CONCEPTUAL FRAMEWORK OF ACCOUNTING

1. INTRODUCTION

The Conceptual Framework:

 Is aimed at the preparation of general-purpose financial reports.

 Has a specific objective in rendering support to standard setters, auditors, preparers and
users of financial statements.

 Identifies the underlying assumption in the preparation of financial statements:

o Going concern
 The going concern assumption implies that it is assumed that at all times
that the entity will exist in the foreseeable future.
o Accrual basis
 All transactions are recorded when they occur and not when cash is
received or paid.

 Identifies the following fundamental qualitative characteristics of financial statements:

o Relevance
 Information is relevant if it could influence the decisions that users make.
o Faithful representation
 For information to be a faithful representation, the information needs to
be complete, neutral and free from error.

 Identifies the following four (4) enhancing qualitative characteristics of financial

statements:
o Comparability
 Comparability enable users to identify and understand similarities and
differences among items.
o Verifiability
 Verifiability helps assure users that the information has been
independently assessed by knowledge observers and found to be
faithfully represented. Verifiability gives users a measure of confidence in
the information provided.
o Timeliness
 Timeliness means that information is available to decision-makers in time
to be capable of influencing their decisions.
o Understandability
 Understandable information is classified, characterised and presented
clearly and concisely.

 Discusses the definitions of the following elements of financial statements:

o Assets
o Liabilities
o Equity
o Income, and
o Expenses
  Distinguish between the measurement bases available for elements of financial
statements

2. COMPONENTS OF FINANCIAL STATEMENTS

 Statement of financial position (balance sheet)

o Portrays the economic resources of an entity
o The claims against the resources, and
o The impact of transactions and events on the resources, and
o The liquidity and solvency of the entity.
o Information is useful in predicting future cash flows and the ability of the entity
to raise finance and meet commitments.

 Statement of profit or loss and other comprehensive income (Income statement)

o Provides information on the financial performance during a specified period.
o Historic information is used to predict future performance and the ability to
generate cash flow.

 Statement of cash flow

o Provides information on the changes in financial position in order to assess the
entity’s investing, financing and operating activities, and
o The way the entity acquires and distributes cash and cash equivalents

 Statement of changes in equity

o Information on the changes in the structure of the entity’s equity,
o Capital transactions,
o Dividends paid and
o Other distributions made to the owners.

 Notes and supplementary schedules

o Necessary for a better understanding of the financial statements
o Accounting policies applied
o Risks and uncertainties affecting the entity
o Resources and obligations not recognised in the financial statements

3. QUALITATIVE CHARACTERISTICS OF FINANCIAL INFORMATION

 Fundamental qualitative characteristics

o Relevance
 Predictive value or confirmatory value
 Nature and Materiality
o Faithful representation
 Completeness
 Neutrality: free from bias
 Free from error
  Enhancing qualitative characteristics
o Comparability
 Comparability enable users to identify and understand similarities and
differences among items.
o Verifiability
 Verifiability helps assure users that the information has been
independently assessed by knowledge observers and found to be
faithfully represented. Verifiability gives users a measure of confidence in
the information provided.
o Timeliness
 Timeliness means that information is available to decision-makers in time
to be capable of influencing their decisions.
o Understandability
 Understandable information is classified, characterised and presented
clearly and concisely.

4. UNDERLYING ASSUMPTIONS

4.1 GOING CONCERN

 The assumption that the entity will continue to operate in the foreseeable future.
 Should this assumption not be valid, elements of the financial statements should be
measured at liquidation values and
 Provision for liquidation costs should be made.

4.2 ACCRUAL CONCEPT

 All transactions are recorded when they occur and not when cash is received or paid.
 The expected future movement of cash is therefore shown in the financial statements.

5. ELEMENTS OF FINANCIAL STATEMENTS

5.1 ASSETS
 Definition: An asset
o Is a present economic resource
- An economic resource is a right,
- That has the potential to produce economic benefits.
o Controlled by the entity
o As a result of past events.

 What is meant by a “RIGHT”

o Rights to receive cash
o Rights to receive goods or services
o Rights to benefit from an obligation of another party to transfer an economic
resource if an uncertain specified future event occurs.
o Rights over physical objects, such as property, plant, equipment or
inventories
o Rights to use intellectual property
  What is meant by “potential to produce economic benefits”
o Potential does NOT mean it is certain, or likely that the right will produce
economic benefits
o The right must just exist and in one circumstance produce the entity economic
benefits beyond those available to any other party.

