting which dictates that strict adherence to GAAP is not required when the items
are not significant enough to affect the evaluation, decision, and fairness of the financial statements.

Materiality is really a quantitative “threshold” linked very closely to the qualitative characteristic of relevance.

Materiality of an item depends on relative size rather than absolute size. What is material for one entity may be
immaterial for another. For instance, and error of P500,000 in the financial statements of a multinational entity may not
be important, but may be so critical for a small entity.

There is no strict or uniform rule for determining whether an item is material or not. Very often, this is dependent on
good judgment, professional expertise, and common sense.

Materiality also depends on the magnitude and nature of the financial information. In the exercise of judgment in
determining materiality, the relative size and nature of an item are considered.

The size of the item in relation to the total of the group to which the item belongs is taken into account. For example,
the amount of advertising in relation to total selling expenses.

The nature of the item may be inherently material because by its very nature, it affects economic decision. For instance,
the discovery of a P20,000 bribe is a material event even for a very large entity.

b. Faithful Representation
Faithful representation means that the financial report must present what it purports to represent. In other words, the
description and figures must match what really existed or happened.

The following are the ingredients of faithful representation:

a. Completeness
b. Neutrality
c. Free from error
Completeness
Completeness requires that 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.

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

A neutral depiction is not slanted, weighted, emphasized, de-emphasized or otherwise manipulated to increase the
probability that financial information will be received favorably or unfavorably by users.

The Revised Conceptual Framework has reintroduced the concept of prudence.

Prudence is the exercise of care and caution when dealing with the uncertainties in the measurement process such that
assets or income are not overstated and liabilities or expenses are not understated.

Neutrality is supported by the exercise of prudence.

Free from Error

Free from error means there are no errors or omissions in the description of the phenomenon or transaction.

The Concept of Substance Over Form

If information is to represent faithfully the transactions and other events it purports to represent, it is necessary that the
transactions and events are accounted in accordance with their substance and reality and not merely their legal form.

The economic substance of transactions and events are usually emphasized when economic substance differs from legal
form.

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

II. Enhancing Qualitative Characteristics

The enhancing qualitative characteristics are:
a. Comparability
b. Understandability
c. Verifiability
d. Timeliness

a. Comparability
Comparability means the ability to bring together for the purpose of noting points of likeness and difference.

Comparability may be within an entity or between and across entities.

Comparability within an entity is also known as horizontal comparability or intracomparability; while comparability
between and across entities is also known as intercomparability or dimensional comparability.

The Principle of Consistency

Implicit in the qualitative characteristics of comparability is the principle of consistency.

In a broad sense, consistency refers to the use of the same method for the same item, either from period to period
within an entity or in a single period across entities. In a limited sense, consistency is the uniform application of
accounting method from period to period within an entity.
b. 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 terminology that a user understands.

An essential quality of the information provided in financial statements is that it is readily understandable by users.

However, financial statements cannot realistically be understandable to everyone. Financial reports are prepared for
users who have a reasonable knowledge of business and economic activities and who review and analyze information
diligently.

Understandability is very essential because a relevant and faithfully represented information may prove useless if it is
not understood by users.

c. 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.

Verification can be direct or indirect.

Direct verification means verifying an amount or other representation through direct observation; for instance, by
counting cash.

Indirect verification means checking the inputs to a model, formula, or other technique and recalculating the inputs
using the same methodology.

d. Timeliness
Timeliness means that financial information must be available or communicated early enough when a decision is to be
made. Relevant and faithfully represented financial information furnished after a decision is made is useless or of no
value.

Generally, the older the information, the less useful.

Financial Statements and Reporting Entity

Financial Statements
Financial statements provide information about economic resources of the reporting entity, claims against the entity,
and changes in the economic resources and claims.

Financial statements are the means by which the information accumulated and processed in financial accounting is
periodically communicated to the users.

Financial statements are a structured financial representation of the financial position and financial performance of an
entity.

