Chapter 1: The Objective of general purpose financial

reporting

The primary users of general purpose financial reporting are present and potential investors, lenders and
other creditors, who use that information to make decisions about buying, selling or holding equity or debt
instruments, providing or settling loans or other forms of credit, or exercising rights to vote on, or otherwise
influence, management’s actions that affect the use of the entity’s economic resources.

The primary users need information about the resources of the entity not only to assess an entity's
prospects for future net cash inflows but also how effectively and efficiently management has discharged
their responsibilities to use the entity's existing resources (i.e., stewardship).
The IFRS Framework notes that general purpose financial reports cannot provide all the information that
users may need to make economic decisions. They will need to consider pertinent information from other
sources as well.
The IFRS Framework notes that other parties, including prudential and market regulators, may find general
purpose financial reports useful. However, these are not considered a primary user and general purpose
financial reports are not primarily directed to regulators or other parties.
Information about a reporting entity's economic resources, claims, and changes in resources and claims
Economic resources and claims
Information about the nature and amounts of a reporting entity's economic resources and claims assists
users to assess that entity's financial strengths and weaknesses; to assess liquidity and solvency, and its need
and ability to obtain financing. Information about the claims and payment requirements assists users to
predict how future cash flows will be distributed among those with a claim on the reporting entity.
A reporting entity's economic resources and claims are reported in the statement of financial position.
Changes in economic resources and claims
Changes in a reporting entity's economic resources and claims result from that entity's performance and
from other events or transactions such as issuing debt or equity instruments. Users need to be able to
distinguish between both of these changes.
Financial performance reflected by accrual accounting
Information about a reporting entity's financial performance during a period, representing changes in
economic resources and claims other than those obtained directly from investors and creditors, is useful
in assessing the entity's past and future ability to generate net cash inflows. Such information may also
indicate the extent to which general economic events have changed the entity's ability to generate
future cash inflows.
The changes in an entity's economic resources and claims are presented in the statement of
comprehensive income.
Financial performance reflected by past cash flows
Information about a reporting entity's cash flows during the reporting period also assists users to assess
the entity's ability to generate future net cash inflows and to assess management’s stewardship of the
entity’s economic resources. This information indicates how the entity obtains and spends cash,
including information about its borrowing and repayment of debt, cash dividends to shareholders, etc.
The changes in the entity's cash flows are presented in the statement of cash flows.
Changes in economic resources and claims not resulting from financial performance
Information about changes in an entity's economic resources and claims resulting from events and
transactions other than financial performance, such as the issue of equity instruments or distributions
of cash or other assets to shareholders is necessary to complete the picture of the total change in the
entity's economic resources and claims.
The changes in an entity's economic resources and claims not resulting from financial performance is
presented in the statement of changes in equity.
Information about use of the entity’s economic resources
Information about the use of the entity's economic resources also indicates how efficiently and
effectively the reporting entity’s management has used these resources in its stewardship of those
resources. Such information is also useful for predicting how efficiently and effectively management will
use the entity’s economic resources in future periods and, hence, what the prospects for future net
cash inflows are.
 Chapter 2 : Qualitative characteristics of useful financial
information

The qualitative characteristics of useful financial reporting identify the types of information are likely to
be most useful to users in making decisions about the reporting entity on the basis of information in its
financial report.
The qualitative characteristics apply equally to financial information in general purpose financial reports
as well as to financial information provided in other ways.
The usefulness of financial information is improved if it is comparable, verifiable, timely and
understandable.

Fundamental qualitative characteristics

Relevance and faithful representation are the fundamental qualitative characteristics of useful financial
information.

Relevance
Relevant financial information is capable of making a difference in the decisions made by users.
Materiality is an entity-specific aspect of relevance based on the nature or magnitude (or both) of the
items to which the information relates in the context of an individual entity's financial report.
Faithful representation
Faithful representation means representation of the substance of an economic phenomenon instead of
representation of its legal form only, and seeks to maximize the characteristics that underlie
completeness, neutrality and freedom from error.

Applying the fundamental qualitative characteristics

Information must be both relevant and faithfully represented if it is to be useful.

