Conceptual Framework for Financial

Accounting
Objective of Financial Reporting
-to provide meaningful financial information to concerned stakeholders or to the primary users
who use the information for decision making

-is the foundation of the Conceptual Framework

Specific Objectives of Financial Reporting

The conceptual framework emphasizes on providing information that can assess the
management’s stewardship of the organization’s resources—how efficient and effective they are
in their job

1. To provide information that can help decide whether to provide the entity with resources
2. To provide information that helps in assessing the cash flow of the entity
3. To provide information about the entity’s economic resources and claims (assets and
liabilities) and changes in them

Target Users
-primary users [of general-purpose FS]

-existing and potential investors, lenders, and other creditors—because they make decisions
related to providing resources to the entity

-the information they need are assumed to meet the needed information of other users (e.g.,
customers, employees, and the government and their agencies)

Economic Decisions Done by Target Users

• Existing and Potential Investors

-to decide whether to provide or settle loans and other forms of credit

• Existing and Potential Lenders and other Creditors

-to decide whether to provide loan and other forms of credit

Assessing Cash Flow Prospects

• Existing and Potential Investors

-they buy, sell, or hold equity instruments depending on the returns that they expect from
an investment

• Existing and Potential Lenders and other Creditors

-they provide or settle loans and other forms of credit depending on the principal and
interest or other returns that they expect

Financial reporting must give information that assesses the amount, timing, and
uncertainty of possible net cash flows of the entity in the future

Economic Resources and Claims

-can be found in the SFP—because SFP shows the assets and liabilities

-assesses an entity’s liquidity, solvency, and the need for financial reporting

• Changes in Economic Resources and Claims

-may be one of the following:

1. result from financial performance and other transactions (e.g., issuing debt or
equity industry)
2. not results from financial performance but affects the entity’s ability to generate
net cash flow (e.g., change in market prices or interest rates)

Financial Performance

*-*pertains to the revenue, expenses, and net income (loss) for a period earned through efficient
and effective use of resources

-also known as result of operations

• Usefulness of Financial Performance

o shows the return that an entity has produced from use of resources
o indicates how well management uses the entity’s resources
o helps predict future returns on entity’s economic resources
o assesses the ability to generate future cash flow from operations
Accrual Accounting
-records effects of business activities on economic resources and claims as they occur, regardless
if cash has been received (paid) in a different period

-in other words, revenue when earned, expenses when incurred, regardless when payments take
place

-provides better basis for assessing past and future performance than cash receipts and payments
do (cash basis of accounting)

Limitations of Financial Reporting

1. Gen purpose financial reporting cannot provide all information needed by primary users
because of #2.
2. They do not measure the value of an entity. Instead, they help the same to assess the
value of an entity
3. Gen purpose financial reporting is intended to provide common information to users—
not those that are needed or requested by specific users
4. Not all figures shown in gen purpose financial reporting are based on actual figures—
most are based on estimates and judgment

Management Stewardship
-how manager’s handle their responsibility over an entity’s assets

-helps predict how managers will use economic resources in the future—thereby, allowing to
assess the entity’s prospect for future net cash flow

Qualitative Characteristics of Useful Financial Information

-attributes that make financial information useful to users

-to decide which information to include in the FS, ensure that the information is useful to users in
making economic decisions

Fundamental Qualitative Characteristics

These relate to the content or substance of financial information—about how information will be
useful to users

1. Relevance

-the capacity of information to influence decisions of users

 -information may still be relevant even if some users might not use them for their
advantage or even if users already know them from other source

2 traits that information must have to be relevant

a) Predictive Value

-an information’s usefulness in making predictions for the next or succeeding

business outcomes

-doesn’t need to be forecast or prediction in self, but may be used in the process
of prediction correctly

b) Confirmatory (Feedback) Value

-information provides feedback if it changes or confirms previous evaluations

These two are interrrelated. When info has 1, it also has the other

2. Faithful Representation

-information must be shown in its economic substance (of what transactions actually
transpired) than just the its legal form (title or whatever label given to the event)

