2 Conceptual Framework For Financial Reporting

Conceptual Framework for Financial Reporting
Learning Objectives
• State the basic purpose, authoritative status, and scope of
the Conceptual Framework.
• State the objective of financial reporting.
• Identify the primary users of financial statements.
• Explain briefly the qualitative characteristics of useful
information and how they are applied in financial
reporting.
• Define the elements of financial statements and state their
recognition criteria.
Conceptual Framework & Acctg.

2
Standards (by: Zeus Vernon B. Millan)
Conceptual Framework for Financial Reporting
• The Conceptual Framework sets out the concepts that

underlie the preparation and presentation of financial
statements for external users.

3
Authoritative Status and Applicability
• 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 information
that is relevant and reliable.
• The Conceptual Framework is concerned with general-
purpose financial statements.

4
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 about providing resources to the
entity. A secondary objective of financial statements is to show the
results of the stewardship of management.
• The objective of general purpose financial reporting forms the

foundation of the Conceptual Framework. Other aspects of the
Conceptual Framework flow logically from the objective.

5
Users and their Needs
• Primary users – those to whom general purpose financial reports

are directed:
(a) Existing and potential investors
(b) Lenders and other creditors.
• Only the common needs of primary users are met by the financial
statements.

6
Qualitative Characteristics
• Qualitative Characteristics are the qualities or attributes that make

financial accounting information useful to the users.

7
Qualitative Characteristics
I. Fundamental qualitative characteristics
(1) Relevance
(a) Predictive value
(b) Feedback value
 Materiality – entity-specific aspect of relevance
(2) Faithful representation
(a) Completeness
(b) Neutrality
(c) Free from error
II. Enhancing qualitative characteristics

(3) Comparability
(4) Verifiability
(5) Timeliness
(6) Understandability
8
RELEVANCE
• Is the capacity of the information to influence a decision

9
Predictive Value and Confirmatory Value
• Predictive value-information has predictive value when it can

help users increase the likelihood of correctly predicting or
forecasting outcome of events.
• Confirmatory value-information has feedback value when it
enables users confirm or correct earlier expectations.

10
Materiality
• is a practical rule in accounting which dictates that strict adherence

to GAAP is not required when the items are not enough to affect the
evaluation, decision and fairness of the financial statements.
• Materiality is also known as the doctrine of convenience.
• Materiality is really a “quantitative threshold” linked very closely to
the qualitative characteristic of relevance. The relevance of
information is affected by its nature and materiality.

11
Faithful Representation
• quality of information that assures users that the information is free

from bias and error, and faithfully represents what it purports to
represent.

12
Completeness
• requires that relevant information should be presented in a way that

facilitates understanding and avoids erroneous implication.

13
Neutrality
• means that the financial statements should not be prepared so as to

favor one party to the detriment of another party.

14
Free from error
• Means there are no errors or omissions from the description of the

phenomenon or transaction.

15
Understandability
• requires that financial information must be comprehensible or

intelligible if it is to be useful.

16
Comparability
• means the ability to bring together for the purpose of noting points
of likeness and difference. Comparable information presents
similarities and dissimilarities. Comparability may be made within
an entity or across entities.

17
Timeliness
• requires that the accounting information must be available or

communicated early enough when a decision is to be made.

18
Verifiability
• Means that different knowledgeable and independent observers

could reach consensus although not necessarily complete
agreement, that a particular depiction is a faithful representation

19
Financial Statements and reporting entity
Underlying Assumptions

20
GENERAL OBJECTIVE OF FINANCIAL STATEMENTS
• Financial statements provide information about economic resources

of the reporting entity, claims against the entity and changes in
economic resources and claims

21
Types of financial statements
• 1. Consolidated financial statements-these are the FS prepared when

the reporting entity comprises both the parent and its subsidiaries.
• 2. Unconsolidated financial statements-these are the FS prepared
when the reporting entity is the parent alone.
• 3. Combined financial statements- these are the FS prepared when
the reporting entity comprises two or more entities that are not
linked by a parent and subsidiary relationship

22
REPORTING ENTITY
• A reporting entity is an entity that is required or chooses to prepare

financial statements

23
UNDERLYING ASSUMPTIONS
• Are the basic notions or fundamental premises on which accounting

process is based. AKA postulates
• Going Concern
• Implicit basic assumptions

o 1. Accounting entity
o 2. time period
o 3. Monetary unit

24
Going Concern
• Means that in the absence of evidence to the contrary, the

accounting entity is viewed as continuing in operation indefinitely.
• Thus, assets are normally recorded at cost.

