FR2 ConceptualFramework (Stud)

Session 2: Conceptual Framework
Conceptual
Framework
oSession 2
AC2091: Financial Reporting
Learning Objectives
• Define a conceptual framework
• Identify the main efforts by the US, IASC and
the UK to introduce a conceptual framework
• Describe the objectives of financial reporting
as per the conceptual framework
• Define assets and liabilities as suggested by
these frameworks
• Explain and describe recognition and
measurement
1
Conceptual Framework
• sets out the concepts that underlie the
preparation and presentation of financial
statements for external users [IFRS]
• sets out the principles that … should underlie
the preparation of financial statements [ASB]
• coherent system of interrelated objectives and
fundamental concepts that prescribes the
nature, function, and limits of financial
accounting and reporting [FASB]
• Rationale for Conceptual Framework
o Facilitate decisions on controversial accounting
issues
 Clearbasis for reaching conclusions that those with vested
interests would find it hard to resist
o Provide a common framework of reference on
theoretical issues
 Basis for resolving accounting disputes
o Reduce the need for many detailed standards on
specific issues
 Fundamental principles need not be repeated in standards
2
• Purpose of Conceptual Framework
o Assist the accounting standards board to develop
standards that are based on consistent concepts;
o 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; and
o Assist all parties to understand and interpret the
accounting standards
[IASB Conceptual Framework for Financial Reporting (2018)]
• Includes guidance on the following [IFRS]:
o Objective of financial reporting
o Qualitative characteristics of useful financial
information
o Definition, recognition and measurement of the
elements from which financial statements are
constructed
o Concepts of capital and capital maintenance
3
US FASB UK ASB IASB
•Concept •Statement •Conceptual

Statements of Framework
(SFAC) Principles for
•SFAC 4, 5, for Financial
6, 7, 8 Financial Reporting
Reporting
(SOP)
Financial Reporting
Reporting Entity Users of Financial Statements
Objectives of Financial Statements
Underlying Assumptions
Qualitative Characteristics Elements of Financial Statements
Recognition of elements Measurement of elements
4
9
Conceptual Framework:
Reporting Entity
• An entity that is required, or chooses, to prepare
financial statements
• Can be a single entity or a portion of an entity or can
comprise more than one entity
• If a reporting entity comprises both the parent and its
subsidiaries, the reporting entity’s financial statements are
referred to as ‘consolidated financial statements
• If a reporting entity comprises two or more entities that are not
all linked by a parent-subsidiary relationship, the reporting
entity’s financial statements are referred to as ‘combined financial
statements
• Not necessarily a legal entity

10
Objectives of General Purpose
Financial Reporting
• 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.
• Decisions involve buying, selling or holding equity
and debt instruments; providing or settling loans and
other forms of credit; or exercising rights to vote on,
or otherwise influence, management’s actions that
affect the use of the entity’s economic resources
10
5
11
Underlying Assumptions
• 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
11
12
Qualitative Characteristics
Relevance
Fundamental
QCs
Faithful representation
Qualitative
Characteristics Comparability
[QCs]
Enhancing Verifiability
QCs
Timeliness
Understandability
12
6
13
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
o Predictive value: can be used to predict future outcomes
o Confirmatory value: gives feedback about previous evaluations
• Material information is relevant
o Information is material if its omission or misstatement would
influence the decisions that users make
o Based on the nature or magnitude, or both
13
14
 Faithful representation
• Reports substance of transactions or events and not
just their legal form
• Enhances confidence in the information presented
• Reliability of credible and believable information
• Embodies the characteristics of completeness,
neutrality and freedom from error
14
7
Conceptual Framework: 15

 Faithful representation
• Completeness
o Includes
all information necessary for a user to understand the
phenomenon being depicted
• Neutrality
o Without bias in the selection or presentation of financial
information
o Supported by the exercise of caution when making judgements
under conditions of uncertainty (i.e. prudence)
• Freedom from error
o No errors or omissions in the description of the phenomenon
and process used to produce the information
o Does not mean accuracy in all respects
15
Enhancing Qualitative Characteristics

