The Conceptual Framework for

Financial Reporting
Nkuhlu Department of Accounting
 Learning outcomes
On completion of this unit students should be able to:
 Identify and discuss the following:
 the purpose and status of the framework for the preparation and
presentation of financial statements
 the users of financial statements and their information needs
 the objectives of financial statements
 the elements of financial statements (particularly the definitions)
 the recognition criteria
 the measurement of the elements of financial statements
 capital and capital maintenance
 Apply the principles set out in the framework in the application of
all statements of IFRS

2
REFERENCE MATERIAL

International Financial Reporting Standard:

The Conceptual Framework for Financial
Reporting

Gripping GAAP – 2022/2023 edition

Chapter 2

3
Conceptual framework

What is Conceptual Framework?

Foundation on which all IFRSs are
built.

What is it not?
Standard, nor
An interpretation
Conceptual framework consists of:

 Status and Purpose of the Conceptual Framework

 Chapter 1 – Objective of general purpose financial reporting
 Chapter 2 – Qualitative characteristics of useful financial
information
 Chapter 3 – Financial statements and the reporting entity
 Chapter 4 – Elements of financial statements
 Chapter 5 – Recognition and derecognition
 Chapter 6 – Measurement
 Chapter 7 – Presentation and disclosure
 Chapter 8 – Capital and capital maintenance
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 relating to providing resources to the entity.
• Primary users
 Investors
 Lenders
 Creditors

Limitations:
 Provides financial information only
 Not designed for all users
 Not designed for all decisions
 Provides historical information
 Financial information

 Economic resources and claims of the entity.

 Changes in economic resources and claims.
 Financial performance reflected by accrual
accounting.
 Financial performance reflected by past cash flows.
 Changes in economic resources and claims not
resulting from financial performance.
 Assessments made by users

 The prospects for future net cash inflows to the

entity.

 Management’s stewardship of the entity’s economic

resources.
Economic resources (A) and claims (L)

Financial position:

 Liquidity
 Solvency
 Need for financing
Changes in resources and claims
Financial performance or other:
 Caused by combination of the entity’s financial
performance:
 Income earned; and
 Expenses incurred

Other events and transactions unrelated to financial

performance:
 Equity contributions
 Equity distributions
 Changes in assets and liabilities that did not increase
or decrease equity.
Presentation of financial performance

Accrual accounting:
 Recording the effects of transactions and
events in the period in which they occur,
even if cash flow occurs in another period.
(Income & expenses)
Cash flow accounting:
 Recording the effects of transactions and
events in the period in which the cash flow
occurs. (Operations, investing or financing
activities)
General purpose financial statements
Financial Statements
A particular form of general purpose financial report.
Provides information about:
 economic resources that meet the definitions of
assets
Claims that meet the definition of Liability or Equity.
Only those changes in the economic resources and
claims that meet the definition of income or expenses.
Give information about the economic phenomena that
meets the definition of the five elements.
General purpose financial statements

Financial reports:
 Provide information about:
 Economic resources, claims and
changes in these economic resources
and claims (economic phenomena)
 Management efficiency and
effectiveness in using resources.
Objective of financial statements
To provide users with useful financial information about
the reporting entity’s elements:
 Assets
 Liabilities
 Equity
 Income
 Expenses

 Useful for assessing the prospects for future net cash

inflows to the reporting entity, and
 In assessing management’s stewardship of the
entity’s economic resources.
Financial statements
Constitute:

Statement of financial position.

Statement of financial performance.
Other statements and notes.
The reporting entity
 A reporting entity is an entity that chooses
or is required to prepare financial
statements.
 A company that has control over others
prepares consolidated financial statements.
 A group of companies where there is no
control, combined financial statements.

 Reporting period – normally a year.

Going concern assumption
Unless otherwise stated, users may assume
that financial statements provide information
about a reporting entity that is a going
concern.

