CONCEPTUAL FRAMEWORK FOR FINANCIAL

REPORTING

ACCT201
2ND SEM AY 2019-2020
 Learning Objectives

1. Describe the usefulness of a conceptual framework.

2. Describe efforts to construct a conceptual framework.
3. Understand the objective of financial reporting.
4. Identify the qualitative characteristics of accounting information.
5. Define the basic elements of financial statements.
6. Describe the basic assumptions of accounting.
7. Explain the application of the basic principles of accounting.
8. Describe the impact that constraints have on reporting
accounting information.
Conceptual Framework For Financial Reporting

Third Level:
Second Level: Recognition,
Conceptual First Level: Basic
Fundamental Measurement, and
Framework Objective
Concepts Disclosure
Concepts

Need Qualitative Basic assumptions

characteristics
Development Basic principles
Basic elements
Overview Constraints
Summary of the
structure
 Conceptual Framework

Conceptual Framework establishes the concepts

that underlie financial reporting.

Need for a Conceptual Framework

Rule-making should build on and relate to an
established body of concepts.

Enables IASB to issue more useful and consistent

pronouncements over time.
 Conceptual Framework

Development of a Conceptual Framework

IASB and FASB are working on a joint project to

develop a common conceptual framework

Framework will build on existing IASB and FASB

frameworks.

Project has identified the objective of financial

reporting and the qualitative characteristics of
decision-useful financial reporting information.
 The Revised Conceptual Framework

IASB issued the revised Conceptual Framework for Financial

Reporting in March 2018. It sets out:

● The objective of financial reporting

● The qualitative characteristics of useful financial
information
● A description of the reporting entity and its boundary
● Definition of an asset, a liability, equity, income and
expenses
● Criteria for including assets and liabilities in financial
statements (recognition) and guidance on when to remove
them (derecognition)
● Measurement bases and guidance on when to use them
● Concepts and guidance on presentation and disclosure
 Conceptual Framework

Overview of the Conceptual Framework

Three levels:
First Level = Basic objective

Second Level = Qualitative characteristics and

elements of financial statements

Third Level = Recognition, measurement, and

disclosure concepts
 2010
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. Those decisions involve buying,
selling, or holding equity and debt instruments, and
providing or settling loans and other forms of credit.

2018
The objective of general purpose financial reporting is to
provide financial information about the reporting entity that
is useful to existing and potential investors, lender and other
creditors in making decisions relating to providing resources
to the entity.
 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition 2. Materiality
3. Monetary unit 3. Expense recognition Third
level
4. Periodicity 4. Full disclosure
5. Accrual

QUALITATIVE
CHARACTERISTICS ELEMENTS
1. Fundamental 1. Assets
qualities 2. Liabilities
3. Equity
Second level
2. Enhancing
4. Income
qualities
5. Expenses

OBJECTIVES
OBJECTIVE
ToProvide information
provide financial
about the reporting
information that is
entity that is useful
to useful
presentto andusers in
potential First level
making decisions
equity investors,
lenders,to
relating and other
providing
creditors in their
resources to the
capacity as capital
entity.
Providers.
Stewardship
Users of financial reports need information to help
them assess management’s stewardship. The
Conceptual Framework explicitly discusses this
need as well as the need for information that
helps users assess the prospects for future net
cash inflows to the entity.
 Second Level: Fundamental Concepts

Qualitative Characteristics of Accounting

Information

IASB identified the Qualitative Characteristics of

accounting information that distinguish better (more
useful) information from inferior (less useful)
information for decision-making purposes.
Second Level: Fundamental Concepts
 Second Level: Fundamental Concepts

Fundamental Quality - Relevance

Information is relevant if it is capable of making a difference
to the decisions made by users.
 Second Level: Fundamental Concepts

Fundamental Quality – Faithful Representation

Information must faithfully represent the substance of what it
purports to represent. It is affected by level of measurement
uncertainty.
 Second Level: Fundamental Concepts

Enhancing Qualities
Distinguish more-useful information from less-useful
information.
 Cost Constraint

The benefit of providing the information

needs to justify the cost of providing and
using the information.
 Materiality Constraint

The materiality constraint is a threshold

used to determine whether business
transactions are important to the financial
results of a business.
 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition 2. Materiality
3. Monetary unit 3. Expense recognition Third
level
4. Periodicity 4. Full disclosure
5. Accrual

QUALITATIVE
CHARACTERISTICS ELEMENTS
1. Fundamental 1. Assets
qualities 2. Liabilities
3. Equity
Second level
2. Enhancing
4. Income
qualities
5. Expenses

OBJECTIVES
OBJECTIVE
ToProvide information
provide financial
about the reporting
information that is
entity that is useful
to useful
presentto andusers in
potential First level
making decisions
equity investors,
lenders,to
relating and other
providing
creditors in their
resources to the
capacity as capital
entity.
Providers.
 Second Level: Basic Elements