3 traits that information must have to be faithfully represented

a) Complete

-all relevant information are presented

-a way to do it is to abide by the adequate disclosure standard or the principle of

full disclosure

-involves all information that a user need to understand the phenomenon,

including descriptions and explanations

b) Neutral

-there is no bias in the selection or presentation of financial information

-information must not be slanted, weighted, emphasized, de-emphasized, or

manipulated

-information must not favor one group of users only—it must benefit and provide
the common needs of all users
 -to be neutral is to be fair

c) Free from Error

-does not mean that everything is 100% accurate

-means that there is no error or omission in the description of the phenomenon

-also means that correct—not erroneous— method of producing the reported

information was used and applied

Materiality

-affects the relevance of information

-pertains to the characteristic of information that could reasonably be expected to influence*

decisions by primary users if they are omitted, misstated, or obscured

-an entity-specific aspect of relevance. Meaning, this changes according to context—the nature
or magnitude**, or both of items which the information relates to

-what is material in one may be immaterial to another

-IASB has no uniform threshold to determine which is material or not because of aforementioned
reason—it being contextual

*emphasizes that the primary users are the threshold or benchmark in determining the relevance
of information and adds reasonability on which economic decisions are made. Remember, the
assumption is that, what primary users need are, most likely, what other users need

*these are the factors of materiality

Standard of Adequate Disclosure

-applied in the Notes to Financial Statements

-necessitates the clear report of all significant and relevant FS information

-states that information known to accountant must state facts not disclosed in the FS but are
necessary to fully comprehend and not misunderstand their contents

Notes to Financial Statement

-exists to abide by the PFRS requirement of necessary disclosure

-describes or disaggregates items in the FS and items not qualified for recognition
Prudence

-supports neutrality

-old principle of accounting which is only implicitly required by the current standard-setting
body

-states that caution must be practiced under uncertain conditions [to recall examples of such
conditions, refer to the example about receivables in Int Acc 1]

-assets and income must not be overstated while expenses and liabilities must not be understated

Conservatism

-also not explicitly stated in the Revised Conceptual Framework, but is still considered in current
accounting practices

-synonymous with prudence

-states that if there are alternatives, choose the one with the least effect of equity

-”when in doubt, record any loss and do not record any gain”

Measurement Uncertainty

-if monetary amounts in financial reports must be estimated because they cannot be directly
observed

-may affect faithful representation if level of uncertainty is high. However, if the estimate is
clearly and accurately described, it does not affect the information’s usefulness

-using this does not undermine the usefulness of the financial information

Substance over form

****-as stated in faithful representation, when the actual transaction and events differ from the
legal form, the accountant must present the former.

Enhancing Qualitative Characteristics

Relate to the presentation or form of the financial information. These increase the usefulness of
the financial information

1. Comparability

-allows users to identify the similarities and differences among items

 -does not necessitate that FS are uniform. The similar information must simply look
alike, and the differences be distinctly different

-requires at least two items

2 Types of comparability

a) Comparability within an entity

-horizontal or intra-comparability

-in a single entity through time or from one accounting period to the next

b) Comparability between and across entity

-dimensional or inter-comparability

-quality of information that allows comparisons between 2 or more entities in the

same industry

2. Understandability

-requires that information must be comprehensible

-some phenomena are difficult to understand. Omitting them makes the report
understandable. However, the result is an incomplete and, most probably, misleading
report

How to make information understandable?

a) Classify
b) Characterize
c) Present clearly and concisely
3. Verifiability

-assure faithful representation of information

-can be observed if independent examiners can reach a consensus—not necessarily

uniform opinion—about the presented in formation.

Types of verification:

a) Direct Verification

-verifying an amount through direct observation

 b) Indirect Verification

-checking the inputs to a model, formula, or other technique, and recalculating the
inputs using the same methods

4. Timeliness

-means that information is provided at the time that users need it—before they make a
decision

-older information, generally, is less useful. However, some old information may still be
timely because users might need them to identify and assess trends

Consistency

-implicit in the characteristic of comparability

-not synonymous to comparability

-in a limited sense, application of uniform method from period to period

-to expound, it may be the use of same method for:

1. the same item either from one period to another in an entity; or

2. in a single period across entities

💡 Changing of method if a new one will give more relevant information is the exemption in the
rule of consistency. This change, however, must be disclosed in the Notes to the Financial
Statement

Cost [of acquiring relevant information] constrains providing useful information. To make the
cost worthwhile, the benefits of the information must outweigh it.