 Comparability
• Enables users to identify and understand similarities
in, and differences among, items
o With information about the same business for a different period
or different business for the same (or different) period
• Consistency
o Use of same methods for the same items from period to
period within the entity or in a single period across entities
o Helps to achieve the goal of comparability
• Disclosure of accounting policies

o Users are able to distinguish between different accounting
policies so as to make a valid comparison of similar items in
the accounts of different entities
16
8

 Verifiability
• Different knowledgeable and independent observers
could reach a consensus that an item is faithfully
represented
• Usually backed by tangible evidence
o A range ofpossible amounts and the related probabilities
can be verified
 Direct verification via direct observation
 Indirectverification by checking the inputs to a model,
formula or other technique and recalculating the outputs
using the same methodology
17

 Timeliness
• Information provided in time for it to be useful
o Up to date and timely information
• Capable of influencing decisions made by users
o Relevant in predicting future events or confirms past events
• Information less useful if there is delay
o Balance
between timeliness and provision of reliable
information
18
9

 Understandability
• Information is classified and presented in a clear and
concise manner
• Depends on way in which items are aggregated,
classified and presented and on the ability of users to
comprehend information presented.
• Users are presumed to have reasonable knowledge of
business & accounting and can study information
with reasonable diligence
19
20
Elements of Financial Statements

• Transactions & other events grouped into
broad classes according to their economic
characteristics [IFRS]
• Building blocks with which financial
statements are constructed—the classes of
items that financial statements comprise
[FASB]
20
10
21
Financial Position •Assets

(resources & claims •Liabilities
to resources) •Equity
Performance
•Income
(changes in
•Expenses
resources & claims)
21
22

• Asset
o resource controlled by the entity as a result of past
events and from which future economic benefits are
expected to flow to the entity [IFRS (2010)]
o present economic resource controlled by the entity
as a result of past events [IFRS (2018)]
 economic resource: a right that has the potential to
produce economic benefits
o probable future economic benefits obtained or
controlled by a particular entity as a result of past
transactions or events [FASB]
22
11
23

• Liability
o present obligation of the entity arising from past
events, the settlement of which are expected to
result in outflows from the entity of resources
embodying economic benefits [IFRS (2010)]
o present obligation of the entity to transfer an
economic resource as a result of past events [IFRS
(2018)]
o probable future sacrifice of economic benefits
arising from present obligations of a particular
entity to transfer assets or provide services to other
entities in the future as a result of past transactions
or events [FASB]
23
24

• Equity
o residual interest in the assets of the entity after
deducting all its liabilities [IFRS/FASB]
Asset Liabilities Equity
Asset Liabilities Equity
24
12
25

• Income [IFRS (2018)]
o Increases in assets, or decreases in liabilities, that
result in increases in equity, other than those
relating to contributions from holders of equity
claims
o Includes revenue and gains
 Revenue: arises from delivering or producing goods,
rendering services, or other activities that constitute the
entity’s ongoing major or central operations.
 Gain: all other transactions and other events and
circumstances affecting the entity except those that result
from revenues or investments by owners [FASB]
25
26

• Expenses [IFRS (2018)]
o Decreases in assets, or increases in liabilities, that
result in decreases in equity, other than those
relating to distributions to holders of equity claims [
o Includes losses
 Loss:arises from peripheral or incidental transactions of an
entity and from all other transactions and other events and
circumstances affecting the entity except those that result
from expenses or distributions to owners [FASB]
26
13
27

• Recognition of elements [IFRS (2010)]
Reliable
Probable flow Recognition
measurement
of economic in Financial
of cost or
benefits Statements
value
o Probability of future economic benefits

