CONCEPTUAL FRAMEWORK
Financial Reporting and Assumptions
Conceptual Framework
− Summary of the terms and concepts that underlie
the preparation and presentation of financial
statements
− Promulgated by the International Accounting
Standards Board (IASB)
− Overall theoretical foundation for accounting
− Intended to guide standard-setters, preparers, and
users
− The underlying theory for the development of
accounting standards and revisions
− Concerned with general purpose financial
statements
Purposes of Conceptual Framework
a.To assist in developing accounting standards and
reviewing existing standards
b.To assist preparers of financial statements in
applying accounting standards and in dealing with
issue not yet covered by GAAP
c. To assist the FRSC in the review and adoption of
International Financial Reporting Standards
d.To assist auditors in forming an opinion whether
financial statement conform with Phil. GAAP
e. To provide information to those interested in the
work of the FRSC in the formulation of PFRS
Authoritative Status of Conceptual Framework
 In the absence of a standard:
- the management shall consider the applicability of
the Conceptual Framework in developing and
applying an accounting policy
 Conceptual Framework is not a Philippine
Financial Reporting Standard
- it does not define standard for any particular
measurement or disclosure issue
 In case of conflict:
- Philippine Financial Reporting Standard shall
prevail over the Conceptual Framework
Users of Financial Information
Primary Users
− To whom general purpose financial reports are
primarily directed
− They cannot require entities to provide information
directly to them
1. Existing and Potential Investors
− Concerned with the risk inherent in and
return provided by their investments
− Helps them to decide whether to buy, hold,
or sell
− To asses the ability of the entity to pay
dividends
2. Lenders and Other Creditors
− To help them determine if the amounts
owing to them will be paid when due
Other Users
− They find the general purpose financial reports
useful but the reports are not directed to them
primarily
1. Employees
− Interested in the stability and profitability of
the entity
− To know if the entity can provide raises,
remuneration, retirement benefits, and
employment opportunities
2. Customers
− Interested in the continuance of an entity,
especially when they have long-term
involvement, or dependent to it
3. Governments and their Agencies
− Interested in the allocation of resources and
activities of the entity
− For regulating activities, determining
taxation policies, and basis of statistics
4. Public
− Providing information about trends and
range of entity’s activities
Scope of Conceptual Framework
a. Objective of financial reporting
b.Qualitative characteristics of useful financial
information
c. Definition, recognition, and measurement of the
elements from which financial statements are
constructed
d.Concepts of capital and capital maintenance
Financial Reporting
− Provision of financial information useful for
external users in making economic decisions and
assessing the effectiveness of the entity’s
management
− Also refer to other means of communicating
information such as nonfinancial information
OBJECTIVE OF FINANCIAL REPORTING
− Forms the foundation of the Conceptual Framework
− Overall objective: To provide financial
information useful for primary uses in making
decisions about providing resources
− The “why”, purpose, or goal of accounting
Target Users
− These are the existing and potential investors,
lenders, and other creditors who can provide
resources to the entity
− The have the most critical and Immediate need for
information
Specific Objective of Financial Reporting
a. To provide information useful in making decisions
about providing resources
 Investors: whether to buy, sell, or hold equity
investments
 Lenders and other Creditors: whether to
provide or settle loans and other credit form
b.To provide information useful in assessing the cash
flow prospects
 Investors: decisions depend on the returns that
they expect from an investment
 Lenders and other Creditors: depend on the
principal and interest payments or other returns
they expect
c. To provide information about entity resources,
claims, and changes in resources and claims
 Financial Position
- Refer to the economic resources and claims
- Comprise of assets (economic resources),
liabilities and equity (claims)
- Helps users identify the entity’s financial
strength and weakness
o Liquidity – availability of cash to cover
currently maturing obligations
o Solvency – availability of cash to meet
financial commitments when fall due
- Help users predict how future cash flows
will be distributed
 Financial Performance
- Refer to the changes in economic resources
and claims
- The level of income earned by the entity
through the efficient and effective use of its
resources
- Comprises of revenue, expenses, and net
income or loss
- The results of operations and portrayed in
the income statement and statement of
comprehensive income
Usefulness of Financial Performance
− Helps users to understand the return produced by
the entity on the economic resources
− Provides an indication of how well management
has discharged its responsibilities
 Past: predict future returns
 Present: asses the ability to generate future cash
inflows from operations
Accrual Accounting
− Effects of transactions are recognized when
occurred and not as cash is received or paid
− Income is recognized when earned regardless of
when received, and expense is recognized when
incurred regardless of when paid
Limitations of Financial Reporting
a. It does not and cannot provide all of the
information needed
b.It is not designed to show the value of an entity
rather it helps estimate the value of an entity
c. It only provides common information and cannot
accommodate every request
d.It is based on estimate and judgment
UNDERLYING ASSUMPTION
Accounting Assumptions
− The basic notions or fundamental premises on
which the accounting process is based
− Also known as “postulates”
− Serve as the foundation or bedrock of accounting to
enhance the understanding and usefulness of
financial statements
1.Going Concern
- Entity will continue in operations for the
foreseeable future
- The very foundation of the cost principle
- Thus, assets are normally recorded at cost
2.Accounting Entity
- Entity is separate from the owners, managers, and
employees
- Transactions of the entity shall not be merged with
the transaction of the owners
- For a fair presentation of financial statements
- Each business is an independent entity
- However, when parent and subsidiary relationship
exists, consolidated statements for affiliates is
prepared, but, it does not eliminate legal
boundaries.
