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GODFREY
HODGSON
HOLMES
TARCA

CHAPTER 4
A CONCEPTUAL
FRAMEWORK

INTRODUCTION
1.What is conceptual framework of Financial
Accounting?
2.Why do we need Conceptual Framework?
3.How is Conceptual Framework formulated?
4.What are the contents of the Conceptual
Framework?
5.Does Conceptual Framework solve all
accounting problems?
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INTRODUCTION
• An auditor is performing substantive test and finding that
certain transactions have been practiced by his client but have
not been regulated by any accounting standards. What
opinion will be released by the auditor?
• A Company issued Rp 10 million to repair its truck. How will
the expenditure be accounted for? (Expense or capitalized?)
• On September 2023, A company is facing litigation (Rp 10
billion) in the Court as it polluted a river. But, the court
decision will be made on April 2024. What should accountant
do for the litigation as 31 December 2023 the company
prepares financial statement?
• Why should a company report Bad Debt Allowance?
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What is Conceptual
Framework?
… a coherent system of The objectives:
interrelated objectives and the goals of
fundamentals that is financial reporting
expected to lead to
consistent standards and
The fundamentals:
that prescribes the nature, the underlying
function and limits of concepts required
financial accounting and to help achieve
those objectives
reporting. (FASB)
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What is Conceptual
Framework?
• Those concepts (fundamental)  guidance in
selecting transactions, events and circumstances to
be accounted for,
– how they should be recognized and measured
– how they should be summarized and reported

What is Conceptual
… a coherent system of interrelated objectives and fundamentals
that is expected to lead to consistent standards and that prescribes
Framework?
the nature, function and limits of financial accounting and reporting.
( FASB)

• How does CF relate to accounting theory

formulation?
 The words “Coherent system” and “consistent”
mean  FASB advocates A theoretical and non-
arbitrary framework  systematic & structured
approach
 The words “prescribes” supports a normative
approach (normative theory)  what “should be”
• Thus  CF is seen as a structured theory of
accounting 3
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Why we need CF?

• Lesson from US accounting history (1970) before CF
established:
– Accounting standards were set by inductive approaches 
A lot of accounting choices by many accounting authorities
(US IRS, SEC)
– Accounting practices were permissive and flexible
– Inconsistent practices creates problems (confusing users)
• Accounting standards were determined based on
bargaining powers among interested parties
(perceived as political interest)

The Benefits of a conceptual

framework
• Solomon (1980) sees the conceptual framework as a
defence against political interference in the
neutrality of accounting reports
• Benefits of CF:
Offer consistent & logical reporting requirements
Create greater compliance
enhance accountability
Lead to fewer specific standards
Enhance understanding of reporting requirements
Lead to more economical standard setting
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How is CF formulated?
1. Set the Objectives of
Financial Reporting
2. Set the qualitative QUESTION:
characteristics of information Inductive OR
Deductive
3. Determine the elements of Approach of
financial statement accounting
formulation?
4. Set the recognition and
measurement of FS elements

Components of CF
• US CF: “Statement of Financial Accounting
Concepts (SFAC)
a. SFAC No.1: Objectives of Financial Reporting by Business
Enterprises, November 1978
b. SFAC No.2: Qualitative Characteristics of Accounting
Information, May 1980
c. SFAC No.3: Elements of Financial Statements of Business
Enterprises, December 1980
d. SFAC No.4: Objectives of Financial Reporting by
Nonbusiness organizations, December 1980
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Components of CF
e. SFAC No.5: Recognition and Measurement in Financial
Statement of Business Enterprises, December 1984
f. SFAC No.6: Elements of Financial Statements: A
Replecement of FASB Concepts Statement No. 3,
December 1985
g. SFAC No.7: Using Cash Flow Information and Present
Value in Accounting Measurements, February 2000
h. SFAC No. 8: Conceptual Framework for Financial
Reporting ( a replacement of FASB Concepts Statements
No. 1 and No. 2), September 2010

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Objectives of Conceptual
Framework
• The purpose of the concept statements is "to
set forth objectives and fundamental
concepts that will be the basis for:
– development of financial accounting and
– reporting guidance" (SFAC 8)

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The Objectives of FINANCIAL

REPORTING
• Financial reporting  provide useful information to
present and potential investors and creditors and
other users in making rational investment, credit
and similar decisions
• Information should:
– useful in making economic decisions
– useful in assessing cash flow prospects
– depict enterprise resources, claims to those resources and
changes in them
FASB