 Degree of uncertainty that is judged based on the
environment in which entity operates in ad evidence
o Reliability of measurement
 Reasonable estimate of cost or value
27
28

o Only items that meet the definition of an asset, a
liability or equity are recognised in the statement of
financial position
o Only items that meet the definition of income or
expenses are recognised in the statement(s) of
financial performance.
o Asset or liability is recognised only if recognition of
that asset or liability and of any resulting income,
expenses or changes in equity provides users of
financial statements with information that is useful,
i.e. relevant and faithfully represented
28
14
29

o An asset or liability can exist even if the probability
of an inflow or outflow of economic benefits is low
 Only needs the potential to produce economic benefits to
exist, i.e. does not need to be certain, or even likely, that the
right will produce economic benefits
 Information about the magnitude of the possible inflows or
outflows, their possible timing and the factors affecting the
probability of their occurrence to be disclosed in the notes to
financial statements
29
30

o Rights
 Often established by contract, legislation or similar means
 Some goods or services—for example, employee services—
are received and immediately consumed. An entity’s right to
obtain the economic benefits produced by such goods or
services exists momentarily until the entity consumes the
goods or services.
o Control
 Present ability to direct the use of the economic resource and
obtain the economic benefits that may flow from it
 Includes present ability to prevent other parties from
directing the use of the economic resource
30
15
31

• Recognition of elements [ASB]
o If a transaction or other event has created a new
asset or liability or added to an existing asset or
liability, that effect will be recognised if:
 sufficient evidence exists that the new asset or liability has
been created or that there has been an addition to an existing
asset or liability; and
 the new asset or liability or the addition to the existing asset
or liability can be measured at a monetary amount with
sufficient reliability. [SOP]
31
32

• Recognition of elements [FASB]
o Four fundamental recognition criteria:
 Item meets definition of an element
 Has relevant attribute measurable with sufficient reliability
 Relevant and capable of making a difference in user
decisions
 Reliable and representationally faithful, verifiable and
neutral [SFAC5]
32
16
33

• Measurement of elements [IASB]
• Assets recorded at the amount of cash or
cash equivalents paid or fair value of
Historical consideration
Cost
• Liabilities recorded at proceeds received
in exchange for the obligation
• Assets carried at amount of cash or cash

equivalents that would have been paid if
same item acquired currently
Current Cost
• Liabilities carried at cash or cash
equivalents that would be required to settle
the obligation currently
33
34

• Measurement of elements [IASB]
• Assets recorded at the amount of cash

or cash equivalents that could be
Realisable
obtained by selling an asset
(settlement)
Value • Liabilities recorded at amount of cash
or cash equivalents paid to satisfy
liabilities
Present • Current estimate of present discounted

Value value of future net cash flows
34
17
35

• Measurement of elements [FASB – SFAC5]
o Historical cost
o Current cost
o Current market value
o Net realizable (settlement) value
o Present (or discounted) value of future cash flows
35
36
• Advantages
• Clarifies the conceptual underpinnings of proposed
• Facilitates decisions on controversial items, by reducing
the scope for personal bias and political pressure
• Enables standards to be developed on a consistent basis
 Avoids
the development of accounting standards on a
patchwork basis
• Reduce the need to debate basic issues each time a
standard is developed or revised
• Less open to criticism of yielding to external pressure
when there is conflict between user groups
36
18
37
• Advantages
• Helps preparers and users of reports understand the
accounting standard board’s approach to setting
standards and the nature and function of information in
general purpose financial statements
• Provides some guidance regarding topics not covered in
 Helps preparers and auditors with new issues to carry out
initial analysis in the absence of applicable accounting
standards
• Helps justify accounting practices when they are under
attack in the courts, if they can be shown to be consistent
with a conceptual framework
• May reduce the need for many detailed standards if
accountants can resolve issues by general principles
37
38
• Advantages
• Ease in interpreting information in financial reports
prepared in conformity to framework
• Limits the bounds of judgement and hence
increases comparability
38
19
39
• Disadvantages
• Inability to satisfy needs of all users of financial
statements and information
• Need for variety of standards for different purposes
due to diversity of user requirements
• Not necessarily easier to prepare and implement
standards prescribed
• Does not eliminate the need for judgment and
ensuing differences in opinion or interpretation
39
40
IAS 1: Presentation of Financial

Statements
• Covers the form and content of financial
statements, with main components as follows:
a) Statement of Profit or Loss and Other Comprehensive
Income
b) Statement of Financial Position
c) Statement of Changes in Equity
d) Statement of Cash Flows
e) Notes to Financial Statements
f) a statement of financial position as at the beginning of
the earliest comparative 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.
40
20
41

