CONCEPTUAL

FRAMEWORK
AND REPORTING
STANDARDS
Course Material No. 2
The Conceptual Framework
for Financial Reporting

Marina V. Justiniani, CPA, MBA

 2 Conceptual Framework for Financial Reporting • NU LAGUNA

Conceptual Framework
for Financial Reporting 2
LEARNING OUTCOMES

Here’s what I will teach you in this course material:

LESSON OUTLINE
• State the purpose, status, and scope of the Conceptual Framework
• Purpose, Status and Scope of • State the objective of financial reporting
Conceptual Framework
• Explain briefly the qualitative characteristics of useful information and how
Unit Outline
they applied in financial reporting
• Objective of General Purpose
Financial Reporting • Define two concepts of capital
• Determine net income under the financial capital and physical capital concept
• Qualitative Characteristics of
Financial Information

RESOURCES NEEDED
• Financial Statements and the
Reporting Entity
For this lesson, you would need the following resources:
• Elements of Financial
• Conceptual Framework and Accounting Standard Book
Statements

• Concepts of Capital and

Capital Maintenance
Conceptual Framework for Financial Reporting • NU LAGUNA 3

TABLE OF CONTENTS

Pretest 3 Questions for Review and

Discussion
Before you start, try answering the following
questions.
4 Accountant’s Word Hunt

1. Define Conceptual Framework.

_________________________________________
_________________________________________ 5 Purpose and Scope of the
Framework
_________________________________________

2. What is the objective of financial reporting? 10 Test Yourself

_________________________________________
_________________________________________
_________________________________________ 11 Posttest

3. Who are the primary users?

________________________________________
________________________________________ 13 References
________________________________________

4. Give the two fundamental qualitative characteristics

of a useful financial information.

________________________________________
________________________________________
________________________________________

5. What are the four enhancing qualitative

characteristics of a useful financial information?

________________________________________
________________________________________
________________________________________
4
Conceptual Conceptual Framework for Financial Reporting • NU LAGUNA

Framework for
Financial
Reporting
This lesson comprises the
purpose, status and scope
of Conceptual Framework.
The objective of financial
reporting will be
thoroughly explained.
Likewise, the different
qualitative characteristics
of useful financial
information and how they
are applied in financial
report will be explained.
The elements of financial
statements will be defined.

Accountant’s Word Hunt

Identify what is needed and color it according to the designated color
after the questions.

M A T E R I A L I T
Find all the words that
L I A B I L I T Y E
corresponds to elements
S S S S I N C O M E of Financial Statements
S H E H S G P R O Q inside the Box
H C T S G E F I R U

S N S D S Q T A G I
L I A B I I L I T Y
E Y I Q N U P E S T
L O A N S T E Q U I
E Q U I T Y E S A S
S E E X P E N S E S
 Conceptual Framework for Financial Reporting • NU LAGUNA 5

Conceptual Framework for Financial Reporting

Hello Class. How is your day? I hope your fine. Today, I will share to you the purpose, status
and scope of Conceptual Framework.

The Conceptual Framework prescribes the concepts for general purpose financial reporting. Its purpose is
to:

1. assist the International Accounting Standards Board (IASB) in developing Standards that are
based on consistent concepts;

2. 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

3. assist all parties in understanding and interpreting the Standards.

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.

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. Concepts of capital and capital maintenance

Now, let’s discuss the objective general purpose financial 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.
6 Conceptual Framework for Financial Reporting • NU LAGUNA

Qualitative Characteristics
I. Fundamental qualitative characteristics

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

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.

2. Enhancing qualitative characteristics

a. Comparability – the information helps users in identifying similarities and differences between
different sets of information.

b. Verifiability – different users could reach consensus as to what the information purports to
represent.

c. Timeliness – the information is available to users in time to be able to influence their decisions.

d. Understandability – users are expected to have:

• reasonable knowledge of business activities;

• and willingness to analyze the information diligently

Financial statements and the 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

Conceptual Framework for Financial Reporting • NU LAGUNA 7

b. management’s stewardship over economic resources.

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.

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.