25
Accounting Entity
• The entity is separate from the owners, managers, and employees

who constitute the entity

26
Time period
• Requires that the indefinite life of an entity is subdivided into

accounting periods, which are usually of equal length for the
purpose of financial reports on financial position, performance and
cash flows.

27
Monetary Unit
• Quantifiability-means that the assets, liabilities, equity, income

and expenses should be stated in terms of a unit of measure which is
the peso in the Philippines.
• Stability of peso-means that the purchasing power of the peso is
stable or constant and that its instability is insignificant and
therefore may be ignore.

28
Elements of Financial Statements
Financial Position
1. Asset - resource controlled by the entity as a result of past events and
from which future economic benefits are expected to flow to the entity
2. Liability - present obligation of the entity arising from past events,
the settlement of which is expected to result in an outflow from the
entity of resources embodying economic benefits.
3. Equity – assets less liabilities
Performance
1. Income – encompasses both (a) revenues and (b) gains
2. Expense – encompasses both (b) expenses and (losses)

29
Recognition
• Recognition –the process of capturing for inclusion in the financial
statements an item that meets the definition of an asset, liability, equity,
income or expense.
• Recognition:
a. Only items that meet the definition of an asset, a liability or equity
are recognized in the statement of financial position
b. Only items that meet the definition of income or expense are
recognized in the statement of financial performance
c. The said items are recognized only when their recognition provides
users of financial statements with information that is both relevant
and faithfully represented.

30
Recognition of Income and Expense
• Point of sale income recognition- income shall be recognized when

earned.
• Expenses are recognized when incurred.

31
Expense Recognition Principles
1. Direct association or matching

2. Systematic and rational allocation
3. Immediate recognition

32
Direct association or matching
• “the expense is recognized when the revenue is already recognized”

on the basis of a presumed direct association of the expense with
specific revenue. This is actually the “strict matching concept”.

33
Systematic and rational allocation
• Under the systematic and rational allocation principle, some costs

are expensed by simply allocating them over the periods benefited.
•
• The reason for this principle is that the cost incurred will benefit
future periods and that there is an absence of a direct or clear
association of the expense with specific revenue.

34
Immediate recognition
• the cost incurred is expensed outright because of uncertainty of

future economic benefits or difficulty of reliably associating certain
costs with future revenue.

35
Derecognition
• The removal of all or part of recognized asset or liability from the

statement of financial position.

36
Measurement
• Quantifying in monetary terms the elements in the financial

statements.
• 2 Categories
o A. Historical cost
o B. Current value

37
Historical Cost
• Of an asset- is the cost incurred in acquiring or creating the asset

comprising the consideration paid plus transaction cost.
• Of a liability- is the consideration received to incur the liability
minus the transaction cost.
• Historical cost is the entry price or entry value to acquire an asset or

to incur a liability.

38
Current value
a. Fair value
b. Value in use for asset
c. Fulfillment value for liability
d. Current cost

39
Fair Value
• Of an Asset- is the price that would be received to sell an asset in an

orderly transaction between market participants at measurement
date.
• Of a liability- is the price that would be paid to transfer a liability in
an orderly transaction between market participants at measurement
date.
• Exit price or exit value

40
Value in use
• Is the present value of the cash flows than an entity expects to derive
from the use of an asset and from the ultimate disposal.
• Exclude transaction costs.

41
Fulfillment value of liability
• Is the present value of cash that an entity expects to transfer in

paying or settling a liability.
• Exclude transaction costs.
• Exit price or exit value

42
Current cost
• Of an asset-is the cost of an equivalent asset at the measurement

date comprising the consideration paid and transaction cost.
• Of a liability-is the consideration that would be received less any
transaction cost at a measurement date.
• Also based on entry price or entry value but reflects market
conditions on measurement date.

43
PRESENTATION AND DISCLOSURE
• Effective communication tool about the information in financial

statements.
• Effective communication makes the information more relevant and
contributes to a faithful representation of an entity’s assets,
liabilities, income and expenses.