Enhancing qualitative characteristics

based on comparability, can be verified, timeliness and can be understood are qualitative characteristics
that increase the usefulness of relevant information and are represented faithfully

Comparison
Information about reporting entities is more useful if it can be compared with similar information about
other entities and with similar information about the same entity for another period or another date

Verifiability
Verifiability helps to assure users that information represents faithfully the economic phenomena it
purports to represent. Verifiability means that different knowledgeable and independent observers
could reach consensus, although not necessarily complete agreement, that a particular depiction is a
faithful representation.

Timeliness
Timeliness means that information is available to decision-makers in time to be capable of influencing
their decisions.
The cost constraint on useful financial reporting
maximizing the information that is only needed.

The cost constraint on useful financial reporting

Cost is a pervasive constraint on the information that can be provided by general purpose financial
reporting. Reporting such information imposes costs and those costs should be justified by the benefits
of reporting that information
 Chapter 3: Financial Statements and the Reporting Entity

Financial Statements
The financial statements should provide the useful information about the reporting entity:

Financial statements are always prepared for a specified period of time, or the reporting period.

Normally, the financial statements are prepared on the going concern assumption.

It means that an entity will continue to operate for the foreseeable future (usually 12 months after the
reporting date).
Reporting Entity

Reporting entity is an entity who must or chooses to prepare the financial statements. It can be:
A single entity – for example, one company;
A portion of an entity – for example, a division of one company;
More than one entities – for example, a parent and its subsidiaries reporting as a group.
As a result, we have a few types of financial statements:

Consolidated: a parent and subsidiaries report as a single reporting entity;

Unconsolidated: e.g. a parent alone provides reports, or
Combined: e.g. reporting entity comprises two or more entities not linked by parent-subsidiary
relationship.
Summary of chapter 3 :

Chapters 3-8 focus on information provided in the financial statements, and do not deal with other
forms of financial reporting, such as management commentary.
It describes the scope and objective of financial statements, stating that financial statements are a
particular form of financial report, which provides information about the assets, liabilities, equity,
income and expenses of the reporting entity. Consolidated, unconsolidated and combined financial
statements are all acknowledged as forms of financial statements in the revised Conceptual Framework.
Chapter 3 also provides a description of the reporting entity. The 2010 Conceptual Framework did not
discuss what a reporting entity is or how to determine the boundary of such an entity. In developing
concepts for the revised Conceptual Framework, the Board considered comments received on the 2010
Exposure Draft Conceptual Framework for Financial Reporting – The Reporting Entity, as well as
comments received on the 2015 Conceptual Framework exposure draft. The Board acknowledged that
it does not have authority to determine who must or should prepare financial statements, but it
provides general guidance that a reporting entity is:

• An entity that chooses, or is required to, prepare financial statements

• Not necessarily a legal entity – it could take many forms, e.g. a portion of an entity. It is sometimes
difficult to define the boundary of a reporting entity if it does not have typical legal form. In this
case, the Board recommends that the boundary is determined by considering the users’
information needs of that entity, based on the assumption (per Chapter 2) that users need
information that is relevant and representationally faithful.
 Chapter 4 : The elements of financial statements

This chapter defines the five elements of financial statements :

1. Asset
2. Liability
3. Equity
4. Income
5. Expenses
The major changes are to the definitions of an asset and a liability, as discussed below.

 Definition of an asset:

Previous definition New definition

A resource controlled by the entity as a result of A present economic resource controlled by the entity
past events and from which future economic as a result of past events. An economic resource is a
benefits are expected to flow to the entity right that has the potential to produce economic
benefits

 Definition of a liability:

Previous definition New definition

A present obligation of the entity arising from past A present obligation of the entity to transfer an
events, the settlement of which is expected to result economic resource as a result of past events. An
in an outflow from the entity of resources obligation is a duty of responsibility that the entity has
embodying economic benefits no practical ability to avoid
Chapter 4 has also been amended for the following:

 Income and expenses – the definitions have changed to reflect changes in the definitions of an
asset and a liability

 Equity is still defined as the residual interest in the assets of an entity after deducting all the
liabilities. The boundary between liabilities and equity will be further explored by the IASB in
its research project on Financial Instruments with Characteristics of Equity

 Unit of account - decisions about selecting a unit of account for recognition and measurement
of an element of the financial statements would need to be made at the standard level, but
the chapter includes a discussion of factors to consider when determining which unit of
account to use

 Executory contracts - revised and more extensive supporting guidance has been provided for
these types of contracts.
 Chapter 5 : Recognition and derecognition

This chapter discusses criteria for recognising assets and liabilities in financial statements, and provides
guidance on when to remove – or derecognise – them. The 2010 Conceptual Framework did not define
derecognition, or describe when it occurs. Recognition is ‘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’.