Elements of Financial Statements

The elements of financial statements are:

1. Assets

2. Liabilities These relate to the entity’s financial position

3. Equity

4. Income

5. Expenses These relate to the entity’s financial performance

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.”

Three aspects in the definition of an 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.
8 Conceptual Framework for Financial Reporting • NU LAGUNA

Liability is “a present obligation of the entity to transfer an economic resource as a

result of past events

Three aspects in the definition of a 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.

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.

Equity is the residual interest in the assets of the entity after deducting all its liabilities.”

• Equity equals Assets minus Liabilities

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 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.”

Recognition and Derecognition

Recognition criteria

• An item is recognized if:

a. it meets the definition of an asset, liability, equity, income or expense;

b. recognizing it would provide useful information, i.e., relevant and

faithfully represented information.
Conceptual Framework for Financial Reporting • NU LAGUNA 9

How does Relevance play an important role in recognition?

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. (Conceptual Framework 5.12)

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.

In Faithful representation, the level of measurement uncertainty and other factors can
affect an item’s faithful representation, but not necessarily its relevance.

What is 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.

When does Derecognition happens?

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.

Measurement could be done through the following

1. 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:

10 Conceptual Framework for Financial Reporting • NU LAGUNA

c. Depreciation, amortization, or impairment of assets

d. Collections or payments that extinguish part or all of the asset or liability

e. Unwinding of discount or premium when the asset or liability is

measured at amortized cost

2. Current value

a. 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)

b. 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.”

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.”

c. Current cost

The current cost of:

1. 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.”

2. 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.”

Presentation and Disclosure

Information is communicated through presentation and disclosure in the financial

statements. Effective communication makes information more useful. Effective
communication requires:
Conceptual Framework for Financial Reporting • NU LAGUNA 11

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.

The principles include:

a. the use of entity-specific information is more useful that standardized

descriptions, and
b. duplication of information is usually unnecessary.

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.

Financial capital is a monetary amount of the net assets contributed by shareholders and
the amount of the increase in net assets resulting from earnings retained by the entity.
Financial capital is based on historical cost

Under the financial capital concept, net income occurs when the nominal amount of the
net assets at the end of the year exceeds the nominal amount of the net assets at the
beginning of the period, after excluding distributions to and contributions by owners
during the period.

Physical concept of capital – capital is regarded as the entity’s productive capacity, e.g.,
units of output per day or physical capacity of productive assets to produce goods and
services.

Physical capital is a quantitative measure of the physical productive capacity to produce

goods and services. Productive assets include inventories and property, plant and
equipment

This concept requires that productive assets be measured at current cost. Under this
concept, net income occurs when the physical productive capital of the entity at the end
of the year exceeds the physical productive capital at the beginning of the period, after
excluding distributions to and contributions from owners during the period
 12 Conceptual Framework for Financial Reporting • NU LAGUNA

Test yourself

Task: The goal of this activity is to make you enhance your theoretical knowledge and your deep
understanding in the subject.
Identification:
1. __________ is a monetary amount of the net assets contributed by shareholders and the amount of the increase in
net assets resulting from earnings retained by the entity.
2. __________ quantitative measure of the physical productive capacity to produce goods and services.
3. __________ is a present obligation of the entity to transfer an economic resource as a result
of past events

4. __________ 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.

5. __________ is an increase in assets, or decrease in liabilities, that result in increase in equity, other than those
relating to contributions from holders of equity claims.

6. __________ is a decrease in assets, or increase in liabilities, that result in decrease in equity, other than those
relating to distributions to holders of equity claims.

7. __________ means the entity has the exclusive right over the benefits of an asset and the ability to prevent others
from accessing those benefits.

8. __________ is a duty or responsibility that an entity has no practical ability to avoid.

9. __________ is the residual interest in the assets of the entity after deducting all its liabilities.

10. _________ means the information can affect the decisions of users
Conceptual Framework for Financial Reporting • NU LAGUNA 13

Post Test
Post Test
Choose the best answer:

1. A soundly developed conceptual framework of concepts and objectives should

a. increase financial statement users' understanding of and confidence in financial reporting.
b. enhance comparability among companies' financial statements.
Reference
c. allow new and emerging practical problems to be more quickly soluble.
d. all of these.