Financial Reporting ≠ Financial Statements 7

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Financial Statement vs Financial

Reporting
Financial Statements Financial Reporting
• Statement of financial • Reporting is to provide all
position relevant information for
• Statement of decision making
comprehensive income • 5 Financial statement, PLUS
• Statement of changes  Other media of
in equity reporting:
• Statement of cash – Sustainability reporting
flows – CSR Disclosure
– Corporate Governance
• Notes to FS Disclosure, etc
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Financial Statements
Financial Reporting 8
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the qualitative characteristics of

information
• The qualitative characteristics establish
criteria for selecting and evaluating
accounting alternatives which will meet the
objectives.
– What quality of information should be provided
by financial reporting?
– How is information perceived as useful?
• Described as Hierarchy of Qualitative
Characteristics

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The qualitative characteristics of

information

US Old Version
SFAC #2

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The qualitative characteristics of

information
US NEW Version
SFAC #8

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OLD VERSION (SFAC 2) NEW VERSION (SFAC 8)

PRIMARY QUALITY: FUNDAMENTAL QUALITY:
A. RELEVANCE: A. RELEVANCE:
• Predictive Value • Predictive Value
• Feedback Value • Confirmatory Value
• Timeliness
B. RELIABILITY: B. FAITHFUL REPRESENTATION:
• Verifiability • Completeness
• Representational • Neutrality
Faithfulness • Free from material errors
• Neutrality
SECONDARY QUALITY: ENHANCING QUALITY:
A. Comparability • Comparability and Consistency
B. Consistency • Verifiability
• Timeliness
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• Understandability 20
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ELEMENT OF FINANCIAL
STATEMENT
• FASB: • IASB:
– Assets – Assets
– Liabilities – Liabilities
– Equity – Equity
– Revenues – Income (Revenue &
– Expenses gains)
– Gains – Expenses
– Losses
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ELEMENT OF FINANCIAL
STATEMENT
FASB VERSION IASB VERSION

ASSETS: probable future economic benefits ASSETS: A present economic resource

obtained or controlled by a particular controlled by the entity as a result of past
entity as a result of past transactions. or events.
events An economic resource is a right that has the
potential to produce economic benefits
LIABILITIES: Probable future sacrifices of LIABILITIES: A present obligation of the entity
economic benefits arising from present to transfer an economic resource as a result
obligations of a particular entity to transfer of past events
assets or provide services to other entities
in the future as a result of past transactions An obligation is a duty or responsibility that
or events the entity has no practical ability to avoid
EQUITY (net assets): the residual interest in EQUITY: the residual interest in the assets of
the assets of an entity that remains after the entity after deducting all its liabilities
deducting its liabilities
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ELEMENT OF FINANCIAL
STATEMENT
FASB VERSION
COMPREHENSIVE INCOME: the change in
equity [net assets] of a business enterprise
during a period from transactions and other
events and circumstances from non-owner
sources.
REVENUES: inflows or other enhancements
of assets of an entity or settlements of its
liabilities (or a combination of both) from
delivering or producing goods, rendering
services, or other activities that constitute
the entity’s ongoing major or central
operations.
IASB VERSION
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
REVENUE: the gross inflow of economic
benefits (cash, receivables, other assets)
arising from the ordinary operating
activities of an entity (such as sales of
goods, sales of services, interest, royalties,
and dividends). [IAS 18.7]

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ELEMENT OF FINANCIAL
STATEMENT
FASB VERSION IASB VERSION
EXPENSES: outflows or other using up of assets or EXPENSE: Decreases in assets, or
incurrences of liabilities (or a combination of both) increases in liabilities, that result
from delivering or producing goods, rendering in decreases in equity, other
services, or carrying out other activities that than those relating to
constitute the entity’s ongoing major or central distributions to holders of equity
operations. claims
GAINS: increases in equity (net assets) from No specific definition
peripheral or incidental transactions of an entity and The definition of income
from all other transactions and other events and encompasses both revenue
circumstances affecting the entity except those that and gains
result from revenues or investments by owners.
LOSSES: decreases in equity (net assets) from No specific definition
peripheral or incidental transactions of an entity and
from all other transactions and other events and
circumstances affecting the entity except those that
result from expenses or distributions to owners. 12
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Recognition and Derecognition

Recognition = Process of capturing
for inclusion in financial statements
an item that meets the definition of
asset, liability, equity, revenue, Recognition
criteria
expense, income, gains, losses (How
we record transactions in a ledger)

