Conceptual Framework 2

03/07/2023
“
Conceptual Framework
for Financial Reporting
Conceptual Framework & Acctg. Standards
Conceptual Framework 2
for Financial Reporting
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 the 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.
Status of the Conceptual Framework 4
 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.
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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
Objective of general purpose financial 6

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.
Qualitative Characteristics 8
I. Fundamental qualitative characteristics

(1) Relevance
(a) Predictive value
(b) Feedback value
 Materiality – entity-specific aspect of relevance
(2) Faithful representation
(a) Completeness
(b) Neutrality
(c) Free from error
II. Enhancing qualitative characteristics

(1) Comparability
(2) Verifiability
(3) Timeliness
(4) Understandability
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Fundamental vs. Enhancing
 The fundamental qualitative characteristics are the

characteristics that make information useful to users.
 The enhancing qualitative characteristics are the
characteristics that enhance the usefulness of
information
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Relevance
 Information is relevant if it can affect the decisions of

users.
 Relevant information has the following:
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
 Faithful representation means the information provides

a true, correct and complete depiction of what it
purports to represent.
 Faithfully represented information has the following:
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.
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Financial statements and the 13

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.

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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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.
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Elements of Financial Statements
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Asset
 Asset is “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)
Three aspects in the definition of an 18

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.
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Liability
 Liability is “a present obligation of the

entity to transfer an economic
resource as a result of past events.”
(Conceptual Framework 4.26)
Three aspects in the definition of a 20

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.
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Three aspects …… liability (continuation)
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; and
b. as a consequence, the entity will or may have to transfer
an economic resource that it would not otherwise have
had to transfer.
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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.
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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.”
 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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Recognition & Derecognition
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.
26
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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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.
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.
28
Faithful representation
 The level of measurement uncertainty and other factors can affect an
item’s faithful representation, but not necessarily its relevance.
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.
30
Unit of account
 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.”
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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.
 Historical cost is updated over time to depict the
following:
 Depreciation, amortization, or impairment of assets
 Collections or payments that extinguish part or all of
the asset or liability
 Unwinding of discount or premium when the asset
or liability is measured at amortized cost
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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)
34
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)
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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.”
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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), whereas 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).
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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.
40
Presentation and disclosure objectives 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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Classification
 Classifying means combining similar items and separating

dissimilar items.
 Offsetting of assets and liabilities is generally not appropriate.
Classification of income and expenses

 Income and expenses are classified as recognized either in:
a. profit or loss; or
b. other comprehensive income.
42
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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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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APPLICATION OF
CONCEPTS
PROBLEM 6: FOR CLASSROOM DISCUSSION
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 QUESTIONS????
 REACTIONS!!!!!
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END
23

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03/07/2023

Conceptual Framework & Acctg. Standards

Conceptual Framework & Acctg. Standards

 The Conceptual Framework prescribes the

Conceptual Framework & Acctg. Standards

Status of the Conceptual Framework 4

 The Conceptual Framework is not a PFRS. When there is

Conceptual Framework & Acctg. Standards

The Conceptual Framework is concerned with general purpose financial

Conceptual Framework & Acctg. Standards

Objective of general purpose financial 6

 The objective of general purpose financial reporting is to

Conceptual Framework & Acctg. Standards

 Primary users – are those who cannot demand

 Only the common needs of primary users are met by

Conceptual Framework & Acctg. Standards

I. Fundamental qualitative characteristics

II. Enhancing qualitative characteristics

Conceptual Framework & Acctg. Standards

 The fundamental qualitative characteristics are the

Conceptual Framework & Acctg. Standards

 Information is relevant if it can affect the decisions of

 Materiality – is an ‘entity-specific’ aspect of relevance.

Conceptual Framework & Acctg. Standards

 Faithful representation means the information provides

Conceptual Framework & Acctg. Standards

1. Comparability – the information helps users in

Conceptual Framework & Acctg. Standards

Financial statements and the 13

Objective and scope of financial statements

Conceptual Framework & Acctg. Standards

Financial statements and the 14

Conceptual Framework & Acctg. Standards

Financial statements and the 15

Conceptual Framework & Acctg. Standards

Conceptual Framework & Acctg. Standards

 Asset is “a present economic resource

Conceptual Framework & Acctg. Standards

Three aspects in the definition of an 18

1. Right – asset refers to a right, and not necessarily to a

Conceptual Framework & Acctg. Standards

 Liability is “a present obligation of the

Conceptual Framework & Acctg. Standards

Three aspects in the definition of a 20

1. Obligation – An obligation is “a duty or responsibility that an entity

Conceptual Framework & Acctg. Standards

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

Conceptual Framework & Acctg. Standards

 An executory contract “is a contract that is equally

Conceptual Framework & Acctg. Standards

 “Equity is the residual interest in the assets of the

 Equity equals Assets minus Liabilities

Conceptual Framework & Acctg. Standards

Conceptual Framework & Acctg. Standards

The recognition process

Conceptual Framework & Acctg. Standards

Conceptual Framework & Acctg. Standards

However, the presence of one or both of the

Conceptual Framework & Acctg. Standards

Conceptual Framework & Acctg. Standards

Conceptual Framework & Acctg. Standards

 Unit of account is “the right or the group of rights,

Conceptual Framework & Acctg. Standards