Statements
• Points to note:
o An entity whose financial statements comply with
IFRSs shall make an explicit and unreserved
statement of such compliance in the notes
o When preparing financial statements, management
shall make an assessment of an entity’s ability to
continue as a going concern
 Financial statements prepared 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
41
42

Statements
• Points to note:
o Entities are to prepare financial statements as least
annually. If the end of the reporting period is
changed, entity should disclose:
a) Reason why a period other than one year is used;
b) Fact that comparative figures are not in fact comparable
o Usefulness of financial statements is diminished in
event of long delay in publication
 Specific deadlines set by local legislation and market
regulation for submission of statements on timely basis
42
21
43
IAS 1: Presentation of Financial Statements

• Statement of Profit or Loss & Other Comprehensive Income
• Minimum disclosure on face of statement

include:
o Revenue
o Finance costs
o Share of profit and losses of associates and joint
ventures accounted for using the equity method
o Single amount comprising the total of (i) the post-
tax profit or loss of discontinued operations and (ii)
the post-tax gain or loss recognised on the disposal
of the assets or disposal group(s) constituting the
discontinued operation
43
44

• Minimum disclosure on face of statement

include (continued):
o Tax expense
o Profit or loss
o Disclosure on face of statement as allocations

of profit or loss for the period:
o profit or loss for the period attributable to non-
controlling interests and owners of the parent
o total comprehensive income attributable to non-
controlling interests and owners of the parent
44
22
45

• Separate disclosure either on the face of

statement or in the notes, if material:
o write-downs of inventories to net realisable value or
of property, plant and equipment to recoverable
amount, as well as reversals of such write-downs
o restructurings of the activities of an entity and
reversals of any provisions for the costs of
restructuring
o disposals of items of property, plant and equipment
o disposals of investments
o discontinuing operations
o litigation settlements
o other reversals of provisions
45
46

• Expenses recognised in profit or loss should be

analysed either by:
• nature (raw materials, staffing costs, depreciation,
etc.) or
• function (cost of sales, selling, administrative, etc).
[IAS 1.99]
• If an entity categorises by function, then
additional information on the nature of
expenses – at a minimum depreciation,
amortisation and employee benefits expense –
must be disclosed.
46
23
47

XYZ Group – Statement of comprehensive income for the year ended
31 December 20X7
(illustrating the presentation of comprehensive income in one statement and the
classification of expenses within profit by function)
(in thousands of currency units)
20X7 20X6
Revenue 390,000 355,000
Cost of sales (245,000) (230,000)
Gross profit 145,000 125,000
Other income 20,667 11,300
Distribution costs (9,000) (8,700)
Administrative expenses (20,000) (21,000)
Other expenses (2,100) (1,200)
Finance costs (8,000) (7,500)
(a)
Share of profit of associates 35,100 30,100
Profit before tax 161,667 128,000
Income tax expense (40,417) (32,000)
Profit for the year from continuing
operations 121,250 96,000
Loss for the year from discontinued operations – (30,500)
PROFIT FOR THE YEAR 121,250 65,500
Source: IFRS Foundation - Guidance on Implementing IAS 1 Presentation of Financial Statements
47
48

Other comprehensive income:
Exchange differences on translating foreign
(b)
operations 5,334 10,667
Available-for-sale financial assets(b) (24,000) 26,667
Cash flow hedges(b) (667) (4,000)
Gains on property revaluation 933 3,367
Actuarial gains (losses) on defined benefit
pension plans (667) 1,333
Share of other comprehensive income of
(c)
associates 400 (700)
Income tax relating to components of other
comprehensive income(d) 4,667 (9,334)
Other comprehensive income for the year,
net of tax (14,000) 28,000
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 107,250 93,500
Source: IFRS Foundation - Guidance on Implementing IAS 1 Presentation of Financial Statementsc
48
24
49