Will continue to operate in the foreseeable

future.
Does not intend to liquidate.
Will not cease to operate.
Qualitative characteristics of useful
financial information
There are two types of qualitative
characteristics:
 Fundamental qualitative characteristics
(essential for usefulness)
 Enhancing qualitative characteristics
(improve usefulness)
Fundamental qualitative characteristics
Information must be relevant and be a
faithful representation.
Relevant – capable of making a
difference in the decision of users.
Faithful representation – provides a
faithful representation of the economic
phenomenon it purports to represent.
Relevance
• Information is relevant if it is capable of making a
difference in the decisions made by users.
• Relevant information must have predictive value
and/or confirmatory value.
 Predictive value – information must be simply
information that users can use as inputs in their own
predictions and forecasts.
 Confirmatory value – users must be able to use the
information as feedback on their previous
predictions.
 Relevance is affected by materiality. Information is
material if omitting, misstating or obscuring could
reasonably be expected to influence decisions of
primary users of general purpose financial reports.
Faithful representation

To be a faithful representation, the

information will need to be:
 Complete
 Neutral, and
 Free from error
Faithful representation (Cont.)
• Complete
Completeness means giving all the
information (words and numbers) that the user
needs to understand whatever phenomenon is
being described.
• Neutral
Neutral means free from bias. Not to select
or present information in a way that is biased.
Information should not be manipulated in
order to get a favourable or unfavourable
response.
Faithful representation (Cont.)
• Neutral involves prudence
 Prudence means that wherever there is a level of
uncertainty in the information, caution must be
exercised.
 Be careful not to overstate A and I whilst we
understate E and L.
• Free from error
 There must be no errors or omissions in description
of phenomena and the selection of processes used to
produce information.
Application of fundamental qualitative
characteristics

 Step 1: Identify the economic

phenomenon that has the potential to
be useful to the user.
 Step 2: Identify what type of
information would be most relevant.
 Step 3: Determine whether the
information is available and can be
faithfully represented.
Enhancing qualitative characteristics
Useful information is enhanced by ensuring
that it is:

Comparable
Verifiable
Understandable
Produced on a timely basis
Enhancing qualitative characteristics (Cont.)

• Comparability
Enables users to identify and understand
similarities and differences among items.

• Verifiability
Helps assure users that information has been
independently assessed by knowledgeable
observers and found it to be faithfully
represented.(Direct/Indirect)
Enhancing qualitative characteristics
(Cont.)
• Timeliness
 Information needs to be made available
timeously so that users are able to use
it in their decision making.

• Understandability
 Information must be classified,
characterized and presented clearly
and concisely.
Cost constraint on useful information
There are large costs involved in financial
reporting.

Consider that the benefit justifies the cost.

The cost factor should however not override

the fact that financial reporting that is relevant
and a faithful representation allows users to
make decisions with confidence.
ELEMENTS OF
FINANCIAL
STATEMENTS
Definition of an asset
An asset is
A present economic resource controlled by the
entity as a result of past events.
Economic resource
 Economic resource is a right that has a
potential to produce economic benefits.
 The right may be established by contract or
legislation or similar means.
 Definition of an asset (Cont.)

 An economic resource is a right – one asset may

be a set of rights
E.g. legal ownership of a machine
• Right to use
• Right to sell
• Right to pledge as security for a debt
• Other rights?
 The economic resources is the set of rights, not
the physical object
 An asset is no longer an object but a right to use
/sell/lease that object.
Definition of an asset (Cont.)
The right
 Accounts receivable represents a right to
receive cash.
 Expenses prepaid represent a right to
receive goods or services.
 Intangible asset may represent a right to use,
or lease or sale of a patent.
 Inventory represents a right to sell an object.
Definition of an asset (Cont.)
 The resource must be controlled by the
entity.
 There is control, if the entity can both:
1. Direct the use of economic resource i.e.
decide how to use Economic Resource AND
2. Obtain the benefits that flow from the
resource
 Control can also arise if you can prevent
others from directing the use and obtaining
the benefits.
Definition of an asset (Cont.)
Has the potential to produce economic benefits:
 Receive contractual cash flows or other economic
resource
 Exchange economic resources on favourable terms
 Produce cash inflows (avoid cash outflows) e.g.
• Use to produce goods/services
• Use to enhance the value of other economic resources
• Lease it to another party
 Sell it and receive cash or other economic resource
 Extinguish liabilities by transferring economic
resource

 Potential does not need to be certain

Definition of an asset (Cont.)

The resource must be as a result of

past events.
 The economic resource must
have risen from a past event
before the reporting date.
 Example: signing a contract
 Example 1

Alpha Services rents office space from a

landlord, at R10 000 pm. It uses this
space to run a business selling financial
advice. At 31 December 2020, it pays rent
for January 2021.