44
Classification
• Is the sorting of assets, liabilities, equity, income and expenses on

the basis of shared or similar characteristics.

45
Aggregation
• Is the adding together of assets, liabilities, equity, income and

expenses that have similar or shared characteristics and are
included in the same classification.

46
Concepts of Capital
• Financial concept of capital - capital is synonymous with net

assets of the enterprise. This is the concept of capital adopted by
most enterprises.
•
• Physical concept of capital – capital is regarded as the
productive capacity of the enterprise based on, for example, units of
output per day.

47
Concepts of Capital Maintenance
• Financial capital maintenance – Under this concept, a profit is earned only

if the financial (or money) amount of the net assets at the end of the of the
period exceeds the financial (or money) amount of the net assets at the
beginning of the period, after excluding any distributions to, and contributions
from, owners during the period.
•
• Physical capital maintenance – Under this concept, a profit is earned only if
the physical productive capacity (or operating capability) of the enterprise (or
the resources need to achieve that capacity) at the end of the period exceeds the
physical productive capacity at the beginning of the period, after excluding any
distributions to, and contributions from, owners during the period.

48
APPLICATION OF
CONCEPTS
PROBLEM 4: FOR CLASSROOM DISCUSSION
Conceptual Framework & Acctg. Standards (by: Zeus Vernon B. Millan) 49

 QUESTIONS????
 REACTIONS!!!!!

50
END
Conceptual Framework & Acctg. Standards (by: Zeus Vernon B. Millan) 51

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2 Conceptual Framework For Financial Reporting

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Conceptual Framework for Financial Reporting

Conceptual Framework & Acctg.

• The Conceptual Framework sets out the concepts that

Conceptual Framework & Acctg.

Conceptual Framework & Acctg.

• The objective of general purpose financial reporting forms the

Conceptual Framework & Acctg.

• Primary users – those to whom general purpose financial reports

Conceptual Framework & Acctg.

• Qualitative Characteristics are the qualities or attributes that make

Conceptual Framework & Acctg.

II. Enhancing qualitative characteristics

• Is the capacity of the information to influence a decision

Conceptual Framework & Acctg.

• Predictive value-information has predictive value when it can

Conceptual Framework & Acctg.

• is a practical rule in accounting which dictates that strict adherence

Conceptual Framework & Acctg.

• quality of information that assures users that the information is free

Conceptual Framework & Acctg.

• requires that relevant information should be presented in a way that

Conceptual Framework & Acctg.

• means that the financial statements should not be prepared so as to

Conceptual Framework & Acctg.

• Means there are no errors or omissions from the description of the

Conceptual Framework & Acctg.

• requires that financial information must be comprehensible or

Conceptual Framework & Acctg.

Conceptual Framework & Acctg.

• requires that the accounting information must be available or

Conceptual Framework & Acctg.

• Means that different knowledgeable and independent observers

Conceptual Framework & Acctg.

Conceptual Framework & Acctg.

• Financial statements provide information about economic resources

Conceptual Framework & Acctg.

• 1. Consolidated financial statements-these are the FS prepared when

Conceptual Framework & Acctg.

• A reporting entity is an entity that is required or chooses to prepare

Conceptual Framework & Acctg.

• Are the basic notions or fundamental premises on which accounting

• Implicit basic assumptions

Conceptual Framework & Acctg.

• Means that in the absence of evidence to the contrary, the

Conceptual Framework & Acctg.

• The entity is separate from the owners, managers, and employees

Conceptual Framework & Acctg.

• Requires that the indefinite life of an entity is subdivided into

Conceptual Framework & Acctg.

• Quantifiability-means that the assets, liabilities, equity, income

Conceptual Framework & Acctg.

Conceptual Framework & Acctg.

Conceptual Framework & Acctg.

• Point of sale income recognition- income shall be recognized when

Conceptual Framework & Acctg.

1. Direct association or matching

Conceptual Framework & Acctg.

• “the expense is recognized when the revenue is already recognized”

Conceptual Framework & Acctg.

• Under the systematic and rational allocation principle, some costs

Conceptual Framework & Acctg.

• the cost incurred is expensed outright because of uncertainty of

Conceptual Framework & Acctg.