ACCOUNTING 3

UNIT 2: CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

CHAPTER TITLE

Chapter 1 The objective of financial reporting

Chapter 2 Qualitative characteristics of useful financial information

Chapter 3 Financial statements and the reporting entity

Chapter 4 The elements of financial statements

Chapter 5 Recognition and derecognition

Chapter 6 Measurement

Chapter 7 Presentation and disclosure

Chapter 8 Concepts of capital and capital maintenance (N/A to Accounting 3 syllabus)

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 Chapter 1: The objective of financial reporting

OBJECTIVE OF FINANCIAL REPORTING

To provide financial information that is useful to users in making decisions relating to

providing resources to the entity.

Information is considered useful when it is about:

(1) The entity’s economic resources, claims against the entity and changes in those resources and claims
(2) How efficiently and effectively management has discharged its responsibilities
to use the entity’s economic resources

Decisions made by users may involve:

a) Buying, selling, holding equity and debt instruments,
b) Providing or settling loans and other forms of credit; or
c) Exercising rights to vote on, or otherwise influence management’s actions that affect the use of the entity’s
economic resources

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In summary, users have expectations about returns from an entity and these expectations depend on
the users assessment of the information that is considered useful (slide 4).

A user would assess the

Future Cash flows
the amount, timing and uncertainty of (the prospects for) future net cash inflows to the entity

However, to make these assessments users need information about:

1. Economic resources, claims against and changes in those resources and claims; and
2. How efficiently and effectively management has discharged its responsibilities
to use the entity’s economic resources (Management’s stewardship of the entity’s economic resources)

CLARIFICATION OF TERMS

1) Stewardship refers to managements’ ability to

• effectively and efficiently perform or execute its responsibilities in using the entity’s
resources;
• predict the future;
• protect against unfavorable effects of economic factors;
• comply with laws, regulations and contractual provisions
2) Users of financial reports
• are an entity’s existing and potential investors, lenders and other creditors;
• rely on general purpose financial reports for much of the financial information they
need;
• are the primary users to whom general purpose financial reports are directed.

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 Chapter 2: Qualitative characteristics of useful financial information

QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION

Fundamental Characteristics
Relevance Faithful representation
Enhancing qualitative characteristics
Comparability Verifiability Timeliness Understandability
Cost constraint
The benefit needs to justify the cost
The benefit received from useful information needs to justify the cost involved in supplying the information

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 Chapter 3: Financial statements and the reporting entity

FINANCIAL STATEMENTS AND THE REPORTING ENTITY

Objective and scope of financial statements
• provide information about the reporting entity’s assets, liabilities, equity, income and
expenses to meet objective of financial reporting (slide 4)

Reporting period
FS are prepared for a specified period of time and provide:
• information about POSITION (assets and liabilities) and PERFORMANCE (income and
expenses)
• comparative information to assess trends (by users)
• forward looking information related to assets, liabilities and equity existing at the
end of the reporting period that is useful (i.e. possible future events)
• information about transactions and events after the year-end
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Perspective
• entity as a whole

Going concern assumption

• entity is a going concern and will continue to operate in the future

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

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Types of financial statements

Consolidated Financial Unconsolidated Combined Financial

Statements
Provide information about
assets, liabilities, equity,
income and expenses of
both the parent and its
subsidiaries as a single
reporting entity
Financial Statements
Provide information about
assets, liabilities, equity,
income and expenses of
the parent only
Statements
Provide information about
assets, liabilities, equity,
income and expenses of
two or more entities that
are not all linked by a
parent-subsidiary
relationship
(not Accounting 3 syllabus)

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 Chapter 4: The elements of financial statements

THE ELEMENTS OF FINANCIAL STATEMENTS

Nature Elements
Financial position Assets
Liabilities
Equity
Financial performance Income
Expenses

Refer to Table 4.1 pgA26 of the Conceptual Framework

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Definition of an asset

Asset A present economic resource (3) controlled by the entity as

a result of past events
Economic An economic resource is a (1) right that has the
resource (2) potential to produce economic benefits

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Three requirements for the definition of an asset

• established from contracts, legislation or similar means

Right
• existence of uncertainty must be resolved

• one circumstance that will produce economic benefits

Potential • might be a low probability (par 4.14)

• links economic resource to the entity

• present ability to:
(1) direct the usage: deploy in its activities or allow others
Control (2) obtain the economic benefits: directly or indirectly
• indication of control: exposure to significant variations in
the amount of economic benefits

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Definition of a liability
Liability A present (1) obligation of the entity to (2) transfer an
economic resource as a result of (3) past events
Obligation A duty or responsibility that the entity has no practical
ability to avoid

For a liability to exist, 3 requirements must all be satisfied, these follow in the next slides.

