Conceptual framework

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IASB publication: Framework for the Preparation
and Presentation of Financial Statements
http://eifrs.ifrs.org/eifrs/bnstandards/en/2015/fram
ework.pdf

International financial reporting and analysis

(essential reading)
Chapter 9

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USA approach, the Financial Accounting Standards Board (FASB):
A Conceptual framework is a constitution, a coherent system of
interrelated objectives and fundamentals that can lead to consistent
standards and that prescribes the nature, function and limits of
financial accounting and financial statements.

UK approach, the ASB:

Statement of Principles (SOP) - sets out the principles that the
Accounting Standards Board believes should underlie the preparation
and presentation of general purpose financial statements… A
coherent frame of reference to be used by the Board in the
development and review of accounting standards.

IASB:
Conceptual Framework sets out the concepts that underlie the
preparation and presentation of financial statements for external
users. 3
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Rationale for a conceptual framework (FASB):

 to facilitate decisions on controversial accounting issues –

providing a clear basis for reaching conclusions that those
with vested interests would find it hard to resist

 to provide a common framework of reference on

theoretical issues, so as to avoid both waste of effort in
addressing such issues from first principles for each
specific standard and the dangers of inconsistency

 to reduce the need for many detailed standards on specific

issues – by enabling accountants to resolve issues by
reference to general principles rather than detailed rules
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Advantages claimed for a conceptual framework (ASB):

 clarify the conceptual underpinnings of proposed accounting standards

 enable standards to be developed on a consistent basis
 reduce the need to debate fundamental issues each time a standard is
developed or revised
 enable preparers and users of financial statements to understand the
Board’s approach to setting standards and the nature and function of
information in general purpose financial statements
 help preparers and auditors with new issues to carry out an initial analysis
of the issues in the absence of applicable accounting standards
 facilitates decisions on controversial items, by reducing the scope for
personal bias and political pressure
 may reduce the need for many detailed standards if accountants can
resolve issues by general principles
 limits the bounds of judgement and hence increases comparability
 may protect accounting from intervention by governments
 helps justify accounting practices when they are under attack in the
courts, if they can be shown to be derived from, and consistent with, a
conceptual framework.
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The purpose of the Conceptual Framework (IASB)

 to assist the Board in the development of future IFRSs and in its review
of existing IFRSs
 to assist the Board in promoting harmonisation of regulations,
accounting standards and procedures relating to the presentation of
financial statements by providing a basis for reducing the number of
alternative accounting treatments permitted by IFRSs
 to assist national standard-setting bodies in developing national
standards
 to assist preparers of financial statements in applying IFRSs and in
dealing with topics that have yet to form the subject of an IFRS
 to assist auditors in forming an opinion on whether financial
statements comply with IFRSs
 to assist users of financial statements in interpreting the information
contained in financial statements prepared in compliance with IFRSs
 to provide those who are interested in the work of the IASB with
information about its approach to the formulation of IFRSs
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ASB’s Statement of Principles:
Chapter 1: The Objective of Financial Statements
Chapter 2: The Reporting Entity
Chapter 3: The Qualitative Characteristics of Financial
Information
Chapter 4: The Elements of Financial Statements
Chapter 5: Recognition in Financial Statements
Chapter 6: Measurement in Financial Statements
Chapter 7: Presentation of Financial Information
Chapter 8: Accounting for Interests in Other Entities.
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FASB’s statements of financial accounting concepts:
SFAC No. 1 Objectives of Financial Reporting by Business Enterprises.
SFAC No. 2 Qualitative Characteristics of Accounting Information.
SFAC No. 4 Objectives of Financial Reporting by Non Business
Organisations.
SFAC No. 5 Recognition and Measurement in Financial Statements of
Business Enterprises.
SFAC No. 6 Elements of Financial Statements (replacing SFAC No. 3).
SFAC No. 7 Using Cash Flow Information and Present Value in
Accounting Measurements.

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THE REVISED CONCEPTUAL FRAMEWORK (IFRS)
a compehensive set of concepts for financial reporting

CHAPTER 1
THE OBJECTIVE OF GENERAL PURPOSE FINANCIAL REPORTING
CHAPTER 2
QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION
CHAPTER 3
FINANCIAL STATEMENTS AND THE REPORTING ENTITY
CHAPTER 4
THE ELEMENTS OF FINANCIAL STATEMENTS
CHAPTER 5
RECOGNITION AND DERECOGNITION
CHAPTER 6
MEASUREMENT
CHAPTER 7
PRESENTATION AND DISCLOSURE
CHAPTER 8
CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE
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Status
 provides concepts and guidance that underpin the decisions
the Board makes when developing Standards
 not a Standard
 does not override any Standard or any requirement in a
Standard

