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Conceptual
Framework

Learning Objectives
• State the purpose, status, and scope of the Conceptual
Framework.
• State the objective of financial reporting.
• Identify the primary users of financial statements.
• Explain briefly the qualitative characteristics of useful
information and how they are applied in financial reporting.
• Define the elements of financial statements and state their
recognition criteria and their derecognition.
• State the measurement bases used in financial reporting.
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Purpose of Conceptual
Framework
The Conceptual Framework prescribes the concepts for
general purpose financial reporting. Its purpose is to:.
a. assist the International Accounting Standards Board (IASB) in
developing Standards that are based on consistent concepts;
b. assist preparers in developing consistent accounting policies
when no Standard applies to a particular transaction or when
a Standard allows a choice of accounting policy; and
c. assist all parties in understanding and interpreting the
Standards.
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Purpose of Conceptual
Framework
The Conceptual Framework provides the foundation for
the development of Standards that:
a. promote transparency by enhancing the international
comparability and quality of financial information.
b. strengthen accountability by reducing the information gap
between providers of capital and the entity’s management.
c. contribute to economic efficiency by helping investors to
identify opportunities and risks around the world, thus
improving capital allocation.
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Status of the Conceptual

Framework
• The Conceptual Framework is not a PFRS. When there
is a conflict between the Conceptual Framework and a
PFRS, the PFRS will prevail.
• In the absence of a standard, management shall
consider the Conceptual Framework in making its
judgment in developing and applying an accounting
policy that results in useful information.

Hierarchy of Reporting
Standards
1. PFRSs
2. Judgment
When making the judgment:
Management shall consider the following:
a. Requirements in other PFRSs dealing with similar transactions
b. Conceptual Framework
Management may consider the following:
a. Pronouncements issued by other standard setting bodies
b. Other accounting literature and industry practices. 7

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Status of the Conceptual

Framework
• To meet the objectives of general purpose financial
reporting, a Standard sometimes contains requirements
that depart from the Conceptual Framework. The
departure is explained in the “Basis for
Conclusions” on that Standards.
• The Conceptual Framework may be revised from time to
time based on the IASB’s experience of working on it.

Scope of the Conceptual

Framework
The Conceptual Framework is concerned with general purpose
financial reporting. General purpose financial reporting involves
the preparation of general purpose financial statements. The
Conceptual Framework provides the concepts regarding the following:
1. The objective of financial reporting
2. Qualitative characteristics of useful financial information
3. Financial statements and the reporting entity
4. The elements of financial statements
5. Recognition and derecognition
6. Measurement
7. Presentation and disclosure
8. Concepts of capital and capital maintenance
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Objective of Financial Reporting

• The objective of general purpose financial

reporting is to provide financial information about the
reporting entity that is useful to primary users in
making decisions about providing resources to the
entity.
• The objective of general purpose financial reporting
forms the foundation of the Conceptual Framework.

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Primary Users

• Primary users – are those who cannot demand

information directly from reporting entities. The
primary users are:
(a) Existing and potential investors
(b) Lenders and other creditors.
• Only the common needs of primary users are met by
the financial statements.

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Primary Users Decision Making

Decisions about providing resources to the entity

• Buying and selling or holding investments
• Providing or settling loans and other forms of credit
• Exercising voting or similar rights that could influence
management’s actions relating to the use of the entity’s
economic resources.

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Information needed by Primary

Users
a. The economic resources of the entity, claims against
the entity and changes on those resources and claims;
(prospects for future net cash inflows) and
b. How efficiently and effectively the entity’s
management has utilized the entity’s economic
resources. (management stewardship)

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Qualitative Characteristics

The qualitative characteristics of useful information

identify the types of information that are likely to be most
useful to the primary users in making decisions using
entity’s financial report.
1. Fundamental qualitative characteristics
- that make information useful to users
2. Enhancing qualitative characteristics
- that enhance the usefulness of information
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Fundamental qualitative
characteristics
These are the characteristics that make the information
useful to user
a. Relevance
b. Faithful Representation

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Relevance

Information is relevant if it can affect the decisions of

users.
a. Predictive value – the information can be used in
making predictions
b. Confirmatory value – the information can be used
in confirming past predictions
 Materiality – is an ‘entity-specific’ aspect of relevance.