2. A Standard sometimes contains requirements that depart from the Conceptual Framework. In such
cases,
a. the requirements of the Conceptual Framework will prevail over those of the Standard.
b. the departure is explained in the ‘Basis for Conclusions’ on that Standard.
c. the entity’s management shall formulate its own accounting policy and disregards both the
requirements of the Conceptual Framework and the Standard.
d. A Standard should never depart from the Conceptual Framework.

3. The overall objective of financial reporting is to provide information

a. about an entity's assets, liabilities, and equity.
b. about an entity's financial performance during a period.
c. that is useful to primary users in making economic decisions about providing resources to the
entity.
d. that allows owners to assess management's performance

4. The two primary qualities that make accounting information useful for decision making are
a. comparability and consistency.
b. materiality and timeliness.
c. relevance and reliability.
14 Conceptual Framework for Financial Reporting • NU LAGUNA

d. faithful representation and relevance

5. Which of the following is considered a qualitative factor in making materiality judgments?

a. the context of an item in relation to the current economic state of the environment where the
entity operates.
b. 10% of profit or loss, in absolute terms
c. 5% of total revenues
d. 1% of total assets

6. Which of the following statements about materiality is not correct?

a. An item must make a difference; otherwise, it need not be reported.
b. Materiality is affected by an item’s relative size and/or importance.
c. An item is material if its inclusion or omission would influence or change the judgment of a
reasonable person.
d. All of these are correct statements about materiality.

7. The Filipino adage “Aanhin mo pa ang damo pag patay na ang kabayo” relates to which of the
following qualitative characteristics?
a. Relevance
b. Timeliness
c. Faithful representation
d. Comparability

8. When information about two different entities has been prepared and presented in a similar manner,
the information exhibits the characteristic of
a. relevance.
b. reliability.
c. consistency.
d. Comparability

9. According to the Conceptual Framework, physical count of inventory is an example of

a. direct verification.
b. indirect verification.
c. timeliness.
d. relevance.

10. Information is considered relevant when it

a. can be depended on to represent the economic conditions and events that it is intended to
represent.
b. is capable of making a difference in a decision.
c. is understandable by reasonably informed users of accounting information.
d. is verifiable and neutral.

11. The quality of information that gives assurance that it is reasonably free of error and bias and provides
a true, correct and complete depiction of what it purports to represent is
a. relevance.
b. faithful representation.
c. verifiability.
Conceptual Framework for Financial Reporting • NU LAGUNA 15

d. neutrality.

12. Information is neutral if it

a. provides benefits which are at least equal to the costs of its preparation.
b. can be compared with similar information.
c. has no impact on a decision maker.
d. is free from bias toward a predetermined result.

13. Decision makers vary widely in the types of decisions they make, the methods of decision making they
employ, the information they already possess or can obtain from other sources, and their ability to
process information. Consequently, for information to be useful there must be a linkage between
these users and the decisions they make. This link is
a. relevance.
b. reliability.
c. Understandability
d. Materiality

14. Which of the following is most likely to result in the recognition of a liability?
a. Customers become entitled to rebates for their past purchases.
b. Intention to acquire inventories in a future period.
c. Entering into a purchase contract for future delivery.
d. Agreeing on an irrevocable future commitment that is not burdensome at present.

15. Which of the following is not an indication of an economic resource’s potential to produce economic
benefits for the entity?
a. The resource cannot be used in the entity’s operations but has a resale value.
b. The resource has no use to the entity but it can be exchanged for another resource with another
party.
c. The entity does not intend to sell or use the resource but instead distribute it to the owners as
dividends.
d. The economic benefits from the resource were already consumed by the entity.
16 Conceptual Framework for Financial Reporting • NU LAGUNA

Reference

Millan,Zeus Vernon B., 19th Edition Conceptual Framework & Accounting Standards, Bandolin
Enterprise

Valix, Conrado T., 20th Edition Conceptual Framework and Accounting Standards, GIC Enterprises
& Co., Inc

Cabrera, E. and Ocampo Reynaldo Financial Accounting and Reporting Standards and Applications
Volume 3 2014-2015 Edition GIC Enterprises & Co., Inc.