ACF 1101 Financial

Accounting
Week 2: The Conceptual Framework for Financial Reporting
Academic Year 2020/21 Semester 1
Department of Business Finance
University of Peradeniya

Revised Conceptual Framework

• On March 29, 2018, the IASB published its revised

Conceptual Framework for Financial Reporting. The
amendments are effective for annual periods beginning on
or after January 1, 2020 in Sri Lanka.
• We are going to look at the revised Conceptual Framework
Issued in 2018 and be effective in 2020.
 Conceptual Framework of
Financial Reporting

• The conceptual framework is ‘a coherent system of interrelated objectives and fundamentals that
prescribes the nature, function, and limitations of financial reporting’.
• Also, it is an attempt to provide a structured theory of accounting that prescribes practice.
• A sound conceptual framework is essential to ensure the production of high quality financial reports
that meet the needs of their users.
Conceptual Framework for Financial Reporting Cont.
● The framework is concerned with general purpose financial statements including consolidated financial
statements.
• Financial statements are part of the process of financial reporting. A complete set of financial statements
normally includes , Statement of Financial Position, Statement of Profit or Loss and other Comprehensive
Income, Statement of changes in equity, Statement of Cash flow and Notes to the Accounts.
● The framework applies to financial statements of all commercial, industrial and business reporting
enterprise, whether in the public or private sectors.
Purpose of the Framework
¤ The framework describes the objective of, and the concepts for general purpose financial reporting .
¤ The purpose of the framework is to:

(a) assist the Council of the Institute of Chartered Accountants of Sri Lanka (Council) to develop Sri
Lanka Accounting Standards (Standards) that are based on consistent concepts;
(b) assist preparers to develop consistent accounting policies when no Standard applies to a particular
transaction or other event, or when a Standard allows a choice of accounting policy;
(c) assist all parties to understand and interpret the Standards

General Purpose Financial Reporting

• A report that provides financial information about the reporting
entity’s economic resources, claims against the entity and changes
in those economic resources and claims that is useful to primary
users in making decisions relating to providing resources to the
entity.
 How does it differ from an accounting
standard?
¤ Framework is not an accounting standard .

¤ Framework
is a set of principles to be applied when preparing financial
statements.

¤ General concepts or principles - designed to provide guidance in

the preparation of financial reports.
Ex. CF defines what is an asset and when it should
be included in financial statements.
¤ Accounting standards –are specific requirements for a particular
area of financial reporting, may go beyond the framework, are
 mandatory and sometimes conflict with the framework. Ex. - LKAS
16 on PPE

Scope of the Conceptual Framework

¤ The Conceptual Framework deals with:

Chapter 1 :- The Objective of 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
Chapter 1: Objective of Financial Reporting
• 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.
 Chapter 2: Qualitative Characteristic of Useful
Financial Information
Qualitative
characteristics

Fundamental Enhancing
Characteristics Characteristics

Relevance Timeliness

Faithful Understandability
Representati
on
Comparability

Verifiability
Fundamental Qualitative Characteristics
Relevance: Relevant financial information is capable of making a difference in the
decisions made by users. Financial information is capable of making
a difference in decisions if it has;
Predictive value
Confirmatory value or both.
Materiality (entity-specific)
Faithful representation: Financial reports represent economic phenomena in
words and numbers. To be useful, financial information must not only
represent relevant phenomena, but it must also faithfully represent the
substance of the phenomena that it purports to represent.
To be a perfectly faithful representation, a depiction would have three
characteristics
Complete
Neutral (unbiased)
free from error (ideally)
 Enhancing Qualitative Characteristics
• Comparability: Information about a reporting entity is more useful if it
can be compared with similar information about other entities and with
similar information about the same entity from another period or
another date. Consistency is not the same but related to comparability.

• Verifiability: Verifiability helps assure users that information faithfully

represents the economic phenomena it purports to represent.
Knowledgeable and independent observers could reach consensus, but
not necessarily complete agreement.

• Timeliness: having information available to decision-makers in

time to be capable of influencing their decisions.

• Understandability: Classifying, characterizing, and presenting

information clearly and concisely makes it understandable.
 Chapter 3: Financial statements and the reporting entity

• Financial Statements
- Objective and scope of financial statements
The objective of financial statements is to provide financial information
about the reporting entity’s assets, liabilities, equity, income and expenses
that is useful to users of financial statements in assessing the prospects for
future net cash inflows to the reporting entity and in assessing
management’s stewardship of the entity’s economic resources.
- Reporting period
Financial statements are prepared for a specified period of time
(reporting period) and provide information about:
(a)assets and liabilities—including unrecognised assets and
liabilities—and equity that existed at the end of the reporting period,
or during the reporting period; and
(b) income and expenses for the reporting period.
 Going Concern Assumption
• Going concern – Financial statements are normally prepared on
the assumption that the reporting entity is a going concern and will
continue in operation for the foreseeable future.
Reporting Entity
 A reporting entity is an entity that is required, or chooses, to
prepare 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: The Elements of Financial Statements
• Asset: 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.

• Liability: 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

• Equity: The residual interest in the assets of the entity after deducting
all its liabilities.
Equity = Assets - 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.
 Recognition of Elements in the previous version

• Recognise item that meets element definition when

– probable that benefits will flow to/from the entity
– has cost or value that can measured reliably

Chapter 05: Recognition & Derecognition of Elements

• Recognition is the inclusion in the statement of financial position or the
statement(s) of financial performance an item that meets the definition
of one of the elements of financial statements—an asset, a liability,
equity, income or expenses. (Simply speaking, recognition means
including an element of financial statements in the financial
statements.)

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
In Summary

• An element would be recognised if recognition provides:

relevant information about the element
a faithful representation of the element

Derecogniton

Chapter 06: Measurement

• Measurement is the process of determining monetary amounts

at which elements are recognised and carried.
• To a large extent, financial reports are based on estimates,
judgements and models rather than exact depictions.

Measurement Bases

• Framework outlines two broad ways of measuring the

elements:
Historical cost
Current value

• Historical cost : The Price paid for an asset or for the event
which gave rise to the liability. This price will be constant.

• Current value: it measures the element updated to reflect the

conditions at the measurement date. Here, several methods are
included:

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.
Value in use : Present Value of the cash flows, or other economic benefits, that
an entity expects to derive form the use of an asset and its ultimate disposal.

Fulfillment value :Fulfillment value provides information about the present

value of the estimated cash flows needed to fulfill a liability.

Current cost :Current cost, like historical cost, is an entry value. It reflects
prices in the market in which the entity would acquire asset or incur the
liability.

Chapter 07: Presentation and disclosure

• Effective communication of information in financial statements

makes that information more relevant and contributes to a
faithful representation of an entity’s assets, liabilities, equity,
 income and expenses. It also enhances the understandability
and comparability of information in financial statements.
• Effective communication of information in financial statements
requires:
(a)focusing on presentation and disclosure objectives and
principles rather than focusing on rules;
classifying information in a manner that groups similar items and
(b)

separates dissimilar items; and

(c)aggregating information in such a way that it is not obscured
either by unnecessary detail or by excessive aggregation

In Summary

Chapter 08: Concepts of capital

• Different concepts of capital maintenance
• Financial capital
– Capital is synonymous with the net assets (equity) of the
entity
 – Profit exists only after the entity has maintained its capital,
measured as the rupee value (or purchasing power) of equity
at the beginning of the period
• Physical capital
– Capital is viewed as the operating capability of the entity’s
assets
– Profit exists only after the entity has set aside enough capital
to maintain the operating capability of its assets