3.Time Period
- the indefinite life of an entity is subdivided into
accounting periods of equal length
- One-year period: traditional accounting period
 Calendar Year – ends on December 31
 Fiscal Year/Natural Business Year – end on
any month when the business is at the lowest or
at its slack season
4.Monetary Unit
 Quantifiability – items should be stated in terms
of a unit of measure – Peso in the Phil.
  Stability of the Peso – purchasing power of the
peso is stable or constant
 Stable Peso Postulate – amplification of the
going concern assumption, so, adjustments are
unnecessary to reflect any changes in purchasing
power
 Accounting Function – to account for nominal
pesos only and not for constant pesos or changes
in purchasing power
QUALITATIVE CHARACTERISTICS
− The qualities or attributes that make financial
accounting information useful to other users
Fundamental Qualitative Characteristics
− Relate to the content or substance
− Information must be both relevant and faithfully
represented
1.Relevance
- The capacity of the information to influence a
decision
- Information should be related or pertinent to the
economic decision
 Predictive Value – forecast outcome of
events (what might happen in the future)
 Confirmatory Value – confirms or corrects
previous predictions (feedback value)
a.Materiality
- “Doctrine of Convenience”
- Materiality of an item depends on relative size
- It is a matter of good judgment, professional
expertise, and common sense
- Information is material if its omission or
misstatement of information could influence
the economic decision
- Factors of materiality: size and nature of the
item
2.Faithful Representation
- The descriptions and figures must match what
really existed or happened
- The actual effects of the transactions shall be
properly accounted for and reported
a.Completeness
- Information should be presented in a way that
facilitates understanding and avoids erroneous
implication
- Includes all information necessary for a user to
understand the phenomenon being depicted
 Standard of Adequate Disclosure
- Disclosure of any financial facts
significant enough to influence the
judgment of user
- Financial statement shall be accompanied
by notes to financial statement
b.Neutrality
- Information is not slanted, weighted,
emphasized, de-emphasized, or manipulated
- Information does not favor one party
- “Principle of Fairness”
c. Free from Error
- No errors or omissions in the description
- The amount is described clearly and accurately
 Substance over Form
- Transactions and events are accounted in
accordance with their substance and
reality and not in their legal form
 Conservatism
- When alternatives exist, the alternative
which has the least effect on equity
should be chosen
- In case of doubt, record any loss and do
not record any gain
- It is not a license to deliberately
understate net income and net assets
 Prudence
- The desire to exercise care and caution
when dealing with the uncertainties
Enhancing Qualitative Characteristics
− Relate to the presentation or form
− Intended to increase the usefulness
1.Comparability
- The ability to bring together for the purpose or
noting points of likeness and difference of items
 Horizontal Comparability/Intracomparability
 Dimensional Comparability/Intercomparability
a.Consistency
- Use of the same method for the same item
- If there is a change, there shall be full
disclosure
2.Understandability
- Information should be presented in a form and
expressed in terminology that user understands
3.Verifiability
- Different knowledgeable and independent
observers could reach consensus
 Direct – through direct observation
 Indirect – checking the inputs to a model,
formula, or other technique and recalculating
using the same method
4.Timeliness
- Financial information must be available or
communicated early enough when a decision is to
be made
  Cost Constraint – the benefit derived from the
information should exceed the cost incurred in
obtaining the information
ELEMENTS OF FINANCIAL STATEMENT
- The quantitative information presented
- “Building blocks”
- Financial Position: Asset, Liability, and Equity
- Financial Performance: Income, and Expense
Recognition of Elements
- Reporting of an asset, liability, income, or expense
1.Asset Recognition Principle
− Assets should be recorded initially at original
acquisition cost
 Asset
- A resource controlled by the entity as a result
of past events with future economic benefits
 Conditions for Recognition
- Probable flow of future economic benefit
- Cost or value be measured reliably
 Ways for Asset to Flow
- Production of goods or services to be sold by
the entity
- Exchange of other assets
- Used to settle a liability
- Distribute to the owners of the entity
 Initial Cost