Objective of Financial Statements

The objective of financial statements is to provide information about the financial position, financial performance and
cash flows of an entity that is useful to a wide range of users in making economic decisions. Financial statements also
show the results of the management’s stewardship of the resources entrusted to it. To meet this objective, financial
statements provide information about an entity’s:
(a) assets;
(b) liabilities;
(c) equity;
(d) income and expenses, including gains and losses;
 (e) contributions by and distributions to owners in their capacity as owners; and
(f) cash flows.

Components of a Complete Set of Financial Statements

Since the purpose of the financial statements is to provide information regarding the entity’s assets, liabilities, equity,
income and expenses (including gains and losses), contributions by and distributions to owners in their capacity as
owners, and cash flows; a complete set of financial statements must include those statements that provide these
information.

A complete set of financial statements comprises:

1. A statement of financial position at the end of the period – provides information regarding the entity’s (a)
assets; (b) liabilities; and (c) equity
2. A statement of profit or loss and other comprehensive income for the period – provides information regarding
the entity’s (d) income and expenses, including gains and losses
3. A statement of changes in equity for the period – provides information regarding the closing of the income and
expenses to the equity account; and (e) contributions by and distributions to owners in their capacity as owners
4. A statement of cash flows for the period – provides information regarding the entity’s (f) cash flows
5. Notes, comprising significant accounting policies and other explanatory information – provides other
information that are not presented in the face of the other statements but are useful to the users
6. Comparative information in respect of the preceding period
7. A statement of financial position as at the beginning of the preceding period when an entity applies an
accounting policy retrospectively or makes a retrospective restatement of items in its financial statements, or
when it reclassifies items in its financial statements

Reporting Entity
A reporting entity is an entity that is required or choose to prepare financial statements.

The reporting entity can be a single entity or a portion of an entity, or can comprise more than one entity. A reporting
entity is not necessarily a legal entity.

Accordingly, the following can be considered a reporting entity:

a. Individual corporation, partnership, or proprietorship
b. The parent alone
c. The parent and its subsidiaries as single reporting entity
d. Two or more entities without parent and subsidiary relationship as a single reporting entity
e. A reportable business segment of an entity

Underlying Assumptions
Accounting assumptions are the basic notions or fundamental premises on which the accounting process is based.
Accounting assumptions are also known as postulates.

The Conceptual Framework mentions only one assumption: the going concern assumption.

However, implicit in accounting are the basic assumptions of:

a. Accounting entity;
b. Time period; and
c. Monetary unit

Going Concern
The only assumption in accounting is the going concern assumption, which is the assumption that the entity will
continue to operate for the foreseeable future.
When preparing financial statements, management shall make an assessment of an entity’s ability to continue as a going
concern. An entity shall prepare financial statements on a going concern basis unless management either intends to
liquidate the entity or to cease trading, or has no realistic alternative but to do so. When management is aware, in
making its assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the
entity’s ability to continue as a going concern, the entity shall disclose those uncertainties. When an entity does not
prepare financial statements on a going concern basis, it shall disclose that fact, together with the basis on which it
prepared the financial statements and the reason why the entity is not regarded as a going concern.

Accounting Entity
In financial accounting, the accounting entity is the specific business organization which may be a proprietorship,
partnership, or corporation. Under this assumption, the entity is separate from the owners, managers, and employees
who constitute the entity.

Accordingly, the transactions of the entity shall no be merged with the transactions of the owners.

Time Period
A completely accurate report on the financial position and performance of an entity cannot be obtained until the entity
is finally dissolved and liquidated. Only then can the final net income and networth of the entity be determined
precisely.

However, users of financial information need timely information for making an economic decision. It becomes necessary
therefore to prepare periodic reports on financial position, performance, and cash flows of an entity.

By convention, the accounting period or fiscal period is one year or a period of twelve months.

Monetary Unit
The monetary unit assumption has two aspects, namely quantifiability and stability of peso.

The quantifiability aspect means that the assets, liabilities, equity, income, and expenses should be stated in terms of a
unit of measure which is the Philippine Peso.

The stability of peso assumption means that the purchasing power of the peso is stable or constant and that its
instability is insignificant and therefore may be ignored.