Objectives of Financial Statements

-provide information about economic resources and claims and the changes in them used to:

1. assess future cash flows of the entity

2. assess the management stewardship of the entity’s economic resources

Financial Statements
Income Statements

-provides information about an entity’s performance or results of operations

-amount of profit or loss is the core of this statement

Statement of Financial Position

-shows the entity’s assets, liabilities, and equity

-representation of the accounting equation

-used to assess the liquidity, solvency, and financial flexibility of the business

Statement of Changes in Owner’s Equity

-shows information about the factors that changed the amount of the entity’s capital

Information Found in the FS

1. Financial Position
2. Financial performance with recognized income and expenses
3. Information about:
1. recognized assets, liabilities, income, and expenses including nature and risks
arising from those recognized assets
2. assets and liabilities that have not been recognized with their nature and risks
3. cash flows
4. contributions from and distributions to enterprise owners
5. methods, assumptions, and judgements in estimation amounts presented, and
changes in those methods, assumptions, and judgments.

Types of Financial Statements

Consolidated Financial Statements

-prepared when entity comprises both the parents and its subsidiaries

-parent and subsidiary are considered as a single entity

-does not provide separate information about the ALCRE of a particular subsidiary

-useful for primary users of the parent company to assess the future net cash inflows to the
parent.

Why only look at the parent’s side? Because the cash inflow of parent includes distributions from
parents to subsidiaries
Parent

-entity that controls the subsidiary

Unconsolidated Financial Statements

-FS is for the parent alone

-useful for the primary users of parent company because having a claim against the parent does
not give the holder/creditor/lender a claim against the subsidiary

-information here, however, is typically insufficient; they do not meet the requirements of the
primary users

-cannot serve as substitute for consolidated financial statements

Combined Financial Statements

-2 or more entities not linked by a parent and subsidiary relationship

-separate FS

Other Terms
Reporting Entity

-entity required or chooses to prepare financial statements

-may be a single entity, a portion of an entity, or comprises more than 1 entity

• Examples of Reporting Entities

o Individual corporation, partnership, or proprietorship
o Parent alone
o Parent and subsidiaries as single reporting entity
o 2 or more entities without parent and subsidiary relationship as a single reporting
entity
o reportable business segment of an entity

Reporting Period

-period when FS for general purpose financial reporting are prepared

-usually, it lasts for 1 year

-may also be prepared on an interim basis (Interim FS), but are not required
Underlying Assumptions
-postulates or fundamental premises that serve as the bases of accounting

-helps avoid misunderstanding and enhance understanding and usefulness of FS

-the Conceptual Framework for Financial Reporting only mentions the going concern
assumption. However, there are also implied assumptions: accounting entity, time period, and
monetary unit

Going Concern

-unless stated or an evidence proves so, the business is assumed to operate perpetually

-foundation of cost principle—which states that transactions must be recorded at their historical
cost or original cost and not at fair market value

-abandoned if there is evidence that the business would experience large and persistent losses or
that operations would be terminated

Accounting Entity

-entity is separate from its owners, managers, and employees who comprise it

-entity is an independent accounting entity

Time Period

-assumes that the indefinite life (because of going concern) of an entity is subdivided into
periods, usually in equal lengths, to prepare financial reports

• 3 Kinds of Year
1. Fiscal Period

-accounting period that last up to 12-months

2. Calendar Year

-begins on January 1 and ends on December 31

3. Natural Business Year

-12-month period that ends on any month when the business is at the lowest or is
experiencing a slack season
Monetary Unit

2 aspects

1. Quantifiability Aspect

-states that the ALCRE should be stated in terms of a unit of measure (PHP in the PH)

2. Stability of the Peso

-states that the purchasing power of the peso is stable

-any instability or fluctuations in its value is insignificant and can be ignored

Elements of Financial Statement

-according to the Conceptual framework, these are:

1. assets, liabilities, equity (which relates to financial position)

2. income and expenses (which to the entity’s performance)

Assets

-present economic resource* controlled by the entity as a result of past events

economic resource is a right that can potentially produce economic benefits

**potential economic benefits are no longer required or expected to flow to the entity, unlike in
the Old Conceptual Framework