• Statement of Financial Position
• Minimum disclosure on face of statement include:

o Property, plant & equipment
o Investment property
o Intangible assets
o Inventories
o Trade and other receivables
o Cash & cash equivalents
o Trade & other payables
o Current tax liabilities & assets
o Deferred tax liabilities & assets
o Investments under the equity method
o Non-controlling interests
o Any other line items that is necessary for understanding the
entity’s financial position
49
50

• Criteria for separate presentation in statement:

o Nature and liquidity of assets and their materiality
o Function within the entity
o Amounts, nature and timing of liabilities
• Current/non-current distinction
o Entity must present current and non-current assets as
separate classifications
o Only if a presentation based on the order of liquidity
provides information that is reliable and more relevant may
the current/non-current split be omitted.
o Entity is to disclose any portion of asset or liability which is
expected to be recovered or settled after more than 12
months
50
25
51

Assets which are:
Expected to be realised in normal course of

entity’s operating cycle; or
Held primarily for trading purposes or for short term and expected
to be realised within 12 months of balance sheet date; or
Is cash and cash equivalent
CURRENT ASSETS
51
52

Liabilities which are:
Expected to be discharged in normal course of

entity’s operating cycle; or
Held primarily for trading purposes or for short term and due to be
settled within 12 months of balance sheet date; or
Entity has no right to defer settlement for at least 12 months after

the end of the reporting period.
CURRENT LIABILITIES
52
26
53

XYZ Group – Statement of financial position as at 31 December 20X7
(in thousands of currency units)
31 Dec 31 Dec
20X7 20X6
ASSETS
Non-current assets
Property, plant and equipment 350,700 360,020
Goodwill 80,800 91,200
Other intangible assets 227,470 227,470
Investments in associates 100,150 110,770
Available-for-sale financial assets 142,500 156,000
901,620 945,460
Current assets
Inventories 135,230 132,500
Trade receivables 91,600 110,800
Other current assets 25,650 12,540
Cash and cash equivalents 312,400 322,900
564,880 578,740
Total assets 1,466,500 1,524,200
Source: IFRS Foundation - Guidance on Implementing IAS 1 Presentation of Financial Statements
53
54

EQUITY AND LIABILITIES
Equity attributable to owners of the parent
Share capital 650,000 600,000
Retained earnings 243,500 161,700
Other components of equity 10,200 21,200
903,700 782,900
Minority interest 70,050 48,600
Total equity 973,750 831,500
Non-current liabilities
Long-term borrowings 120,000 160,000
Deferred tax 28,800 26,040
Long-term provisions 28,850 52,240
Total non-current liabilities 177,650 238,280
Current liabilities
Trade and other payables 115,100 187,620
Short-term borrowings 150,000 200,000
Current portion of long-term borrowings 10,000 20,000
Current tax payable 35,000 42,000
Short-term provisions 5,000 4,800
Total current liabilities 315,100 454,420
Total liabilities 492,750 692,700
Total equity and liabilities 1,466,500 1,524,200
54
27
XYZ Group – Statement of changes in equity for the year ended 31 December 20X7
Statements
Source: IFRS Foundation - Guidance on Implementing IAS 1 Presentation of Financial
IAS 1: Presentation of Financial Statements (in thousands of currency units) 55
Statement of Changes in Equity Share Retained Translation Available- Cash Revaluation Total Minority Total
capital earnings of foreign for-sale flow surplus interest equity
operations financial hedges
assets
Balance at 1
January 20X6 600,000 118,100 (4,000) 1,600 2,000 - 717,700 29,800 747,500
Changes in
accounting
policy - 400 - - - - 400 100 500
Restated
balance 600,000 118,500 (4,000) 1,600 2,000 - 718,100 29,900 748,000
Changes in
equity for
20X6
Dividends - (10,000) - - - - (10,000) - (10,000)
Total
comprehensive
income for the
(k)
year - 53,200 6,400 16,000 (2,400) 1,600 74,800 18,700 93,500
Balance at
31 December
•
20X6 600,000 161,700 2,400 17,600 (400) 1,600 782,900 48,600 831,500
Changes in
equity for
20X7
Issue of share
capital 50,000 - - - - - 50,000 - 50,000
Dividends - (15,000) - - - - (15,000) - (15,000)
Total
comprehensive
income for the
year(l) - 96,600 3,200 (14,400) (400) 800 85,800 21,450 107,250
Transfer to
retained
earnings - 200 - - - (200) - - -
Balance at
31 December
20X7 650,000 243,500 5,600 3,200 (800) 2,200 903,700 70,050 973,750
55
56