Asset – 2018
Asset – 2010
A present economic resource
A resource controlled by the
controlled by the entity as a
entity as a result of past events
result of past events. An
and from which future economic
economic resource is a right
benefits are expected to flow to
that has the potential to
the entity.
produce economic benefits.
 Second Level: Basic Elements

Main changes in the definition of an asset:

• Separate definition of an economic resource – to

clarify that an asset is the economic resource, not the
ultimate inflow of economic benefits.
• Deletion of “expected flow” – it does not need to be
certain, or even likely, that economic benefits will
arise.
• A low probability of economic benefits might affect
recognition decision and the measurement of the
asset.
 Second Level: Basic Elements

Liability – 2010 Liability – 2018

A present obligation of the A 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.
entity to transfer an economic
resource as a result of past
events. An obligation is a duty
or responsibility that the entity
has no practical ability to avoid.
 Second Level: Basic Elements

Main changes in the definition of a

liability:

• Separate definition of an economic resource – to clarify

that a liability is the obligation to transfer the economic
resource, not the ultimate outflow of economic benefits.
• Deletion of “expected flow” – with the same implication as
asset.
• Introduction of the “no practical ability to avoid” criterion
to the definition of obligation.
 Second Level: Basic Elements

“No practical ability to avoid”

Applied to:

• If a duty or responsibility arises from the entity’s customary

practices, published policies or specific statements – the entity has
an obligation if it as no practical ability to act in a manner
inconsistent with those practices, polices or statements.
• If a duty or responsibility is conditional on a particular future
action that the entity itself may take – the entity has an obligation
if it has no practical ability to avoid taking that action.
 Review

Identify the qualitative characteristic(s) to be used given the

information provided. Characteristics
(a) Qualitative characteristic being Relevance
employed when companies in the Faithful representation
same industry are using the same Predictive value
accounting principles.
Confirmatory value
(b) Quality of information that confirms Neutrality
users’ earlier expectations.
Completeness
(c) Imperative for providing comparisons Timeliness
of a company from period to period.
Verifiability
(d) Ignores the economic consequences
Understandability
of a standard or rule.
Comparability
 Review

Identify the qualitative characteristic(s) to be used given the

information provided. Characteristics
(e) Requires a high degree of consensus Relevance
among individuals on a given Faithful representation
measurement. Predictive value
(f) Predictive value is an ingredient of this Confirmatory value
fundamental quality of information. Neutrality
(g) Qualitative characteristics that Completeness
enhance both relevance and faithful Timeliness
representation.
Verifiability
Understandability
Comparability
 Review

Identify the qualitative characteristic(s) to be used given the

information provided. Characteristics
(h) Neutrality and completeness are Relevance
ingredients of this fundamental quality Faithful representation
of accounting information. Predictive value
(i) Two fundamental qualities that make Confirmatory value
accounting information useful for Neutrality
decision-making purposes.
Completeness
(j) Issuance of interim reports is an Timeliness
example of what enhancing
Verifiability
ingredient?
Understandability
Comparability
Third Level: Recognition, Measurement, and
Disclosure Concepts

These concepts explain how companies should recognize,

measure, and report financial elements and events.

Recognition, Measurement, and Disclosure Concepts

ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition 2. Materiality
3. Monetary unit 3. Expense recognition
4. Periodicity 4. Full disclosure
5. Accrual
 Definition of Equity

IAS 32.11

Equity is defined as “any contract that evidences a

residual interest in the assets of an entity after
deducting all of its liabilities.
Definition of Revenue
IAS 18

Revenue is the gross inflow of economic benefits

during the period arising from the course of the
ordinary activities of an entity, other than increases
relating to contributions from equity participants.
Revenue arising from the following transactions and
events:
• Sale of goods
• Rendering of services; and
• Use by others of entity assets yielding interest,
royalty and dividends.
 Definition of Income

● Income is increases in economic benefits during

the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities
that result in increases in equity.
Definition of Expenses

Expenses are decreases in economic benefits

during the accounting period in the form of outflows
or depletions of assets or incurrences of liabilities
that result in decreases in equity.
Measurement

● Measurement uncertainty arises when a

measure for an asset or liability cannot be
observed directly and must be estimated.
 In accounting, impairment describes a permanent
reduction in the value of a company's asset, typically
a fixed asset or an intangible asset. When testing an
asset for impairment, the total profit, cash flow, or other
benefit expected to be generated by that specific asset
is periodically compared with its current book value. If it
is determined that the book value of the asset exceeds
the future cash flow or benefit of the asset, the
difference between the two is written off and the value of
the asset declines on the company's balance sheet
 Key Takeaways on Impairment
● Impairment can occur as the result of an unusual or one-
time event, such as a change in legal or economic
conditions, change in consumer demands, or damage that
impacts an asset.
● Assets should be tested for impairment regularly to
prevent overstatement on the balance sheet.
● Impairment exists when an asset's fair value is less than
its carrying value on the balance sheet.
● If impairment is confirmed as a result of testing, an
impairment loss should be recorded.
● An impairment loss records an expense in the current
period which appears on the income statement and
simultaneously reduces the value of the impaired asset on
the balance sheet.
 What Is Impairment Loss?

