CONCEPTUAL FRAMEWORK

 Complete, comprehensive, single document promulgated by IASB.

 Summary of terms and concepts that underlie the preparation and presentation
of financial statements.
 It describes the concepts for the general purpose financial reporting.
 It provides an overall theoretical foundation for accounting.
 It is an underlying theory for the development and revision of accounting
standards.

CONCEPTUAL FRAMEWORK PROVIDES THE FOUNDATION FOR STANDARDS

THAT:
a. Contribute to transparency (enhancing international comparability and quality)
b. Strengthen accountability (reducing information gap)
c. Contribute to economic efficiency (helping investors to identify opportunities and
risks)\

PURPOSES OF REVISED CONCEPTUAL FRAMEWORK

a. To assist the IASB to develop standards based on consistent concepts
b. To assists prepares of FS to develop consistent accounting policy
c. To assist all parties to understand and interpret the standards.

AUTHORITATIVE STATUS OF CONCEPTUAL FRAMEWORK

 If there is a standard that specifically applies to a transaction, the standard
overrides the conceptual framework. The standard will be used.
 In the absence of standard, the management considers the applicability of the
conceptual framework in developing and applying an accounting policy that
results in information that is relevant and reliable.

USERS OF FINANCIAL INFORMATION

1. Primary users
a. Existing and potential investors, lenders and other creditors
2. Other users
a. Employees
b. Customers
c. Governments
d. Public
CHAPTER 1: THE OBJECTIVE OF GENERAL PURPOSE FINANCIAL REPORTING
The main objective of general purpose financial reports is to provide the financial
information about the reporting entity that is useful to existing and potential:
 Investors,
 Lenders, and
 Other creditors
to help them make various decisions (e.g. about trading with debt or equity instruments
of a reporting entity). Chapter 1 is NOT about the financial statements itself – these are
described in Chapter 3.
Instead, Chapter 1 describes more general purpose reports that should contain the
following information about the reporting entity:
 Economic resources and claims (this refers to the financial position);
 The changes in economic resources and claims resulting from entity’s financial
performance and from other events.
Chapter 1 puts an emphasis on accrual accounting to reflect the financial performance
of an entity. It means that the events should be reflected in the reports in the periods
when the effects of transactions occur, regardless the related cash flows.
However, the information about past cash flows is very important to assess
management’s ability to generate future cash flows.

CHAPTER 2: QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL

INFORMATION
In this Chapter, the Framework describes 2 types of characteristics for financial
information to be useful:
1. Fundamental, and
2. Enhancing.

Fundamental qualitative characteristics (relate to content or substance of

information)
 Relevance: capable of making a difference in the users’ decisions. The financial
information is relevant when it has predictive value, confirmatory value, or
both.
o Predictive value- if it can be used as an input to processes employed by
users to predict future outcomes. It helps the users increase the likelihood
of correctly or accurately predicting outcome of the events.
o Confirmatory value- if it provides feedback about previous evaluations. It
enables users to confirm or correct earlier expectations.
Materiality is 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 financial statements. It is closely related to relevance.
Materiality of an item depends on relative size rather than the absolute size. An item is
material if knowledge of it could reasonably affect of influence the economic decision of
the users of the information.
 Faithful representation: The information is faithfully represented when it is
complete, neutral and free from error.
o Complete- relevant information are presented in a way that facilitates
understanding and avoids erroneous implications. Result of adequate
disclosure
o Neutral- it is without bias in the preparation and presentation of the FS.
Information is not slanted, weighted, emphasized, de-emphasized or
manipulated. It is free from bias.
 Prudence- exercise of care and caution when dealing with
the uncertainties in the measurement process such that
assets or income are not overstated and liabilities and
expenses are not understated.
 Conservatism- when alternatives exist, the alternatives
which has the least effect on equity should be chosen.
o Free from error- there are no errors or omissions in the description of the
transaction. The presentation has been presented with no errors.

Enhancing qualitative characteristics

 Comparability: Information should be comparable between different entities or
time periods to identify and understand similarities & dissimilarities among items.
o Consistency- use of the same method for the same item. It is the uniform
application of accounting method
 Verifiability: Independent and knowledgeable observers are able to verify the
information; it is verifiable if it is supported by evidence.
 Timeliness: Information is available in time to influence the decisions of users;
 Understandability: Information shall be classified, presented clearly and
concisely. Understandability requires that financial information must be
comprehensible and intelligible for it to be useful.

CHAPTER 3: FINANCIAL STATEMENTS AND THE REPORTING ENTITY

Financial Statements
The financial statements should provide the useful information about the reporting entity
to:
a. Assess future cash flows of the reporting entity
b. Assess management stewardship of the entity’s economic resources

1. In the statement of financial position, by recognizing

o Assets,
o Liabilities,
o Equity
2. In the statements of financial performance, by recognizing
o Income, and
o Expenses

3. In other statements, by presenting and disclosing information about

o recognized and unrecognized assets, liabilities, equity, income and
expenses, their nature and associated risks;
o Cash flows;
o Contributions from and distributions to equity holders, and
o Methods, assumptions, judgements used, and their changes.
.

Financial statements are always prepared for a specified period of time, or

the reporting period.

Normally, the financial statements are prepared on the going concern assumption.
It means that an entity will continue to operate for the foreseeable future (usually 12
months after the reporting date)
Reporting Entity
Reporting entity is an entity who must or chooses to prepare the financial statements.

It can be:
 Individual corporation, partnership or proprietorship
 The parent alone
 The parents and its subsidiaries as single reporting entity
 Two or more entities without parents and subsidiary relationship as a single
reporting entity
 A reportable business segment of an entity.

