FAR EASTERN UNIVERSITY

INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE

CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

Background

The IASB issued the revised Conceptual Framework for Financial Reporting, a comprehensive set of concepts for
financial reporting, in March 2018.

Structure of the Conceptual Framework

The Framework addresses:

• the objective of financial reporting (Chapter 1)
• the qualitative characteristics of useful financial information (Chapter 2)
• financial statements and the reporting entity (Chapter 3)
• the definition (Chapter 4), recognition and derecognition (Chapter 5), measurement (Chapter 6), presentation
and disclosure (Chapter 7) of the elements from which financial statements are constructed
• concepts of capital and capital maintenance (Chapter 8)

The objective of general-purpose financial reporting forms the foundation of the Conceptual Framework. Other
aspects of the Conceptual Framework flow logically from the objective.

Purpose and Status of the Framework

The Framework describes the basic concepts that underlie the preparation and presentation of financial
statements for external users. The purpose of the Framework is to:

a) assist the FRSC in the development of future Philippine Financial Reporting Standards (PFRSs) and in its
review of existing PFRSs;
b) assist the FRSC in promoting harmonization of regulations, accounting standards and procedures relating
to the presentation of financial statements by providing a basis for reducing the number of alternative
accounting treatments permitted by PFRSs;
c) assist preparers of financial statements in applying PFRSs and in dealing with topics that have yet to form
the subject of an International Financial Reporting Standard (IFRS);
d) assist auditors in forming an opinion as to whether financial statements conform with PFRSs;
e) assist users of financial statements in interpreting the information contained in financial statements
prepared in conformity with PFRSs; and
f) provide those who are interested in the work of FRSC with information about its approach to the
formulation of PFRSs.

The Framework serves as a guide in developing future PFRSs and as a guide to resolving accounting issues that
are not addressed directly in existing PFRSs.

In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use
its judgement in developing and applying an accounting policy that results in information that is relevant and
reliable. In making that judgement, PAS 8 requires management to consider the definitions, recognition criteria,
and measurement concepts for assets, liabilities, income, and expenses in the Framework.

This Framework is not a PFRS and hence does not define standards for any particular measurement or disclosure
issue. Nothing in this Framework overrides any specific PFRS.

The FRSC recognizes that in a limited number of cases there may be a conflict between the Framework and PFRS.
In those cases where there is a conflict, the requirements of the PFRS prevail over those of the Framework.

Chapter 1: The Objective of general-purpose financial reporting

The objective of general-purpose financial reporting is 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.
Primary Users

The primary users of general-purpose financial reporting are present and potential investors, lenders and other
creditors, who use that information to make decisions about buying, selling or holding equity or debt instruments
and providing or settling loans or other forms of credit.

The primary users need information about the resources of the entity not only to assess an entity's prospects for
future net cash inflows but also how effectively and efficiently management has discharged their responsibilities
to use the entity's existing resources (i.e., stewardship).

The Framework notes that general purpose financial reports cannot provide all the information that users may
need to make economic decisions. They will need to consider pertinent information from other sources as well.

Other users

The Framework notes that other parties (including management, members of the public, prudential and market
regulators) may find general purpose financial reports useful. However, they are not considered primary users
and general purpose financial reports are not primarily directed to them.

Information about a reporting entity's economic resources, claims, and changes in resources and
claims

Economic resources and claims

Information about the nature and amounts of a reporting entity's economic resources and claims assists users to
assess that entity's financial strengths and weaknesses; to assess liquidity and solvency, and its need and ability to
obtain financing. Information about the claims and payment requirements assists users to predict how future
cash flows will be distributed among those with a claim on the reporting entity.

A reporting entity's economic resources and claims are reported in the statement of financial position.

Changes in economic resources and claims

Changes in a reporting entity's economic resources and claims result from that entity's performance and from
other events or transactions such as issuing debt or equity instruments. Users need to be able to distinguish
between both of these changes.

Financial performance reflected by accrual accounting

Information about a reporting entity's financial performance during a period, representing changes in economic
resources and claims other than those obtained directly from investors and creditors, is useful in assessing the
entity's past and future ability to generate net cash inflows. Such information may also indicate the extent to
which general economic events have changed the entity's ability to generate future cash inflows.

The changes in an entity's economic resources and claims are presented in the statement of comprehensive
income.
Financial performance reflected by past cash flows

Information about a reporting entity's cash flows during the reporting period also assists users to assess the
entity's ability to generate future net cash inflows. This information indicates how the entity obtains and spends
cash, including information about its borrowing and repayment of debt, cash dividends to shareholders, etc.

The changes in the entity's cash flows are presented in the statement of cash flows.

Changes in economic resources and claims not resulting from financial performance

Information about changes in an entity's economic resources and claims resulting from events and transactions
other than financial performance, such as the issue of equity instruments or distributions of cash or other assets
to shareholders is necessary to complete the picture of the total change in the entity's economic resources and
claims.