• Notes to the financial statements
o Performs the following functions:
 Provide information about basis on which financial
statements were prepared
 Disclose any information, not shown elsewhere in the
statements, which is required by IFRS
 Show any additional information relevant to understanding
which is not provided elsewhere in the financial statements
o Amplifies information in financial statements by:

 Giving detailed analysis or breakdown of figures
 Providing narrative information explaining the figures
 Giving additional information
56
28
57

• Notes to the financial statements
o Recommended order of notes [IASB]:
 Statement of compliance with IFRS
 Statement of measurement bases & accounting policies
 Supporting information for items in financial statements
 Other disclosures (e.g. contingent liabilities , non-financial
disclosures etc.)
o Amplifies information in financial statements by:

 Giving detailed analysis or breakdown of figures
 Providing narrative information explaining the figures
 Giving additional information
57
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Questions
• What are conceptual frameworks? Discuss the main
arguments in favour of and against a conceptual
framework. (UOL 2009 ZA Q6a)
• Explain what is meant by “conceptual framework”.

What issues should be considered when drawing up a
conceptual framework for financial reporting?
(UOL 2005 ZA Q6a)
58
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Session 2: Conceptual Framework

[IASB Conceptual Framework for Financial Reporting (2018)]

•Concept •Statement •Conceptual

Reporting Entity Users of Financial Statements

Objectives of Financial Statements

Qualitative Characteristics Elements of Financial Statements

Recognition of elements Measurement of elements

• Not necessarily a legal entity

Fundamental Qualitative Characteristics

Enhancing Qualitative Characteristics

• Disclosure of accounting policies

Enhancing Qualitative Characteristics

Enhancing Qualitative Characteristics

Enhancing Qualitative Characteristics

Elements of Financial Statements

Elements of Financial Statements

Financial Position •Assets

Elements of Financial Statements

Elements of Financial Statements

Elements of Financial Statements

Asset Liabilities Equity

Asset Liabilities Equity

Elements of Financial Statements

Elements of Financial Statements

Elements of Financial Statements

o Probability of future economic benefits

Elements of Financial Statements

Elements of Financial Statements

[IASB Conceptual Framework for Financial Reporting (2018)]

Elements of Financial Statements

[IASB Conceptual Framework for Financial Reporting (2018)]

Elements of Financial Statements

Elements of Financial Statements

Elements of Financial Statements

• Assets carried at amount of cash or cash

Elements of Financial Statements

• Assets recorded at the amount of cash

Present • Current estimate of present discounted

Elements of Financial Statements

IAS 1: Presentation of Financial

IAS 1: Presentation of Financial

IAS 1: Presentation of Financial

IAS 1: Presentation of Financial Statements

• Minimum disclosure on face of statement

IAS 1: Presentation of Financial Statements

• Minimum disclosure on face of statement

o Disclosure on face of statement as allocations

IAS 1: Presentation of Financial Statements

• Separate disclosure either on the face of

IAS 1: Presentation of Financial Statements

• Expenses recognised in profit or loss should be

IAS 1: Presentation of Financial Statements

Source: IFRS Foundation - Guidance on Implementing IAS 1 Presentation of Financial Statements

IAS 1: Presentation of Financial Statements

Source: IFRS Foundation - Guidance on Implementing IAS 1 Presentation of Financial Statementsc

IAS 1: Presentation of Financial Statements

• Minimum disclosure on face of statement include:

IAS 1: Presentation of Financial Statements

• Criteria for separate presentation in statement:

IAS 1: Presentation of Financial Statements

Assets which are:

Expected to be realised in normal course of

Is cash and cash equivalent

IAS 1: Presentation of Financial Statements