These can be grouped into these:

 A single entity – for example, one company;
 A portion of an entity – for example, a division of one company;
 More than one entities – for example, a parent and its subsidiaries reporting as
a group.

Types of financial statements:

 Consolidated: a parent and subsidiaries report as a single reporting entity;
 Unconsolidated: e.g. a parent alone provides reports, or
 Combined: e.g. reporting entity comprises two or more entities not linked by
parent-subsidiary relationship.

CHAPTER 4: ELEMENTS OF THE FINANCIAL STATEMENTS

This chapter extensively deals with the definitions of individual elements of the financial
statements.

Financial Position elements:

1. Asset = a present economic resource controlled by the entity as a result of past
events
 The asset is a present economic resource
 The economic resource is a right that has the potential to produce
economic benefits
 The economic resource is controlled by the entity as a result of past
events
 Right
a. Right that correspond to an obligation of another entity
 Right to receive cash
 Right to receive goods and services
 Right to exchange economic resources with another entity
under favorable terms
 Right to benefit from an obligation of another entity
b. Right that do not correspond to an obligation of another entity
 Right over assets
 Right to intellectual property
c. Right established by contract or legislation
 Owning a debt instrument or equity instrument

2. Liability = a present obligation of the entity to transfer an economic resource as

a result of past events
 The entity has an obligation
 The obligation is to transfer an economic resource
 It is a present obligation that exists as a result of past events.
Transfer an Economic Resource
a. Obligation to pay cash
b. Obligation to deliver goods or noncash resources
c. Obligation to provide services at some future time
d. Obligation to exchange economic resources with another entity
under unfavorable terms
e. Obligation to transfer economic resources if specified uncertain
future event occurs

3. Equity = the residual interest in the assets of the entity after deducting all its
liabilities;

Financial Performance elements:

4. Income = increases in assets or decreases in liabilities resulting in increases in
equity, other than contributions from equity holders;

5. Expenses = decreases in assets or increases in liabilities resulting in decreases

in equity, other than distributions to equity holders;
CHAPTER 5: RECOGNITION AND DERECOGNITION
This chapter discusses the recognition and de-recognition process.

Recognition
 Recognition means process of capturing for inclusion in the financial statements
an item that meets the definition of an asset, liability, equity, income or expense.
An element is recognized when information would result to be relevant and
faithfully presented.
 Recognition process links the elements in the financial statements according to
the following formula:

Please let me stress here that not all items that meet the definition of one of the
elements listed above are recognized in the financial statements.
The Framework requires recognizing the elements only when the recognition provides
useful information – relevant with faithful representation.
Then, the Framework discusses the relevance, faithful representation, cost constraints
and other aspects in a detail.

Expense recognition- expenses are recognized when incurred regardless when paid
or the application of the matching principle.

Three matching principle applications:

 Cause and effect association
o Expense is recognized when the revenue is already recognized.
 COGS, doubtful accounts, warranty expense, sales commissions
 Systematic and rational allocation
o Expensed by allocating them over the periods benefited.
 Depreciation, amortization, prepayments
 Immediate recognition
o It is expensed outight
 Administrative expenses, selling expense, worthless intangibles.
De-recognition
De-recognition means removal of an asset or liability from the statement of financial
position and normally it happens when the item no longer meets the definition of an
asset or a liability.

CHAPTER 6: MEASUREMENT
Measurement means quantifying IN WHAT AMOUNT to recognize asset, liability,
piece of equity, income or expense in your financial statements.

The Framework discusses two basic measurement basis:

1. Historical cost – this measurement is based on the transaction price at the time
of recognition of the element;
o Historical cost of an asset is updated because
1. Depreciation and amortization
2. Payment received as a result of disposing part or all of the asset
3. Impairment
4. Accrual of interest to reflect any financing component of the asset
5. Amortized cost measurement of financial asset
o Historical cost of a liability is updated because
1. Payment made or satisfying an obligation to deliver goods
2. Increase in value of the obligation
3. Accrual of interest to reflect any financing part of the liability
4. Amortized cost measurement of financial liability’
 2. Current value – it measures the element updated to reflect the conditions at the
measurement date. Here, several methods are included:
o Fair value- price that would be received to sell an asset in an orderly
transaction between market participants at measurement date
o Value in use- present value of the cash flows that an entity expects to
derive from the use of an asset and from ultimate disposal.
o Fulfilment value- present value of the cash that an entity expects to
transfer in paying or settling a liability.
o Current cost- cost of an equivalent asset at the measurement date
comprising the consideration paid and transaction cost.

CHAPTER 7: PRESENTATION AND DISCLOSURE

The main aim of presentation and disclosures is to provide an effective
communication tool in the financial statements.
Effective communication of information in the financial statements requires:
 Focus on objectives and principles of presentation and disclosure, not on the
rules;
 Group similar items and separate dissimilar items;
 Aggregate information, but do not provide unnecessary detail or the opposite –
excessive aggregation to obscure the information.
Classification
 Sorting of assets, liabilities, equity, income and expenses on the basis of shared
or similar characteristics.

Aggregation
 Adding together of assets, liabilities, equity, income and expenses that have
similar or shared characteristics and are included in the same classification.

CHAPTER 8: CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE

The Framework explains two concepts of capital:
1. Financial capital – this is synonymous with the net assets or equity of the entity.
Under the financial maintenance concept, the profit is earned only when the amount of
net assets at the end of the period is greater than the amount of net assets in the
beginning, after excluding contributions from and distributions to equity holders.

The financial capital maintenance can be measured either in

o Nominal monetary units, or
o Units of constant purchasing power.
2. Physical capital – this is the productive capacity of the entity based on, for
example, units of output per day.
Here the profit is earned if physical productive capacity increases during the
period, after excluding the movements with equity holders.