The changes in an entity's economic resources and claims not resulting from financial performance is presented
in the statement of changes in equity.
Chapter 2: Qualitative characteristics of useful financial information

The qualitative characteristics of useful financial reporting identify the types of information are likely to be most
useful to users in making decisions about the reporting entity on the basis of information in its financial report.
The qualitative characteristics apply equally to financial information in general purpose financial reports as well as
to financial information provided in other ways.
Financial information is useful when it is relevant and represents faithfully what it purports to represent. The
usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable.

Fundamental qualitative characteristics

Relevance and faithful representation are the fundamental qualitative characteristics of useful financial
information. Information must be both relevant and faithfully represented if it is to be useful.
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.
The predictive value and confirmatory value of financial information are interrelated.

Materiality is an entity-specific aspect of relevance based on the nature or magnitude (or both) of the items to
which the information relates in the context of an individual entity's financial report.

Faithful representation
General purpose financial reports represent economic phenomena in words and numbers, To be useful, financial
information must not only be relevant, it must also represent faithfully the phenomena it purports to represent.
This fundamental characteristic seeks to maximize the underlying characteristics of completeness, neutrality and
freedom from error.

Enhancing qualitative characteristics

Timeliness, verifiability, understandability and comparability are qualitative characteristics that enhance the
usefulness of information that is relevant and faithfully represented.

Timeliness

Timeliness means that information is available to decision-makers in time to be capable of influencing their
decisions.

Verifiability

Verifiability helps to assure users that information represents faithfully the economic phenomena it purports to
represent. Verifiability means that different knowledgeable and independent observers could reach consensus,
although not necessarily complete agreement, that a particular depiction is a faithful representation.

Understandability

Classifying, characterizing and presenting information clearly and concisely makes it understandable. While some
phenomena are inherently complex and cannot be made easy to understand, to exclude such information would
make financial reports incomplete and potentially misleading. Financial reports are prepared for users who have a
reasonable knowledge of business and economic activities and who review and analyze the information with
diligence.

Comparability

Information about a reporting entity is more useful if it can be compared with a similar information about other
entities and with similar information about the same entity for another period or another date. Comparability
enables users to identify and understand similarities in, and differences among, items.
Applying the enhancing qualitative characteristics

Enhancing qualitative characteristics should be maximized to the extent necessary. However, enhancing
qualitative characteristics (either individually or collectively) cannot render information useful if that information
is irrelevant or not represented faithfully.

The cost constraint on useful financial reporting

Cost is a pervasive constraint on the information that can be provided by general purpose financial reporting.
Reporting such information imposes costs and those costs should be justified by the benefits of reporting that
information. The IASB assesses costs and benefits in relation to financial reporting generally, and not solely in
relation to individual reporting entities. The IASB will consider whether different sizes of entities and other factors
justify different reporting requirements in certain situations.

Chapter 3: Financial statements and the reporting entity

Financial statements

A particular form of financial reports that provide information about the reporting entity’s assets, liabilities,
equity, income and expenses.

Consolidated - provide information about assets, liabilities, equity, income and expenses of both the parent and
its subsidiaries as a single reporting entity

Unconsolidated - provide information about assets, liabilities, equity, income and expenses of the parent only

Combined - provide information about assets, liabilities, equity, income and expenses of two or more entities that
are not all linked by a parent-subsidiary relationship

Going concern assumption

The Framework states that the going concern assumption is an underlying assumption. Thus, the financial
statements presume that an entity will continue in operation indefinitely or, if that presumption is not valid,
disclosure and a different basis of reporting are required.

Reporting entity

• an entity that is required, or chooses, to prepare financial statements

• not necessarily a legal entity—could be a portion of an entity or comprise more than one entity

Boundary of a reporting entity

Determining the appropriate boundary of a reporting entity can be difficult if, for example, the entity is not a legal
entity. In such cases, the boundary is determined by considering the information needs of the users of the entity’s
financial statements. Those users need information that is relevant and that faithfully represents what it purports
to represent. A reporting entity does not comprise an arbitrary or incomplete collection of assets, liabilities,
equity, income and expenses.

Chapter 4: The elements of financial statements

Elements of financial statements are the grouping, into broad classes, of the financial effects of transactions and
other events according to economic characteristics.

Chapter 1 Element Definition or description

Economic resource 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.
Claim Liability A present obligation of the entity to transfer an
economic resource as a result of past events.
Equity The residual interest in the assets of the entity after
deducting all its liabilities.
 Changes in economic resources
and claims, reflecting financial
performance
Other changes in economic
resources and claims
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.
– Contributions from holders of equity claims, and
distributions to them.
– Exchanges of assets or liabilities that do not result in
increases or decreases in equity

Chapter 5: Recognition and derecognition

Recognition

Recognition is the process of capturing for inclusion in the statement of financial position or the statement(s) of
financial performance an item that meets the definition of an asset, a liability, equity, income or expenses.