● The technical definition of impairment loss is a

decrease in net carrying value, the acquisition
cost minus depreciation, of an asset that is greater
than the future undisclosed cash flow of the same
asset. An impairment occurs when assets are sold or
abandoned because the company no longer expects
them to benefit long-run operations. This is different
from a write-down, though impairment losses often
result in a tax deferral for the asset. Depending on the
type of asset being impaired, stockholders of a
publicly held company may also lose equity in their
shares, which results in a lower debt-to-equity ratio.
 Why Recognition is Important

● Recognizing assets, liabilities, equity, income and

expenses depicts an entity’s financial position and
financial performance in structured summaries (the
FS).
● The amounts recognized in a statement are included
in the totals and, if applicable, subtotals, in the
statement.
● The statements are linked because income and
expenses are linked to changes in assets and
liabilities.
Measurement
 Third Level: Assumptions

Basic Assumptions
Economic Entity – company keeps its activity separate from
its owners and other business unit.
Going Concern - company to last long enough to fulfill
objectives and commitments.
Monetary Unit - money is the common denominator.
Periodicity - company can divide its economic activitiesinto
time periods.
Accrual Basis of Accounting – transactions are recorded in
the periods in which the events occur.
 Third Level: Assumptions

Identify which basic assumption of accounting is best

described in each item below.
(a) The economic activities of FedEx Corporation
(USA) are divided into 12-month periods for the Periodicity
purpose of issuing annual reports.
(b) Total S.A. (FRA) does not adjust amounts in its Monetary
financial statements for the effects of inflation. Unit
(c) Barclays (GBR) reports current and non-current
classifications in its statement of financial Going Concern
position.
(d) The economic activities of Tokai Rubber
Industries (JPN) and its subsidiaries are merged Economic
for accounting and reporting purposes. Entity
 Third Level: Assumptions

Principles
Measurement
Cost is generally thought to be a faithful representation of the
amount paid for a given item.
Fair value is “the amount for which an asset could be exchanged,
a liability settled, or an equity instrument granted could be
exchanged, between knowledgeable, willing parties in an arm’s
length transaction.”
IASB has taken the step of giving companies the option to use fair
value as the basis for measurement of financial assets and
financial liabilities.
 Third Level: Assumptions

Revenue Recognition - revenue is to be recognized when it

is probable that future economic benefits will flow to the company
and reliable measurement of the amount of revenue is possible.
 Third Level: Assumptions

Expense Recognition - outflows or “using up” of assets

or incurring of liabilities (or a combination of both) during a
period as a result of delivering or producing goods and/or
rendering services.

“Let the expense follow the revenues.”

 Third Level: Principles

Full Disclosure – providing information that is of sufficient

importance to influence the judgment and decisions of an informed
user.
Provided through:
Financial Statements
Notes to the Financial Statements
Supplementary information
 Third Level: Principles

Identify which basic principle of accounting is best

described in each item below.
(a) Parmalat (ITA) reports revenue in its income
statement when it is earned instead of when the
cash is collected.
(b) Google (USA) recognizes depreciation expense for
a machine over the 2-year period during which that
machine helps the company earn revenue.
(c) KC Corp. (USA) reports information about pending
lawsuits in the notes to its financial statements.
(d) Fuji Film (JPN) reports land on its balance sheet at
the amount paid to acquire it, even though the
estimated fair market value is greater.
 Third Level: Principles
Identify which basic principle of accounting is best
described in each item below.

(a) Parmalat (ITA) reports revenue in its income Revenue

statement when it is earned instead of when the Recognition
cash is collected.
(b) Google (USA) recognizes depreciation expense for Expense
a machine over the 2-year period during which that Recognition
machine helps the company earn revenue.
(c) KC Corp. (USA) reports information about pending Full
lawsuits in the notes to its financial statements. Disclosure
(d) Fuji Film (JPN) reports land on its balance sheet at
the amount paid to acquire it, even though the Measurement
estimated fair market value is greater.
 Third Level: Constraints

Constraints
Cost – the cost of providing the information must be weighed
against the benefits that can be derived from using it.

Materiality - an item is material if its inclusion or omission

would influence or change the judgment of a reasonable
person.
 Third Level: Constraints

What accounting constraints are illustrated by the items

below?

(a) Willis Company does not disclose any

information in the notes to the financial
statements unless the value of the information
to users exceeds the expense of gathering it.
(b) Beckham Corporation expenses the cost of
wastebaskets in the year they are acquired.
 Third Level: Constraints

a. Willis Company does not disclose

any information in the notes to the Cost
financial statements unless the value of
the information to users exceeds the
expense of gathering it.
a. Beckham Corporation expenses the
cost of wastebaskets in the year they Materiality
are acquired.
Summary of
the Structure

OBJECTIVES
To provide financial
information that is
useful to users in
making decisions
relating to providing
resources to the
entity.