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Faithful Representation

The information provides a true, correct and complete

depiction of what it purports to represent.
a.Completeness – all information necessary for users to
understand the phenomenon being depicted is provided.
b.Neutrality – information is selected or presented
without bias.
c.Free from error – there are no errors in the description
and in the process by which the information is selected
and applied
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Enhancing Qualitative
Characteristics
1. Comparability – the information helps users in identifying
similarities and differences between different sets of
information.
2. Verifiability – different users could reach consensus as to
what the information purports to represent.
3. Timeliness – the information is available to users in time to
be able to influence their decisions.
4. Understandability – users are expected to have:
a. reasonable knowledge of business activities; and
b. willingness to analyze the information diligently. 18

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Financial statements and the

Reporting entity
Objective and scope of financial statements
The objective of general purpose financial statements is
to provide financial information about the reporting
entity’s assets, liabilities, equity, income and expenses
that is useful in assessing:
a. the entity’s ability to generate future net cash
inflows; and
b. management’s stewardship over economic
resources 19

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Financial statements and the

Reporting entity
Reporting period
Financial statements are prepared for a specific period of time
(i.e., the reporting period) and include comparative
information for at least one preceding reporting period.
Going concern
Financial statements are normally prepared on the assumption
that the reporting entity is a going concern, meaning the entity
has neither the intention nor the need to end its
operations in the foreseeable future.
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Financial statements and the

Reporting entity
Reporting entity
A reporting entity is one that is required, or chooses, to prepare
financial statements, and is not necessarily a legal entity. It can be
a single entity or a group or combination of two or more entities.
Parent
a. Consolidated FS – parent
and its subsidiaries.
b. Unconsolidated FS –
Jollibee alone
c. Combined FS – Chowking
and Greenwich
Subsidiaries 21

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Elements of Financial
Statements
1. Assets
2. Liabilities Entity’s financial position
3. Equity
4. Income
Entity’s financial performance
5. Expenses

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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.”
(Conceptual Framework 4.3 & 4.4)

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Three aspects in the definition

of an asset
1. Right – asset refers to a right, and not necessarily to a
physical object, e.g., the right to use, sell, lease or transfer a
building.
2. Potential to produce economic benefits – the right has
a potential to produce economic benefits for the entity that
are beyond the benefits available to all others. Such potential
need not be certain or even likely – what is important is that
the right already exists and that, in at least one circumstance,
it would produce economic benefits for the entity.
3. Control – means the entity has the exclusive right over the
benefits of an asset and the ability to prevent others from
accessing those benefits. 24

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Liability

“a present obligation of the entity to transfer an

economic resource as a result of past events.”
(Conceptual Framework 4.26)

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Three aspects in the definition

of a liability
1. Obligation – An obligation is “a duty or responsibility that an entity has no
practical ability to avoid.” (CF 4.29) An obligation can be either legal obligation or
constructive obligation.

2. Transfer of an economic resource – the obligation has the potential to

require the transfer of an economic resource to another party. Such potential
need not be certain or even likely – what is important is that the obligation
already exists and that, in at least one circumstance, it would require the
transfer of an economic resource.

3. Present obligation as a result of past events – A present obligation

exists as a result of past events if:
a. the entity has already obtained economic benefits or taken an action; an

b. as a consequence, the entity will or may have to transfer an economic resource that it would
not otherwise have had to transfer. 26

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Executory contracts
• An executory contract “is a contract that is equally unperformed –
neither party has fulfilled any of its obligations, or both parties have
partially fulfilled their obligations to an equal extent.” (CF 4.56)
• An executory contract establishes a combined right and obligation to
exchange economic resources.
• The contract ceases to be executory when one party performs its
obligation.
If the entity performs first, the entity’s combined right and obligation changes
to an asset.
If the other party performs first, the entity’s combined right and obligation
changes to a liability. 27

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Equity

• “Equity is the residual interest in the assets of the entity

after deducting all its liabilities.” (Conceptual Framework 4.63)
• Equity equals Assets minus Liabilities

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Income and Expenses

• Income
Income is “increases in assets, or decreases in liabilities, that
result in increases in equity, other than those relating to
contributions from holders of equity claims.” (Conceptual Framework
4.68)

• Expenses
Expenses are “decreases in assets, or increases in liabilities,
that result in decreases in equity, other than those relating to
distributions to holders of equity claims.” (Conceptual Framework 4.69)
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Income and Expenses

Income
 Increases in Assets or
Decreases in Liabilities
 Results in increase in equity
 Excludes contributions from the
entity’s owners
Expenses
 Decreases in Assets or
Increases in Liabilities
 Results in decrease in equity
 Excludes distributions from the
entity’s owners

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Recognition

The recognition process

Recognition is the process of including in the statement
of financial position or the statement(s) of financial
performance an item that meets the definition of
one of the financial statement elements (i.e., asset,
liability, equity, income or expense).
This involves recording the item in words and in
monetary amount and including that amount in the
totals of either of those statements.
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Recognition Links to FS (BS/IS)

Statement of Financial Position at Beginning of reporting period

Assets – Liabilities = Equity

Statement of Financial Performance

Income – Expenses
Changes
in Equity
Contributions from holders of equity
–
Distributions to holders of equity

Statement of Financial Position at End of reporting period

Assets – Liabilities = Equity
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Recognition Criteria

An item is recognized if:

a. it meets the definition of an asset, liability, equity,
income or expense; and
b. recognizing it would provide useful information, i.e.,
relevant and faithfully represented information.