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.

Cost constrains recognition decisions, just as it constrains other financial reporting decisions

The revised recognition criteria refer explicitly to the qualitative characteristics of useful information.

The IASB’s aim was to develop a more coherent set of concepts, not to increase or decrease the range of assets
and liabilities recognized.

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

Chapter 6: Measurement

Historical cost measurement bases

• historical cost provides information derived, at least in part, from the price of the transaction or other event
that gave rise to the item being measured
• historical cost of assets is reduced if they become impaired and historical cost of liabilities is increased if they
become onerous
• one way to apply a historical cost measurement basis to financial assets and financial liabilities is to measure
them at amortized cost

Current value measurement bases

Current value provides information updated to reflect conditions at the measurement date. Current value
measurement bases include:

• 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. It reflects market participants’ current
expectations about the amount, timing and uncertainty of future cash flows.

• Value in use (for assets)/ Fulfillment value (for liabilities) - reflects entity-specific current expectations about
the amount, timing and uncertainty of future cash flows.
• Current cost - reflects the current amount that would be paid to acquire an equivalent asset or be received to
take on an equivalent liability.

The factors to be considered when selecting a measurement basis are relevance and faithful representation,
because the aim is to provide information that is useful to investors, lenders and other creditors.

Relevance of information provided by a measurement basis is affected by:

Characteristics of the asset or liability

• the variability of cash flows

• sensitivity of the value to market factors or other risks
• for example, amortized cost cannot provide relevant information about a derivative

Contribution to future cash flows

• whether cash flows are produced directly or indirectly in combination with other economic resources
• the nature of the entity’s business activities
• for example, if assets are used in combination to produce goods or services, historical cost can provide
relevant information about margins achieved in a period

Whether a measurement basis can provide a faithful representation is affected by:

Measurement inconsistency

• if financial statements contain measurement inconsistencies (accounting mismatch), those financial

statements may not faithfully represent some aspects of the entity’s financial position and financial
performance

Measurement uncertainty

• does not necessarily prevent the use of a measurement basis that provides relevant information
• but if too high might make it necessary to consider selecting a different measurement basis

Cost constrains the selection of a measurement basis, just as it constrains other financial reporting decisions

Chapter 7: Presentation and disclosure

Better communication

Information about assets, liabilities, equity, income and expenses is communicated through presentation and
disclosure in the financial statements.

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.

The revised Conceptual Framework includes concepts that describe how information should be presented and
disclosed in financial statements.

The IASB is also working on several projects on the theme of Better Communication to make financial information
more useful to investors, lenders and other creditors and to improve the communication of that information.
The statement of profit or loss

• The statement of profit or loss is the primary source of information about an entity’s financial performance
for the reporting period
• Profit or loss could be a section of a single statement of financial performance or a separate statement
• The statement(s) of financial performance include(s) a total (subtotal) for profit or loss
• In principle, all income and expenses are classified and included in the statement of profit or loss

Other comprehensive income

• In exceptional circumstances, the IASB may decide to exclude from the statement of profit or loss income or
expenses arising from a change in current value of an asset or liability and include those income and expenses
in other comprehensive income
• The IASB may make such a decision when doing so would result in the statement of profit or loss providing
more relevant information or a more faithful representation

Recycling

• In principle, income and expenses included in other comprehensive income in one period are recycled to the
statement of profit or loss in a future period when doing so results in the statement of profit or loss providing
more relevant information or a more faithful representation
• When recycling does not result in the statement of profit or loss providing more relevant information or a
more faithful representation, the IASB may decide income and expenses included in other comprehensive
income are not to be subsequently recycled

Chapter 8: Concepts of capital and capital maintenance

Concepts of capital

A financial concept of capital is adopted by most entities in preparing their financial statements. Under a financial
concept of capital, such as invested money or invested purchasing power, capital is synonymous with the net
assets or equity of the entity. Under a physical concept of capital, such as operating capability, capital is regarded
as the productive capacity of the entity based on, for example, units of output per day.

Concepts of capital maintenance and the determination of profit

• Financial capital maintenance. Under this concept a profit is earned only if the financial (or money) amount of
the net assets at the end of the period exceeds the financial (or money) amount of net assets at the
beginning of the period, after excluding any distributions to, and contributions from, owners during the
period. Financial capital maintenance can be measured in either nominal monetary units or units of constant
purchasing power.

• Physical capital maintenance. Under this concept a profit is earned only if the physical productive capacity (or
operating capability) of the entity (or the resources or funds needed to achieve that capacity) at the end of
the period exceeds the physical productive capacity at the beginning of the period, after excluding any
distributions to, and contributions from, owners during the period.