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Requirement ONE: entity has an OBLIGATION

Definition:
(1) duty or responsibility that the entity has (2) no practical ability to avoid
Nature:
• Owed to another party
• Other party has a right
• Right and obligation not recognised and measured the same
How established
• Contract, Legislation or similar means and are Legally enforceable (legal)
• Customary practices, published policies or specific statements (constructive)
If the entity has no practical ability to act in a manner inconsistent with those practices,
policies or statements
• Conditional on the future actions of the entity itself (e.g. operating in a particular
market in the future)
Obligation if the entity has no practical ability to avoid taking the actions
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Requirement TWO: TRANSFER of an economic resource

• the obligation, must have the potential to require the entity to transfer an economic
resource to another party (parties)
• that potential does not need to be certain nor likely (= low probability) for the
economic resource to be transferred
• only necessary that the obligation exists and only in one circumstance that
obligation will result in the transfer
• the obligation exists until settled, transferred or replaced

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Requirement THREE: PAST EVENT

Two separate indicators

• Obtaining the economic benefits
• Taken action that creates the obligation

Past
event

Consequential test
• An entity will or may have to transfer
an economic resource that it would
not otherwise had to transfer

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Requirement THREE: PAST EVENT

Clarify that past event:

• Could be over time
• Could only be enforceable in the future
• Must be linked to executory contracts (e.g. employment contract)

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Other definitions = just as important

Equity = The residual interest in the assets of the entity after

unchanged deducting all its liabilities

Income = Increases in assets, or decreases in liabilities, that result in

updated 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

updated decreases in equity, other than those relating to
distributions to holders of equity claims

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 Chapter 5: Recognition and derecognition

Definition of recognition

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.

Basic principle
• Meeting the definition of an asset, liability or equity

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Recognition criteria

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

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Derecognition

Definition
The removal of all or part of a recognised asset or liability from an
entity’s statement of financial position

Aim to faithfully represent (plus disclosure):

• any assets and liabilities retained
• the change in the entity’s assets and liabilities
Normal principles
• Asset: when the entity loses control of all or part
• Liability: when the entity no longer has a present obligation for all or part

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 Chapter 6: Measurement

Measurement basis
Assets Liabilities
(1) Historical cost = transaction based (1) Historical cost = transaction based
Current value = updated value
(2) Fair value = market based (2) Fair value = market based
(3) Value-in-use = entity specific (3) Fulfilment value = entity specific
(4) Current cost = replacement value (4) Current cost = received to take on equivalent
liability

Fulfilment value:
• Reflects entity-specific current expectations about the amount,
timing and uncertainty of future cash flows to fulfil a liability.

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Selecting a measurement basis is based on factors

Main factors
• Relevance
• Faithful representation
Additional factors Importance of factors are
• Enhancing qualitative characteristics based on facts and
circumstances
• Cost constraint
Other
• Effect on statement of financial position and performance = more than one
measurement basis
• Initial recognition
• Measurement of equity (total vs components)
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Consideration of relevance

(1) Characteristics of the asset or liability

• Variability of cash flows
• Sensitivity of the value to market factors or other
risks

Relevance

(2) 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

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Consideration of faithful representation

(1) 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.
Faithful
representation

(2) Measurement uncertainty

• Associated with a measurement basis may affect
• If measurement uncertainty is too high might consider
selecting a different measurement basis

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Chapter 7: Presentation and Disclosure

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Nature of chapter
• Includes concepts on presentation and disclosure
• Guidance on including income and expenses in profit or loss and other
comprehensive income.
Better communication of objective of elements
• Through presentation and disclosure
• Effective communication makes information more relevant and contributes to
faithful representation
• Concepts and other projects

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Guidance on profit and loss and OCI

Statement of • Primary source of information about an entity’s financial
profit or loss performance for the reporting period
• Single statement of financial performance or a separate
statement
• Statement(s) of financial performance include(s) a total (subtotal)
for profit or loss
• In principle, all income and expenses included in the statement of
profit or loss
OCI • In exceptional circumstances, the Board may decide to include in
OCI
• Income or expenses arising from a change in current value of an
asset or
• When doing so would result in the statement of profit or loss
providing more relevant information or a more faithful
representation 34

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Thank you

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