• Essential Characteristics of Asset

1. is a present economic resource
2. economic resource is a right that can potentially provide economic benefits
3. resource is controlled by the entity due to past events
• Forms of Rights
1. Rights corresponding to an obligation of another entity
1. Rights to receive cash
2. Right to receive goods and services
3. Right to exchange economic resources with another party on favorable
terms
4. Right to benefit from another party’s obligation if a specified uncertain
events occur
2. Rights not corresponding to an obligation of another entity
1. Right over physical objects
2. Right over intellectual property
3. Rights through contract or legislation
 1. owning a debt or equity instrument
2. owning a registered patent

“Potential to produce economic benefit”

-means that only the existence of the right is necessary—certain economic benefit from it is not
required

-hence, a right is still an economic resource even if the probability to produce an economic
benefit is low

-potential, not future economic benefit is what’s included in the phrase

Control of an economic resource

-may arise if entity enforces legal rights over an asset

-entity only has control over an asset if it has the present ability to:

1. direct the use of an asset

2. gain economic benefits that flow from it
3. prevent others from using it that also hinders others from getting the economic benefit

Liability

-present obligation to transfer an economic resource due to past events

-can also pertain to the transfer of economic resource and not the ultimate outflow of economic
benefits

• Characteristics of Liability
1. It’s an obligation
2. Obligation entails the transfer of an economic resource
3. Obligation is a present one caused by past events

Obligation

-duty or responsibility that an entity cannot avoid

• Inclusions in “transfer of economic resource”

1. Obligation to pay cash
2. Obligation to deliver goods or non-cash resources
3. Obligation to provide services at some future time
4. Obligation to exchange economic resources with another party on unfavorable
terms
 5. Obligation to transfer an economic resource if specified uncertain future event
occurs

Equity

-residual interest in assets after deducting all liabilities

-aka net assets of entity

Income

-increase in assets or decrease in liabilities that results in increase in equity—other than those
from the owners’ contributions

Expenses

-decease in assets, increase in liabilities that result in decrease in equity other than those related
to distributions to owners

Recognition and Measurement

Recognition

-process of capturing for inclusion in the FS an item that meets the definition of any of the FS
elements

-basically, knowing which ones to include in the FS

-involves naming a financial statement element and assigning a monetary amount (carrying
value) to it

• Criteria to be recognized
1. Meets the definition of an asset, liability, equity, income, or expense
2. Provides useful information that is relevant and faithfully represented
3. Benefits of the information to the users justifies the cost of obtaining, providing,
and using it. (the cost of getting info does not outweigh its benefits)
4. It is measurable

Derecognition

-new term introduced by the Revised Conceptual Framework

-removal of, or all, parts of the currently recognized asset or liability from the SFP

-usually occurs if an asset or liability no longer qualifies as such

-for assets, they are derecognized when entity loses control of all or part of the asset

-for liability, they are derecognized when entity no longer has a present obligation for all part of
the liability

-no profit or loss will be recognized when an asset or liability is derecognized while a part of it is
retained unless the remaining portion is remeasured or reclassified

Measurement

-quantifying in monetary terms the elements in the FS—giving corresponding amounts to the FS
elements, in other words

-measurement basis must be one that gives the most relevant and faithful representation of the
information, considering its information that will be produced in the FS

-initial measurement (at date of creation) and subsequent measurement (date of reporting) are
both considered in choosing a measurement basis

-characteristic of asset and liability and how they contribute to future cash flow also affect the
measurement basis choice

• Measurement Bases
1. Historical Cost

-based on the price of the transaction that gave rise to the FS element

-does not reflect changes in values, except changes relating to asset impairment or
liability becoming onerous

-historical cost of an asset is the amount paid to acquire asset + transaction cost

-historical cost of a liability is the amount received — transaction cost

-the historical cost of an asset or liability is the current value at the date of its
recognition and is used as a starting point for subsequent measurement of
historical cost

-based on entry price

Reasons that could update the historical cost of an asset:

a) Consumption or a part or all of the economic resource (depreciation and

amortization)
b) payment received extinguished part or all of the asset
 c) Impairment—effect of events that causes the carrying amount to be no
longer recoverable)
d) accrual of interest to reflect any financing component