The revised Conceptual Framework goes on to state that recognition is only appropriate if it results in
both relevant information about the element being recognised, and faithful representation of that
element. This differs from the 2010 Conceptual Framework, which stated that an entity should
recognize an item if it was probable that economic benefits would flow to the entity, with a cost/value
that could be determined reliably. The Board’s aim is to refer explicitly to the qualitative characteristics
of useful information, in order to provide a more coherent set of concepts across the revised
Conceptual Framework.
Derecognition - is ‘the removal of all or part of a recognised asset of liability from an entity’s statement
of financial position’. It goes on to say that derecognition normally occurs:

 For an asset, when the entity loses control of all or part of the recognized asset
 For a liability, when the entity no longer has a present obligation for all or part of the recognised
liability

Derecognition should aim to faithfully represent those assets and liabilities retained after the
transaction, if any, and any change in assets and liabilities as a result of the transaction that led to the
derecognition.

The guidance on derecognition reflects the Board’s view that both the control approach and the risk-
and-rewards approach to derecognition are valid. Therefore, it does not specify the use of one or the
other. The Board has adopted an approach that aims to faithfully represent both the change in the
entity’s assets and liabilities as a result of the derecognition transaction or event, and the assets and
liabilities (if any) that are retained.
 Chapter 6 : Measurement

This chapter describes various measurement bases, the information they provide and factors to consider
when selecting a measurement basis. The 2010 Conceptual Framework did not include much guidance on
measurement. In developing the revised Conceptual Framework, the Board considered whether a single
measurement basis should be mandated. However, it concluded that different measurement bases could
provide useful information to users in different circumstances. Therefore, two categories of measurement
basis were identified:
• Historical cost measurement basis
• Current value measurement basis

Historical cost measures provide information about elements that is derived from the historical price of the
transaction or event that gave rise to the item being considered for measurement; so, for an asset, this
would be the cost incurred in acquiring/creating the asset. For a liability, this would be the value
of the consideration received to incur/take on the liability.
Current value measures provide monetary information about elements, using information updated to reflect
conditions at the measurement date. Measurement bases may include fair value, value in use, fulfilment
value and current cost.
Selection of a measurement basis – consistent with the earlier chapters, the factors to be considered in
selecting a measurement basis are in line with the qualitative characteristics of useful information -
relevance and faithful representation :

• Relevance of information provided by a measurement basis is affected by the characteristics of the

asset or liability, and contribution to future cash flows
• Faithful representation of information provided by a measurement basis is affected by measurement
inconsistency and measurement uncertainty

When selecting a measurement basis, the entity needs also to consider the nature of the information –
whether it will be presented in the statement of financial position and/or the statement(s) of financial
performance. Cost will also constrain the selection of a measurement basis. The Board acknowledges
that consideration of all these factors is likely to result in the selection of different measurement bases
for different assets, liabilities, income and expenses.
 Chapter 7 – Presentation and disclosure

The topic of presentation and disclosure was not addressed in the 2010 Conceptual Framework. The
outreach done by the Board indicated that effective communication of information in financial
statements makes that information relevant and contributes to the faithful representation of an entity’s
financial position. The revised Conceptual Framework therefore introduces the following:

• Concepts describing how information should be presented and disclosed in financial statements

• Guidance on classifying income and expenses for the Board to use when it decides whether they are
to be included in or outside of the statement of profit or loss