Effective date
 immediately for the Board and the IFRS Interpretations
Committee
 annual periods beginning on or after 1 January 2020 for
preparers who develop an accounting policy based on the
Conceptual Framework
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Qualitative characteristics
If financial information is to be useful, it must be
relevant and faithfully represent what it purports
to represent (fundamental qualities).
–Financial information without both relevance and faithful
representation is not useful, and it cannot be made useful by being
more comparable, verifiable, timely or understandable.
The usefulness of financial information is
enhanced if it is comparable, verifiable, timely
and understandable (enhancing qualities—less
critical but still highly desirable)
–Financial information that is relevant and faithfully represented may
still be useful even if it does not have any of the enhancing qualitative
characteristics. 13
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 Fundamental qualitative characteristics

Relevance
Relevant information is capable of making a difference in the
decisions made by users. It is capable of making a difference in
decisions if it has predictive value, confirmatory value or both.

The relevance of information is affected by its nature and its

materiality.

Materiality. Information is material if omitting it or misstating it

could influence decisions that users make on the basis of financial
information about a specific reporting entity.

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 Fundamental qualitative characteristics
Faithful representation
Financial information must faithfully represent the phenomena that it purports to
represent.
To be a faithful representation information must be complete, neutral and free
from error.

A complete depiction includes all information necessary for a user to understand

the phenomenon being depicted, including all necessary descriptions and
explanations.
A neutral depiction is without bias in the selection or presentation of financial
information. This means that information must not be manipulated in any way in
order to influence the decisions of users.
Free from error means there are no errors or omissions in the description of the
phenomenon and no errors made in the process by which the financial
information was produced.

Note: faithful representation replaces reliability

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 Enhancing Qualitative Characteristics
Comparability: like things look alike; different things look
different
Verifiability: knowledgeable and independent observers could
reach consensus, but not necessarily complete agreement,
that a depiction is a faithful representation
Timeliness: having information available to decision-makers in
time to be capable of influencing their decisions
Understandability: Classify, characterise, and present
information clearly and concisely

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 Pervasive constraint
• Reporting financial information imposes costs, and it is
important that those costs are justified by the benefits of
reporting that information.
 Benefits include more efficient functioning of capital markets and a
lower cost of capital for the economy.
 Costs include collecting, processing, verifying and disseminating
financial information and the costs of analysing and interpreting the
information provided.
• In applying the cost constraint, the IASB assesses whether the
benefits of reporting particular information are likely to justify
the costs incurred to provide and use that information. Those
assessments are usually based on a combination of
quantitative and qualitative information.

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GOING CONCERN
The financial statements are normally prepared
on the assumption that an entity is a going
concern and will continue in operation for the
foreseeable future. Hence, it is assumed that
the entity has neither the intention nor the
need to liquidate or curtail materially the scale
of its operations; if such an intention or need
exists, the financial statements may have to be
prepared on a different basis and, if so, the
basis used is disclosed.
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Elements (IASB CF)

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 Elements

FASB (10) IASB (5)

Assets Gains Assets
Liabilities Losses Liabilities
Equity Revenue Equity
Investments by Comprehensive Income
owners Income
Distributions Expenses Expenses
to owners

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Element definitions:
• Asset: A present economic resource controlled by the entity as
a result of past events.
• Liability: A present obligation of the entity to transfer an
economic resource as a result of past events.
• Equity: is the residual interest in the assets of the entity after
deducting all its liabilities.
• 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.
• Expenses: decreases in assets, or increases in liabilities, that
result in decreases in equity, other than those relating to
distributions to holders of equity claims.
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ASSET DEFINITION
An 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.

Three aspects of those definitions:

• right;
• potential to produce economic benefits;
• control.

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RIGHTS
Rights that have the potential to produce economic benefits take many forms, including:

(a) rights that correspond to an obligation of another party, for example:

• rights to receive cash.
• rights to receive goods or services.
• rights to exchange economic resources with another party on favourable terms.
Such rights include, for example, a forward contract to buy an economic resource on
terms that are currently favourable or an option to buy an economic resource.
• rights 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, for example:
• rights over physical objects, such as property, plant and equipment or inventories.
Examples of such rights are a right to use a physical object or a right to benefit from
the residual value of a leased object.
• rights to use intellectual property.