Reasons to update the historical cost of a liability

e) Fulfillment of all, or part of , the liability

f) Historical cost does not suffice to represent the obligation—it’s too little
g) Accrual of interest to reflect any financing component
2. Current Value

-uses updated information that reflect the conditions at the measurement date

-does not depend on the price of the transaction or any event that gave rise to the
asset or liability

-applicable for assets and liabilities that produce cash flow directly (e.g., financial
assets for trading, sale, capital appreciation, for leasing out to others based on
market rentals)

i. Includes:
1. Fair Value

-price to be received if an asset is sold at measurement date

-for liability, the price that would be paid to transfer liability at the
measurement date

-can be observed by using the market price of an asset or liability

-PV of cash flows can be used in cases where fair value cannot be directly
measured

-not adjusted for transaction costs, thus not considering it on the disposal of
an asset or settlement of a liability

2. Value in Use (for assets)

-PV of the cash flows or other economic benefits that is expected to be

derived from the use of an asset and its ultimate disposal

-does not include transaction costs for acquiring asset but uses it for the
disposal of an asset
 3. Fulfillment Value (for liabilities)

-PV of cash that an entity expects to transfer in paying or settling a liability

-no transaction cost in incurring liability, but with transaction cost in paying
the liability

4. Current Cost

-cost of an equivalent asset at the measurement date comprising the

consideration paid and transaction cost

-current cost of a liability is the amount to be received — transaction cost at

measurement date

-based on entry price but reflects market conditions on measurement date

Use of current value—that is, when value of asset is sensitive to market factors or
other risks:

2. Fair value - used if the value is directly observable

3. Value in use or current cost - if value is not directly observed

Entry and Exit Values

Entry Values

-aka entry prices

-measurement based on the date of acquisition, creation, or incurrence

Exit Values

-aka exit prices

-measurement bases on the date of measurement (subsequent to acquisition or incurrence),

disposal, or settlement

💡 Historical and current cost are entry values. Value in use and fulfillment and fair value
are exit values

Presentation and Disclosure

-financial performance and position must be relevant, faithfully represented, and requires:
 1. focusing on presentation and disclosure, objectives and principle than on rules

-information must be communicated well

-balance between giving flexibility [to entities] to provide relevant and faith fully
represented FS elements and achieving comparability within (for 2 different reporting
periods) and across enterprises (for a single period)

2. classifying information (similar items are grouped, dissimilar items are separated)

-grouping items according to nature, function, and way of measurement

3. aggregating information—but not excessive—to avoid unnecessary or too simplified

details

-adding similar FS elements with shared characteristics and classifications

-numerous details, if terribly needed, should be put in the Notes to the FS, instead

Concepts of Capital
Financial Concepts of Capital

-the primary concern of the users of the FS is the maintenance of nominal invested capital or the
purchasing power of the capital

-capital is synonymous with the net assets or equity of the enterprise

-no specific measurement basis required since the usage depends on the type of financial capital
an entity wants to maintain

Physical Concept of Capital

-users of FS are more concerned with the operating capability of the enterprise

-capital is the operating capacity of the enterprise—meaning, the capital size dictates the
productivity of the enterprise

-requires the use of current cost as measurement basis

Concepts of Capital Maintenance

-profit excess of capital, end over capital, beg excluding the effects of contributions from and
distributions to owners
-aka, net worth method of measuring profit

-return on capital is the focus—only inflow of net assets in excess of amount needed to maintain
capital is counted as profit or loss

Financial Capital Maintenance Concept

-holding gain, or increase in price of assets held over the period, is considered an asset

-in capital based on purchasing power units, the profit is only the increase in prices of assets
beyond the increase in the general price level. The rest is capital adjustment

Physical Capital Maintenance Concept

-the quantitative measure of the physical productive capacity (operating capacity) to produce
goods and services

-there is only profit if the ending operating capacity (for this concept, the capital is the operating
capacity) is more than the operating capacity at the start of the period, ofc, excluding transactions
with owners

-all price changes that affects assets and liabilities are regarded as capital maintenance
adjustments—not profit—but are part of equity.