• Guidance for the Board on whether and when income and expenses included in other comprehensive
income (OCI) should subsequently be recycled to profit or loss
This chapter introduces the term ‘statement(s) of financial performance’ to refer to the statement of
profit or loss together with the statement presenting OCI. The statement of profit or loss is the primary
source of information about the entity’s financial performance. As a default, all income and expenses
should be appropriately classified and included in the statement of profit or loss. In exceptional
circumstances, the Board may decide to exclude some income or expenses from the statement of profit
or loss, and include those in OCI, for example, income or expenses arising from a change in the current
value of an asset or liability. Conversely, in principle, any income and expenses included in OCI in one
period should be recycled to the statement of profit or loss in a future period, provided that the
recycling results in more relevant and faithfully representative information in the statement of profit or
loss. If recycling does not result in such information, the Board may decide that income and expenses
included in OCI are not to be subsequently recycled. In principle, all income and expenses should be
included in the statement of profit or loss
 Chapter 8 : Concepts Of Capital and Capital Maintenance

The capital maintenance concept states that a profit should not be recognized unless a business has at
least maintained the amount of its net assets during an accounting period. Stated differently, this means
that profit is essentially the increase in net assets during a period. This concept excludes the following
cash inflows and outflows that impact net assets:
• Increase in assets from the sale of stock to shareholders (increases cash)
• Decrease in assets from the payment of dividends or other distributions to shareholders (decreases
cash)
Technically, the capital maintenance concept means that the amount of net assets should be reviewed
for changes before determining the profit generated during an accounting period. From a practical
perspective, this is rarely done - controllers simply calculate the amount of profit and do not review for
compliance with the capital maintenance concept at all.
The capital maintenance idea is concerned with the net change in account balances during an
accounting period; it is not concerned with the proper maintenance of the actual physical equipment
owned or operated by a business.
The concept can have a more serious impact for nonprofit organizations. State law or donor agreements
may require that endowment balances not be lost - which means that endowment balances must be
replenished from other sources in periods when earnings on invested funds are negative. This can
trigger a sharp downturn in the amount of funds available for operational needs.
What Is Capital Maintenance?

Capital maintenance, also known as capital recovery, is an accounting concept based on the principle
that a company's income should only be recognized after it has fully recovered its costs or its capital has
been maintained. A company achieves capital maintenance when the amount of its capital at the end of
a period is unchanged from that at the beginning of the period. Any excess amount above this
represents the company's profit.

KEY TAKEAWAYS

• Capital maintenance, also called capital recovery, is an accounting concept that says a company's
income should only be recognized after it has fully recovered its costs or its capital has been
maintained.
• The capital maintenance concept means a company only generates a profit if it fully recovers the
costs associated with operations during a selected accounting period.
• There are two primary types of capital maintenance: financial capital maintenance and physical
capital maintenance.
• During times of high inflation, a company may need to adjust its asset valuations in order to
determine if it has achieved capital maintenance.
How Capital Maintenance Works

The capital maintenance concept means that a company only generates a profit once the costs
associated with operations during a selected accounting period have been fully recuperated. To
calculate the profit, the total value of the company's financial and other capital assets at the beginning
of the period must be known.

Types of Capital Maintenance :

• Financial Capital Maintenance

According to financial capital maintenance, a company earns a profit only if the amount of its net
assets at the end of a period exceeds the amount at the beginning of the period. This excludes
any inflows from or outflows to the owners, such as contributions and distributions. It can be
measured either in nominal monetary units or constant purchasing power units.
Financial capital maintenance is only concerned with the actual funds available at the start and
the end of a specified accounting cycle and does not include the value of other capital assets. The
two ways of looking at financial capital maintenance are money financial capital maintenance and
real financial capital maintenance.
• Under money financial capital maintenance
Under money financial capital maintenance, profit is measured if the closing net assets exceed the
opening net assets, with both measured at historical cost. The historical cost refers to the value of
the assets at the time they were acquired by the company. Under real financial capital
maintenance, profit is measured if the closing net assets exceed the opening net assets, with both
measured at current prices.

Physical Capital Maintenance

• Physical capital maintenance is not concerned with the cost associated with the actual maintenance
required on tangible items, such as equipment. Instead, it focuses on a business's ability to
sustain cash flows into the future by maintaining access to income-generating assets in use within
the business's infrastructure.

The Effect of Inflation on Capital Maintenance

A high rate of inflation—especially inflation that has occurred over a short period of time—can impact a
company's ability to accurately determine if it has achieved capital maintenance. The value of a
company's net assets may increase along with the increase in prices. However, this increase could
misrepresent the true value of the company's assets. For this reason, during inflationary times a
company may need to adjust the value of its net assets in order to determine if it has achieved capital
maintenance.