Required: From Alpha’s perspective,

prove that this payment is an asset at 31
December 2020.
Example 1 Solution
• Prepaid rental
 Present economic resource (right)
 Right to occupy office space in January
2020.
 The right has a potential to produce
economic benefits – occupation of the office
to use for making cash.
 The resource is controlled by the entity
 Can be proved through its ability to enforce
legal rights. (The rental agreement and
prepayment of rental)
Example 1 (Cont.)

This resource is as a result of past

event.
Signing of the rental agreement,
and
Prepayment of cash.
Definition of a Liability

 Liability is a present obligation of the entity

to transfer an economic resource as a result
of past event.
 Present Obligation is a
• Duty or responsibility that an entity has no
practical ability to avoid.
No practical ability to avoid if the only way is
to liquidate or cease trading.
Definition of a Liability (Cont.)
An obligation can be established as follows:
 Legally - Entity cannot practically avoid a duty to
another party because the other party can legally
enforce the duty to them e.g. Duty to deliver
inventory to customer or return their cash
 Constructively- If an entity has no practical ability to
act inconsistently with its own customary practices,
published policies or statements made. E.g. If the
entity has a policy to rehabilitate the environment
damage caused by the company.
 Conditional – If an entity’s duty or responsibility to
transfer economic resource is conditional on the
entity’s own future actions and has no practical
ability to avoid these future actions.
Definition of a Liability (Cont.)
 The obligation must have a potential to require a
transfer of economic resources.
• Potential does not need to be certain
• Transferring the right to discharge an obligation
 As a result of past event
1. Entity must have either :
• Obtained the economic benefits, or
• taken action (received something or done something –
cause) AND
2. As a result the entity may have to transfer economic
resources – effect.
Example 2

Beta rents office space from a landlord, at

R10 000 pm. It uses this space to run a
business selling financial advice. At 31
December 2020, the entity still owes rent
for December 2020.

Required: From Beta’s perspective, prove

that this payable is a liability at 31
December 2020.
Example 2 (Cont.)
Present obligation
 The entity has a duty to pay the landlord
monthly rental; and
 The entity has no practical ability of avoiding
this duty since it is legally enforceable
through a legal contract (rental agreement).
 The obligation involves transferring an
economic resource.
 The obligation requires a transfer of economic
resources, by way of a cash payment to the
landlord.
Example 2 (Cont.)
• The obligation is as a result of a past event

 The entity has already obtained the benefits

since it was able to use the office space
during December 2019, and
 As a result Beta will be required to transfer
an economic resource, in the form of cash.
(i.e. the right to use the cash will be
transferred from Beta to the landlord).
Equity
Equity is the residual interest in the assets of
the entity after deducting all its liabilities.

EQUITY = ASSETS - LIABILITIES

Equity claim
 A transaction involving the issue of ordinary
shares is called an equity claim.
 The claims against the entity that do not meet
the definition of a liability. (a claim that does
not involve obligation).
 It is therefore a claim on the residual interest
in the entity’s assets after deducting its
liabilities.
Income
Increase in assets or decrease in
liabilities other than those relating to
contributions from holders of equity
claims.

See example 4 on P63 (Gripping

GAAP).
Expenses
 Decrease in assets or increase in liabilities
other than those relating to distributions to
holders of equity claims.

 Example 5 on P64 (Gripping GAAP).

Recognition
 Recognise the Asset, liability, income ,
expense, equity when:
1. Element meets the definition and
2. Meets the recognition criteria
 RECOGNITION CRITERIA
Recognise elements if the user would find the
information useful.
• Relevant
• A faithful representation
Elements of the financial statements
Derecognition
Asset – loses control
Liability – no longer has present
obligation
No longer in the financial statements
Measurement

Measurement
bases

Historic Cost Current value

Fair Value Value in Use Current Cost

Faithful Enhancing
Relevancy represent qualities
ation Cost benefit
Self study
 Measurement bases.

 Presentation and disclosure.

 Capital and Capital maintenance.

 Unit of account.
QUESTIONS
TUTORIAL QUESTION

 GAAP: Graded question 2.7 –

Grippo Limited

 GAAP: Graded question 2.9 –

Crusty Bakery