 What is meant by “Control”

o Control links an economic resource to an entity
o The entity has the ability to direct the use of the economic resource and
obtain the economic benefits that flow from it
o The entity has the ability to enforce legal rights over the resource
o The entity will either directly or indirectly receive the economic benefits
arising from the use of the resource

5.2 LIABILITIES
 Definition: a Liability
o Is a present obligation of the entity
- A present obligation is a duty or responsibility that an entity has no practical
ability to avoid.
o To transfer an economic resource
o As a result of past events

 What is meant by “obligation”

o Is a duty or responsibility that the entity has no practical ability to avoid
o Many obligations are being established by contract or legislation and is legally
enforceable by the parties to whom they are owed
o In order to transfer the obligation, there must only be a probability that the
economic resource will be transferred
o Obligations to transfer an economic resource may include
 Obligations to pay cash
 Obligations to provide goods or services
 Obligations to transfer an economic resource if a specified uncertain
future event occurs

5.3 EQUITY
 Definition:
o The residual interest in the assets of an entity after deducting all its liabilities;
i.e.
o E = A - L
 Equity is thus dependant on the amount of assets and liabilities and not on the
market value of the entity’s shares
 Subdivided in:
o Contributions by owners (share capital)
o Retained earnings and reserves
 5.4 INCOME
 Definition:
o Increases in assets, or decreases in liabilities
o That result in increases in equity,
o Other than those relating to contributions from holders of equity claims.
 Divided into revenue (arising from normal business activities) and gains (meet the
requirements of the definition of income and may, or may not, arise in the course of
ordinary activities of an entity.

5.5 EXPENSES
.
 Definition:
o Decreases in assets, or increases in liabilities;
o That result in decreases in equity,
o Other than those relating to distributions to holders of equity claims.
 Include losses, as well as those expenses arising in the course of the ordinary activities
of the entity.

THUS: Income and expenses represent

 Changes in economic resources and claims,

 Reflecting financial performance.

5.6 CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE

 Financial concept of capital:

o Capital is equal to the net assets or equity of an entity
 Physical concept of capital
o Capital is equal to the production capacity of an entity

5.7 SUBSTANCE OF CONTRACTUAL RIGHTS AND OBLIGATIONS

 The terms of the contract dictate rights and obligations for an entity that is party to
the contract
 To represent those rights and obligations faithfully, financial statements report their
substance and not necessarily their legal form.

6. RECOGNITION AND DEREGONITION OF FINANCIAL ELEMENTS

 RECOGNITION is the process of capturing for inclusion in the statement of financial
position OR the statement of financial performance an item THAT MEETS THE
DEFINITION OF ONE OF THE ELEMENTS of financial statements (assets, liabilities,
income or expenses).
 Recognition links the elements, the statement of financial position and statement of
financial performance as follows:
o In the statement of financial position total assets less total liabilities equal
equity
o Recognised changes in equity comprise of:
 Income less expenses in the statement of financial performance, and
  Contributions from holders of equity claims less distributions to
holders of equity claims
o The recognition of income occurs at the same time as:
 the original recognition of an asset, or
 the de-recognition of a liability.
o The recognition of expenses occurs at the same time as:
 the initial recognition of a liability, or
 the de-recognition of an asset.

 Other important factors to take into consideration when an element is

recognised:
o Relevance
 Information on assets, liabilities , income and expenditure items must
ALWAYS be relevant to the user of the financial information
 It is doubtful if
 It is uncertain whether the asset or liability exists; or
 The assets or liability exists , but the probability of future
inflows or outflows are low
 Even if uncertainty and probability of inflow are low, full disclosure
should be given in the notes to the financial statements.
o Faithful representation
 Faithful representation might be affected by the level of
measurement uncertainty
 However, reasonable estimates, which are clearly and
accurately described, are an essential part of the preparation
of financial information

 Other important factors to take into consideration when an element is de-

recognised:
o De-recognition is the removal of all, or part of, a recognised asset or liability
o De-recognition normally occurs when that item no longer meets the definition
of an asset or liability:
 For an asset: usually when the entity loses control over all or part of
the recognised asset;
 For a liability: the entity no longer has a present obligation for all or
part of the recognised liability
o Accounting requirements for de-recognition aim to faithfully represent both:
 De-recognition of all assets or liabilities which were consumed,
collected, fulfilled or transferred, leading to resulting income or
expenses
 Continuing to recognise the assets and liabilities retained
7. THE MEASUREMENT OF ELEMENTS

The following measurement bases are generally acceptable in terms of the Conceptual
Framework:
 Historical cost
 Current value
o Fair value
o Value in use and fulfilment value
o Current cost

7.1 Historical cost

 Assets, liabilities income or expenses are recorded by using the price of the
transaction or event which gave rise to them.
 No changes in values are taken into consideration (except impairment on assets, or
if a liability becoming onerous)
 The value of an asset equals the original amount paid for the asset plus any
transaction costs incurred.
 The value of a liability equals the value of the consideration received less any
transaction costs incurred

7.2 Current value

 Current value measures provide monetary information on assets, liabilities and
relating income and expenses, using updated information to reflect conditions at the
measurement date

7.2.1 Fair value

o 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

7.2.2 Value in use and fulfilment value

o 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.
o 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.

7.2.3 Current cost

o Current cost is the cost of an equivalent asset at the measurement date,
comprising the consideration that will be paid less any transaction costs that
will be incurred at that date.