Elements of Financial Statements

The elements of accounting are as follows:
 Presented in the statement of financial position
o Assets
o Liabilities
o Equity
 Presented in the statement of comprehensive income
o Income (which includes revenues and gains)
o Expense (which includes expenses and losses)

Definition of Asset
Previous Definition (under the old Conceptual Framework): A resource controlled by the entity as a result of past events
and from which future economic benefits are expected to flow to the entity.

Revised Definition: 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.

Main changes in the definition:

  separate definition of an economic resource—to clarify that an asset is the economic resource, not the ultimate
inflow of economic benefits
 deletion of ‘expected flow’—it does not need to be certain, or even likely, that economic benefits will arise
 a low probability of economic benefits might affect recognition decisions and the measurement of the asset

Definition of Liability
Previous Definition: A present obligation of the entity arising from past events, the settlement of which is expected to
result in an outflow from the entity of resources embodying economic benefits.

Revised Definition: A present obligation of the entity to transfer an economic resource as a result of past events. An
obligation is a duty or responsibility that the entity has no practical ability to avoid.

Main changes in the definition:

 separate definition of an economic resource—to clarify that a liability is the obligation to transfer the economic
resource, not the ultimate outflow of economic benefits
 deletion of ‘expected flow’—with the same implications as set out above for an asset
 introduction of the ‘no practical ability to avoid’ criterion to the definition of obligation

Definition of Income and Expense

Revised Definition of Income
Increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions
from holders of equity claims.

The definition of income encompasses both revenue and gains.

The main difference between revenue and gain is that revenue arises in the course of the ordinary regular activities.

Revised Definition of Expense

Decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions
to holders of equity claims.

Expenses encompass losses as well as those expenses that arise in the course of the ordinary regular activities.

Recognition and Derecognition

The Revised Conceptual Framework defines recognition as the process of capturing for inclusion in the statement of
financial position or the statement(s) of financial performance an item that meets the definition of an asset, a liability,
equity, income or expenses.

Recognition is appropriate if it results in both relevant information about assets, liabilities, equity, income and expenses
and a faithful representation of those items, because the aim is to provide information that is useful to investors,
lenders and other creditors.

Expense Recognition
The basic expense recognition means that expenses are recognized when incurred.

Actually, the expense recognition principle is the application of the matching principle.

The matching principle has three applications, namely:

a. Cause and effect association
b. Systematic and rational allocation
c. Immediate recognition
The Revised Conceptual Framework introduced the term derecognition, which is defined as the removal of all or part of
a recognized asset or liability from the statement of financial position.

Measurement
Measurement is defined as quantifying in monetary terms the elements in the financial statements.

The Revised Conceptual Framework mentions two categories:

a. Historical cost
b. Current value

Historical Cost
 historical cost provides information derived, at least in part, from the price of the transaction or other event that
gave rise to the item being measured
 historical cost of assets is reduced if they become impaired and historical cost of liabilities is increased if they
become onerous
 one way to apply a historical cost measurement basis to financial assets and financial liabilities is to measure
them at amortized cost

Current Value
Current value provides information updated to reflect conditions at the measurement date. Current value measurement
bases include:
 Fair value – 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; reflects market participants’ current
expectations about the amount, timing and uncertainty of future cash flows
 Value in use (for assets)/Fulfilment value (for liabilities) – reflects entity-specific current expectations about the
amount, timing and uncertainty of future cash flows
 Current cost – reflects the current amount that would be:
o paid to acquire an equivalent asset
o received to take on an equivalent liability

Presentation and Disclosure

The presentation and disclosure can be an effective communication tool about the information in the financial
statements.

A reporting entity communicates information about its assets, liabilities, equity, income and expenses by presenting and
disclosing information in the financial statements.

Capital and Capital Maintenance

The financial performance of an entity is determined using two approaches, namely transaction approach and capital
maintenance approach.

The transaction approach is the traditional preparation of an income statement.

The capital maintenance approach means that net income occurs only after the capital used from the beginning of the
period is maintained.