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Recognition Criteria

Relevance
The recognition of an item may not provide relevant information
if, for example:
a. it is uncertain whether an asset or liability exists; or
b. an asset or liability exists, but the probability of an inflow or
outflow of economic benefits is low. (Conceptual Framework 5.12)
However, the presence of one or both of the foregoing does
not automatically lead to the non-recognition of an item. Other
factors should also be considered.
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Recognition Criteria

Faithful representation
The level of measurement uncertainty and other factors
can affect an item’s faithful representation, but not
necessarily its relevance.

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Recognition Criteria

Measurement uncertainty
Measurement uncertainty exists if the asset or liability needs
to be estimated. A high level of measurement uncertainty
does not necessarily lead to the non-recognition of an asset
or liability if the estimate provides relevant information and
is clearly and accurately described and explained.
However, measurement uncertainty can lead to the non-
recognition of an asset or a liability if making an estimate is
exceptionally difficult or exceptionally subjective.
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Derecognition

• Derecognition is the removal of a previously recognized

asset or liability from the entity’s statement of financial
position.
• Derecognition occurs when the item ceases to meet the
definition of an asset or liability.

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Derecognition

The entity:
a. Derecognizes the assets or liabilities that have expired or
have been consumed, collected, fulfilled or transferred,
and recognizes any resulting income and expenses.
b. Continues to recognize any assets or liabilities retained
after the derecognition. No income or expense is normally
recognized on the retained component unless there is a
change in its measurement basis. After derecognition, the
retained component becomes a unit of account
separate from transferred component. 38

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Unit of Account

is “the right or the group of rights, the obligation or the

group of obligations, or the group of rights and
obligations, to which recognition criteria and
measurement concepts are applied.” (Conceptual Framework 4.48)
 Account title (Cash or Accounts Receivable)
 Group of similar assets (Property, Plant, & Equipment)
 Group of Assets/Liabilities (Cash-generating Unit)

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Measurement

Recognition requires quantifying an item in monetary

terms, thus necessitating the selection of an appropriate
measurement basis

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Measurement Bases

1. Historical cost
2. Current value
a. Fair value
b. Value in use and fulfilment value
c. Current cost

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Historical cost

The historical cost of:

a. an asset is the consideration paid to acquire the asset
plus transaction costs.
b. a liability is the consideration received to incur the
liability minus transaction costs.

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Historical cost

Historical cost is updated over time to depict the

following:
Asset
a. Impairment, depreciation or
amortization
b. Collections that extinguish part b. Payments or fulfilments made
or all of the asset
c. Discount or premium
amortization when the asset is
measured at amortized cost
Liability
a. Increase in the obligation
resulting from the liability
becoming onerous
that extinguish part or all of the
liability
c. Discount or premium
amortization when the liability
is measured at amortized cost 43

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Current Value

• Current Value measures reflect changes in values at the

measurement date.
• Current Value is not derived from the price of the
transaction or other event that gave rise to the asset or
liability.
a. Fair value
b. Value in use and fulfilment value
c. Current cost 44

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Fair Value

Fair value is “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.” (Conceptual Framework 6.12)
• reflects the perspective of market participants (not an
entity specific measurement)
• can be measured directly by observing prices in an
active market or indirectly using measurement
techniques (not adjusted for transaction cost)
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Value in use and fulfilment

value
Value in use is “the present value of the cash flows, or
other economic benefits, that an entity expects to derive
from the use of an asset and from its ultimate disposal.”
(Conceptual Framework 6.17)

Fulfilment value is “the present value of the cash, or

other economic resources, that an entity expects to be
obliged to transfer as it fulfils a liability.”
(Conceptual Framework 6.17)

Note: These values do not include transaction cost in acquiring an

asset or incurring a liability but include transaction cost expected to be
incurred on the ultimate disposal of the asset of fulfilment of the liability. 46

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Current cost

The current cost of:

a. an asset is “the cost of an equivalent asset at the
measurement date, comprising the consideration that
would be paid at the measurement date plus the
transaction costs that would be incurred at that date.”
b. a liability is “the consideration that would be
received for an equivalent liability at the measurement
date minus the transaction costs that would be
incurred at that date.”
(Conceptual Framework 6.21) 47

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Entry values vs. Exit values

Current cost and historical cost are entry values

(i.e., they reflect prices in acquiring an asset or
incurring a liability),
Fair value, value in use and fulfilment value are
exit values (i.e., they reflect prices in selling or using
an asset or transferring or fulfilling a liability).