RELEVANCE – the
FAITHFUL REPRESENTATION
Meet inclusion of the items
– the inclusion of the items
provide relevant
Definition of information for
faithfully represent what is
being reported
decision making

asset, liability,
equity, revenue,
Measurable
expense, income,
gains, losses

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Recognition and Derecognition

DERECOGNITION = The removal of all or part of ecognised assets or

liability from financial statement position

Purpose to faithfully represents:

- Any assets/liabilities retained after the transaction that led to the
derecognition
- The change in entity’s assets/liabilities as a result of that transaction

Derecognition of assets – when the entity loses control of all or

part of the recognized assets

Derecognition of liability – when the entity no longer has a present

obligation for all or part of the recognized liability

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Measurement: the assignment of numbers to the

Measurement attributes or properties of objects being measured

(assets, liabilities, revenue/income on the date of
transaction.

Measurement

information derived from

price of transaction Information updated
(buyer & seller) or other Historical Cost Current Cost to reflect condition at
event that gave rise to Measurement Measurement the measurement
the item being measured date

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 Fair Value Current Cost
measurement date (estimated value)

current amout that would be: 1) paid to

acquire an equivalent assets, 2) received to
take on an equivalent liability 27

BASIC ASSUMPTION

• Basic Assumption (Accounting Postulates) =

self-evident statements/assumptions
underlying accounting practice:
– Economic Entity
– Going Concern
– Monetary Unit
– Periodicity
– Accrual
– Economic Substance over Legal form 14
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BASIC ASSUMPTION
• Economics Entity:
– Entity is assumed to
represent and operate for Investor
itself separated from other
Kreditor Government
parties
– Focus of financial accounting
 the economic activities of
ENTITY
individual business
Represented by
enterprises. Management
– Owners and other parties
(creditors, government etc)
are seen as external parties 29

BASIC ASSUMPTION
• Going Concern Postulate:
– An accounting entity is viewed as continuing in
operation for the foreseeable future in the
absence of evidence to the contrary.
– Financial accounting is formulated assuming that
the business will continue to operate for an
indefinitely long period in the future.

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BASIC ASSUMPTION
• Monetary Unit:
– All transactions should be
measured in a uniform
manner (by monetary unit) Is it possible to
– Money (ex: ID Rupiah) is account 1 kg rice
the common denominator and 1 liter cooking
for goods and services oil without
monetary unit?
– Purchasing power is
assumed stable (no
inflation)
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BASIC ASSUMPTION

• Periodicity Postulate:
– As entity is assumed going concern,
the life cycle of entity can be
presumably divided into periods
– The specified time periods are
shorter than the real life of the Y1 Y1 Yn

enterprise
– The time periods are usually twelve
months
– Time periods facilitate comparisons
of financial statements
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BASIC ASSUMPTION
• Accrual Accounting:
– the effects of
transactions and other
events are recognized
when they occur (and
not as cash is received
or paid)
– all transactions/events
are recorded and
reported in the financial
statements of the
periods to which they
relate
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BASIC ASSUMPTION

• Economic Substance Over Legal Form

– Accounting focus on economic
substance of transactions rather than
legal form
– MARVEL Company buys a luxury car.
This car is then leased by TRON
company based on financial/capital
lease contract (not operating lease).
– Who should recognize the car as an
asset on financial statement? 17
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BASIC ASSUMPTION
• Financial lease contract assumes:
– risk transfer from the lessor to the lessee
– the lessee has buy option at the end of contract
• LEGAL FORM:
– Who hold legal ownership of the car?
– Answer: MARVEL
• ECONOMIC SUBSTANCE:
– Who enjoy the economic benefits of the car?
– Who control the use of the car?
– Who hold risk of the car use?
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BASIC ASSUMPTION
• Thus:
– The Car  recognized as asset of TRON FS
– MARVEL should derecognize the car from FS

Recognized as
TRON asset

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ACCOUNTING PRINCIPLES

 Accounting principles  the common rules

that should be followed when preparing
financial statements :
 The Historical Cost Principle
 The Revenue Principle
 The Matching Principle
 The Full Disclosure Principles
 Will be discussed in the next sessions

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DOES CF SOLVE ALL

ACCOUNTING PROBLEMS?
• Answer: NO
– CF is not a comprehensive accounting theory
– CF is only a policy document
– CF just prescribe guidance
– IN FACT: accounting practices still permit the use
of contradictory accounting standards (Full Cost
method vs Successful Effort Method in oil and gas
industry)

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THE END

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