- Carried w/o change
- Changed by depreciation, amortization or
write-off
- Shifted to other categories (raw Materials to
finished goods)
 Cost of the Asset
- Cash Transaction: cash payment
- Non-Cash Transaction: fair value/carrying
amount
2.Liability Recognition Principle
 Liability
- A present obligation arising from a past event
 Conditions for Recognition
- Probability of an outflow for the settlement
- Amount of obligation can be measured reliably
 Kinds of Obligation
a.Legally Enforceable – consequence of a
binding contract or statutory requirement
b.Constructive Obligation - arise from normal
business practice, custom or desire to maintain
good business relations or act in an equitable
manner
 Ways to Settle Liability
- Payment of cash
- Transfer of Non-Cash Assets
- Provision of services
- Replacement of the obligation with another
obligation
- Conversion of an obligation into equity
3.Income Recognition Principle
− Income shall be recognized when earned
 Income
- Increase in economic benefit through
inflow/increase in asset or decrease in liability
a.Revenue – arise from the ordinary regular
activities of the entity
b.Gain – do not arise in the regular course
 Conditions for Recognition
- Probable flow of future economic benefits
(result of increase in asset or decrease in
liability)
- Economic benefits can be measure reliably
 Point of Sale
- Point of income recognition
- It is where the legal title of the goods passes to
the buyer
 Methods in Income Recognition
a.Installment Method – recognized at the point
of collection; collections multiplied by gross
profit rate
b.Cost Recovery Method (Sunk Cost) –
recognized at the point of collection; all
collections are applied to the cost of
merchandise sold
c. Percentage of Completion Method (Stage of
Completion) - revenue from contracts; contract
cost shall be recognized as revenue and
expense
d.Production Method - recognized at the point
of production (agricultural, forest and mineral
products)
 Other Income Recognition
a.Interest Revenue – recognized based on a time
proportion basis; effective yield of the assets
b.Royalties – recognized in an accrual basis
based on the substance or regular agreement
c. Dividends – recognized upon declaration of the
dividend at the Stockholders’ Meeting
d.Subscription – recognized on a straight-line
basis over the subscription period
e. Admission fees – recognized when the event
takes place
f. Tuition fees – recognized over the period in
which tuition is provided
4.Expense Recognition Principle
− Expenses are recognized when incurred
 Expense
 - A decrease in economic benefit in the form of MEASUREMENT OF ELEMENTS
an outflow/decrease in asset or increase in − The process of determining the monetary amounts
liability the elements are to be recognized and carried
 Conditions for Recognition 1.Historical Cost
- Probable decrease in economic benefit (result - Amount of cash or cash equivalent paid of the fair
of decrease in asset or increase in liability) value at the time of acquisition
- Economic benefit can be measured reliably - “Past Purchase Exchange Rate”
 Matching Principle - Most commonly adopted
- Costs and expenses incurred in earning a 2.Current Cost
revenue shall be reported - Amount of cash or cash equivalent to be paid if the
- There is a cost in earning a revenue same or equivalent asset was acquired currently
a.Cause and Effect Association - “Current Purchase Exchange Price”
- Expense is recognized when the revenue 3.Realizable Value
is already recognized - Amount of cash or cash equivalent that could be
- “Strict Matching Concept” or the obtained by selling the asset
matching cost with revenue - “Current Sale Exchange Price”
- The simultaneous or combined 4.Present Value
recognition of revenue and expenses - The discounted value of the future net cash
Examples: inflows
> Merchandise Sold (COGS) - “Future Exchange Price”
> Doubtful Accounts, Warranty
Expense, and Sales Commission
b.Systematic and Rational Allocation
- Some costs are expensed by simply
allocating them over the periods
benefited
- Cost incurred will benefit future periods
and there is an absence of a direct or
clear association of the expense
Examples:
> Depreciation of PPE
> Amortization of Intangibles
> Allocation of Prepaid Rent, Insurance,
and other Prepayments
c. Immediate Recognition
- Cost incurred is expensed outright
because of uncertainty of economic
benefit
 Conditions for Immediate
Recognition:
- Expenditure produces no future
economic benefit
- Cost incurred ceases/does not
qualify for recognition as an asset
Examples:
> Salaries, Administrative,
Advertising, Selling, Expenses
> Settlement of Lawsuits or Worthless
Intangibles
> Losses from Disposal of PPE or
Investment
> Casualty Losses (Fire, Flood Etc.)