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Potential to produce economic benefits
An economic resource could produce economic benefits for an entity by entitling
or enabling it to do, for example, one or more of the following:
(a) receive contractual cash flows or another economic resource;
(b) exchange economic resources with another party on favourable terms;
(c) produce cash inflows or avoid cash outflows by, for example:
• using the economic resource either individually or in combination with other
economic resources to produce goods or provide services;
• using the economic resource to enhance the value of other economic
resources; or
• leasing the economic resource to another party;
(d) receive cash or other economic resources by selling the economic resource; or
(e) extinguish liabilities by transferring the economic resource.

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CONTROL
An entity controls an economic resource if it has the present ability to direct the
use of the economic resource and obtain the economic benefits that may flow
from it. Control includes the present ability to prevent other parties from directing
the use of the economic resource and from obtaining the economic benefits that
may flow from it. It follows that, if one party controls an economic resource, no
other party controls that resource.

An entity has the present ability to direct the use of an economic resource if it has
the right to deploy that economic resource in its activities, or to allow another
party to deploy the economic resource in that other party’s activities.

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LIABILITY DEFINITION
A liability is a present obligation of the entity to transfer an economic
resource as a result of past events.

For a liability to exist, three criteria must all be satisfied:

(a) the entity has an obligation
(b) the obligation is to transfer an economic resource; and
(c) the obligation is a present obligation that exists as a result of past
events

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OBLIGATION
An obligation is a duty or responsibility that an entity has no
practical ability to avoid. An obligation is always owed to
another party (or parties). The other party (or parties) could
be a person or another entity, a group of people or other
entities, or society at large. It is not necessary to know the
identity of the party (or parties) to whom the obligation is
owed.

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Transfer of an economic resource
The obligation must have the potential to require the entity to transfer an economic resource
to another party (or parties). For that potential to exist, it does not need to be certain, or
even likely, that the entity will be required to transfer an economic resource—the transfer
may, for example, be required only if a specified uncertain future event occurs. It is only
necessary that the obligation already exists and that, in at least one circumstance, it would
require the entity to transfer an economic resource.
An obligation can meet the definition of a liability even if the probability of a transfer of an
economic resource is low.

Obligations to transfer an economic resource include, for example:

(a) obligations to pay cash.
(b) obligations to deliver goods or provide services.
(c) obligations to exchange economic resources with another party on unfavourable terms.
Such obligations include, for example, a forward contract to sell an economic resource on
terms that are currently unfavourable or an option that entitles another party to buy an
economic resource from the entity.
(d) obligations to transfer an economic resource if a specified uncertain future event occurs.
(e) obligations to issue a financial instrument if that financial instrument will oblige the entity
to transfer an economic resource.
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Present obligation as a result of past events
A present obligation exists as a result of past events only 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.

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Consider if there is an asset or liability within the definitions
given by the Conceptual Framework?
1. Abbie Co has purchased a patent for $20,000. The patent gives the
company sole use of a particular manufacturing process which will save
$3,000 a year for the next five years.
This is an asset, an intangible one. There is a past event, control and future
economic benefit (through cost savings).

2. Berry Co paid Mr. King $10,000 to set up a car repair shop, on condition
that priority treatment is given to cars from the company's fleet.
This cannot be classified as an asset. Berry Co has no control over the car
repair shop and it is difficult to argue that there are 'future economic
benefits'.

3. Wheels Co provides a warranty with every car sold.

The warranty claims in total constitute a liability; the business has taken on
an obligation. It would be recognised when the warranty is issued rather
than when a claim is made. 33
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EQUITY
Equity is the residual interest in the assets of the entity after
deducting all its liabilities.
Equity claims are claims on the residual interest in the assets of
the entity after deducting all its liabilities. In other words, they
are claims against the entity that do not meet the definition of a
liability. Such claims may be established by contract, legislation
or similar means, and include, to the extent that they do not
meet the definition of a liability:

(a) shares of various types, issued by the entity; and

(b) some obligations of the entity to issue another equity claim.

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Performance
Profit is used as a measure of performance. It depends directly on the
measurement of income and expenses, which in turn depend (in part) on
the concepts of capital and capital maintenance adopted.
Income and expenses can be presented in different ways in the
statement of profit or loss and other comprehensive income, to provide
information relevant for economic decision-making. For example, income
and expenses which relate to continuing operations are distinguished
from the results of discontinued operations.

The definition of income also includes unrealised gains, eg on revaluation

of marketable securities.
The definition of expenses will also include unrealised losses, eg the fall
in value of an investment.

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RECOGNITION
Recognition links the elements, the statement of financial position and the statement(s) of
financial performance as follows:
(a) in the statement of financial position at the beginning and end of the reporting period,
total assets minus total liabilities equal total equity; and
(b) recognised changes in equity during the reporting period comprise:
(i) income minus expenses recognised in the statement(s) of financial performance; plus
(ii) contributions from holders of equity claims, minus distributions to holders of equity
claims.