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Considerations when selecting a

measurement basis
When selecting a measurement basis, it is important to consider the
following:
a. The nature of information provided by a particular
measurement basis (e.g., measuring an asset at historical cost
may lead to the subsequent recognition of depreciation or
impairment, while measuring that asset at fair value would lead to
the subsequent recognition of gain or loss from changes in fair
value).
b. The qualitative characteristics, the cost-constraint, and
other factors (e.g., a particular measurement basis may be more
verifiable or more costly to apply than the other measurement
bases). 49

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Measurement of Equity

• Total equity is not measured directly. It is simply equal to

difference between the total assets and total liabilities.
• Because different measurement bases are used for different
assets and liabilities, total equity cannot be expected to be
equal to the entity’s market value nor the amount that can be
raised from either selling or liquidating the entity.
• Equity is generally positive, although some of its components
can be negative. In some cases, even total equity can be negative
such as when total liabilities exceed total assets.

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Presentation and Disclosure

• Information is communicated through presentation and

disclosure in the financial statements.
• Effective communication makes information more useful.
Effective communication requires:
a. focusing on presentation and disclosure objectives and principles
rather than on rules.
b. classifying information by grouping similar items and separating
dissimilar items.
c. aggregating information in a manner that it is not obscured either by
excessive detail or by excessive summarization.
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Presentation and Disclosure

Objective and Principles
• The objectives are specified in the Standards
• The principles include:
a. the use of entity-specific information is more useful that
standardized descriptions, and
b. duplication of information is usually unnecessary.

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Presentation and Disclosure

Classification
• Classifying means combining similar items and
separating dissimilar items.
• Offsetting of assets and liabilities is generally not
appropriate

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Presentation and Disclosure

Classification
Classification of income and expenses
Income and expenses are classified as recognized either
in:
a. profit or loss; or
b. other comprehensive income.

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Presentation and Disclosure

Aggregation
Aggregation is “the adding together of assets,
liabilities, equity, income or expenses that have shared
characteristics and are included in the same
classification.” (Conceptual Framework 7.20)

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Presentation and Disclosure

Classification vs Aggregation

Classifying
All receivables arising from sales on
account are classified as “Accounts
Receivable.”
Accounts Receivable is a Unit of Account
for recognition and measurement
purposes
Aggregation
All receivables (i.e., Accounts
Receivables, Notes Receivables,
Advances, etc.) are aggregated and
presented in the statement of financial
position under a single line item called
“Trade and Other Receivables”

Offsetting
Accounts receivable and accounts payable are netted and only the net amount is
presented. This is usually prohibited.
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Concepts of Capital and Capital

Maintenance
• Financial concept of capital
– capital is regarded as the invested money or invested
purchasing power. Capital is synonymous with equity,
net assets, and net worth.
• Physical concept of capital
– capital is regarded as the entity’s productive capacity,
e.g., units of output per day.

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Concepts of Capital and Capital

Maintenance
Determination of Profit
a. Financial Capital Maintenance – profit is earned if the Net
Assets at the end of the period exceeds the Net Assets at the
beginning of the period, after excluding distributions to, and
contributions from, owners during the period.
b. Physical Capital Maintenance – profit is earned only if the
entity’s productive capacity at the end of period exceed
productive capacity at the beginning of period, after excluding
distributions to, and contributions from, owners during the
period.
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Concepts of Capital and Capital

Maintenance - Illustration
Manong Boy sells out balut. One morning, Manong had Php100.
Manong used that amount to buy balut, cook the balut, and sell
them. At the end of the day, Manong had Php240.
Requirement: If Manong uses the financial capital maintenance
concept, how much profit did Manong earned?

Answer:
Net Assets, end Php 240
Less: Net Assets, beg -100
Profit Php 140
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Concepts of Capital and Capital

Maintenance - Illustration
Manong Boy sells out balut. One morning, Manong had Php100.
Manong used that amount to buy balut, cook the balut, and sell
them. At the end of the day, Manong had Php240.
Requirement: What if Manong ate one (1) balut costing Ph10.
Using the financial capital maintenance concept, how much
profit did Manong earned?
Answer:
Net Assets, end Php 240
Add: Distribution to owner 10
Less: Net Assets, beg -100
Profit Php 150 60

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