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DERECOGNITION
Derecognition is the removal of all or part of a recognised asset or liability from an
entity’s statement of financial position. Derecognition normally occurs when that
item no longer meets the definition of an asset or of a liability:
(a) for an asset, derecognition normally occurs when the entity loses control of all or
part of the recognised asset; and
(b) for a liability, derecognition normally occurs when the entity no longer has a
present obligation for all or part of the recognised liability.

In some cases, an entity might appear to transfer an asset or liability, but that asset
or liability might nevertheless remain an asset or liability of the entity. For example:

(a) if an entity has apparently transferred an asset but retains exposure to significant
positive or negative variations in the amount of economic benefits that may be
produced by the asset, this sometimes indicates that the entity might continue to
control that asset ; or

(b) if an entity has transferred an asset to another party that holds the asset as an
agent for the entity, the transferor still controls the asset.
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 MEASUREMENT
Elements recognised in financial statements are quantified in monetary terms.
This requires the selection of a measurement basis.

A measurement basis is an identified feature—for example, historical cost, fair value

or fulfilment value —of an item being measured. Applying a measurement basis to
an asset or liability creates a measure for that asset or liability and for related
income and expenses.

Board does not currently think the Framework should strive to identify a single
measurement attribute for all assets and liabilities
Consideration of the qualitative characteristics of useful financial information and of
the cost constraint is likely to result in the selection of different measurement bases
for different assets, liabilities, income and expenses.

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 MEASUREMENT BASES
A number of different measurement bases are employed to
different degrees and in varying combinations in financial
statements:
Historical cost measures provide monetary information
about assets, liabilities and related income and expenses,
using information derived, at least in part, from the price of
the transaction or other event that gave rise to them. Unlike
current value, historical cost does not reflect changes in
values, except to the extent that those changes relate to
impairment of an asset or a liability becoming onerous.

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 MEASUREMENT BASES
Current value measures provide monetary information about assets,
liabilities and related income and expenses, using information updated
to reflect conditions at the measurement date. Because of the
updating, current values of assets and liabilities reflect changes, since
the previous measurement date, in estimates of cash flows and other
factors reflected in those current values.
Unlike historical cost, the current value of an asset or liability is not
derived, even in part, from the price of the transaction or other event
that gave rise to the asset or liability.
Current value measurement bases include:
(a) fair value;
(b) value in use for assets and fulfilment value for liabilities; and
(c) current cost.
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 MEASUREMENT BASES
When selecting a measurement basis, it is important to consider the nature of the
information that the measurement basis will produce in both the statement of financial
position and the statement of financial performance.

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Example
A machine was purchased on 1 January 2015 for $3m. That was its original cost. It
has a useful life of 10 years. What is the cost/value of the machine at 31/12/2016?
Historical cost convention:
$3m – (0.3 * 2) = $2.4m
Current cost of the machine:
For instance, two year old machines like this one may currently be changing hands
for $2.5m, so that will be an appropriate fair value.
Net realisable value:
If the machine had to be dismantled and transported to the buyer's premises at a
cost of $200,000, the NRV would be $2.3m.
Replacement cost:
The cost of a new machine may now be $3.5m. Assuming a ten-year life, the
replacement cost will therefore be $2.8m.
Present value:
The discounted value of the future cash flows that it is expected to generate. If the
machine is expected to generate $500,000 per annum for the remaining eight
years of its life and if the company's cost of capital is 10%, present value will be
calculated as: $500,000 * 5.335” = $2,667,500
“ Cumulative present of $1 per annum for eight years discounted at 10%
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 CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE
FINANCIAL CONCEPT
capital is synonymous with
the net assets or equity of
the entity
should be adopted if the
users of financial statements
are primarily concerned with
the maintenance of nominal
invested capital or the
purchasing power of
invested capital
PHYSICAL CONCEPT
capital is regarded as the
productive capacity of the
entity based on, for example,
units of output per day
the main concern of users is
with the operating capability
of the entity
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Financial capital maintenance. Under this concept a profit is
earned only if the financial (or money) amount of the net assets
at the end of the period exceeds the financial (or money) amount
of net assets at the beginning of the period, after excluding any
distributions to, and contributions from, owners during the
period. Financial capital maintenance can be measured in either
nominal monetary units or units of constant purchasing power.

Physical capital maintenance. Under this concept a profit is

earned only if the physical productive capacity (or operating
capability) of the entity (or the resources or funds needed to
achieve that capacity) at the end of the period exceeds the
physical productive capacity at the beginning of the period, after
excluding any distributions to, and contributions from, owners
during the period.
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 Thank you for attention!

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