Topic 1 - Conceptual Framework

TOPIC
THE CONCEPTUAL
FRAMEWORK FOR
FINANCIAL
REPORTING
ACT3113
Learning Outcomes
At the end of this chapter, you should be able to:

Explain what is the conceptual framework for financial
reporting
Explain what is general purpose financial statements
Explain the objectives of financial reporting
Identify the primary users of financial reporting
information
Explain the going concern concept, which is the
underlying assumption in the preparation of financial
reports
FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

© Oxford Fajar Sdn. Bhd. (008974-T), 2015 2– 2
Learning Outcomes (cont.)

Define and explain the qualitative characteristics of
useful information
Explain how the qualitative characteristics should be
applied
Explain the constraints in providing useful information
Define and explain the elements of financial
statements
Explain what transactions are recognized when the
recognition criteria are met

Learning Outcomes (cont.)

Explain the measurement basis that can be used
Explain the concept of capital maintenance
Compare and differentiate between the financial capital
maintenance concept and physical capital maintenance
concept
Explain the importance of the capital maintenance
concept to income determination

The Conceptual Framework for
Financial Reporting
 Sets out concepts that underlie the preparation and

presentation of general purpose financial statements
 explains in general sense how financial statements
should be prepared

General Purpose of
Financial Statements
 Reports about an economic entity’s financial performance,
which can be used by a wide range of users
 The report is intended for external users such as investors,
lenders, creditors, employees, government agencies and the
general public
 A complete set of financial statements consist of
 statement of financial position,
 statement of profit or loss and other comprehensive income
 statement of changes in equity
 statement of cash flows and
 notes to the accounts

The Purpose
of the Conceptual Framework
 to assist the standard setters in the development of future
accounting standards and in reviewing the standards;
 to assist preparers of financial statements in applying the
accounting standards and in dealing with topics that have yet to
be addressed by the accounting standards;
 to assist auditors in forming an opinion on whether financial
statements comply with the accounting standards;
 to assist users of financial statement in interpreting the
information contained in financial statements prepared in
compliance with the accounting standards; and
 to provide those who are interested in the work of MASB and
IASB with information about its approach to the formulation of
accounting standards
Differences between the Conceptual
Framework and Financial Reporting
Standards
Conceptual Framework for Financial Reporting

Financial Reporting Standards
 Provides a general guide on how  Provide guidance on a very
financial statements should be
prepared specific issue related to
 Sets up principals which are general financial reporting, e.g. how to
concepts account for inventories, how
 Applicable to a wide range of issues
financial statements should
 Not an accounting standard - when
there is conflict between the be presented and how to
Conceptual Framework and an apply fair value measurement
accounting standardrequirement
of standard prevails
 Apply concepts set out in the
Conceptual Framework

Content of the Conceptual
Framework
Concepts of capital maintenance

2.1 Objective of Financial
Reporting
 To provide financial information about the reporting

entity that is useful for economic decision-making
 Economic decisions are decisions about providing
resources to an entity, for example decision to
 provide capital to a business
 hold shares in a company
 provide loan to a company
 discontinue a business unit


Primary Users of
Financial Reporting Information
 Investors
Existing and potential investors provide capital to the entity. They invest
in equity instruments such as ordinary, or preferences shares or debt
instruments such as bonds. They are interested in minimizing their
risks and maximizing their returns.
 Lenders
Lenders include financial institutions and all parties who lend money to
the entity. Decisions by lenders about providing or settling loans
depend on the company’s ability to service the principal and interest
payments.
 Creditors
Creditors supply goods and services to the entity on credit terms.
Decisions by creditors to extend credit to a company would depend
on the company’s ability to settle the credit on time.

Other Users of Financial
Reporting Information
 Employees
Employees are workers of the entity. They are interested in the
entity’s ability to pay salaries and wages and other
employment benefits such as healthcare benefits and
retirement benefits.
 Customers
Customers are interested in the entity’s ability to continue to
operate in the future, especially those who are dependent
on the goods and services provided by the entity.

Other Users of Financial Reporting Information
(cont.)
 Government agencies and regulators

Government and their agencies need financial information for
few purposes such as tax assessment, compliance to rules
and regulations, to make macroeconomic policies and
regulate activities.
 Public
The public are other users who do not have direct interest in
the entity. They are more interested in the company’s
corporate social activities such as producing green
products, proper management of waste, donations to
charitable institutions and social causes, and provision of
scholarships.
2.2 Qualitative
Characteristics of Useful
Information

Fundamental Qualitative
Characteristics (Relevance)

Fundamental Qualitative
Characteristics
(Faithful Representation)

Enhancing Qualitative
Characteristics

Application of Enhancing
Qualitative Characteristics

Cost Constraint on Useful
Financial Reporting
Costs
Costs to users
Costs to providers Costs of analyzing and interpreting
Costs in collecting, the information and to obtain
processing, verifying and information elsewhere or to
disseminating financial estimate the information in cases
information where the information needed was
not provided by the reporting entity
The guiding principle in determining what information to reportthe

benefit to users should outweigh the costs incurred to prepare the
information
2.3 Underlying
Assumption
Going Concern
 Financial statements are prepared on the assumption
that an entity is a going concern.
 The entity is expected to continue to operate for the
foreseeable future with no intention or the need to
liquidate or reduce significantly the size of its
operations.
 This enables the historical cost to be used as a basis
of measurement.
 If the entity is not a going concern, the historical cost
basis cannot be used.

2.4 Elements of Financial
Statements:
Related to the Measurement of
Financial Position

Elements of Financial Statements:
Financial Performance

Elements of Financial Statements:
Financial Performance (cont.)

2.4.1 Recognition
 When an item is recognized, it is included in the statement of

financial position or statement of profit or loss and other
comprehensive income.
 For an item to be recognized, it must meet the definition of the
element (assets, liabilities, equity, income or expenses) and
fulfil the recognition criteria.
 Recognition criteria
1. It is probable that the future economic benefit associated with
an item will flow to or from the entity; and
2. The item has a cost or value that can be measured reliably.

Recognition
Example: To recognize a building as an asset

2.4.2 Measurement
 Measurement is the process of determining the monetary

amounts for specific items to be recognized, and carried,
on the statement of financial position and the statement of
profit or loss and other comprehensive income.
 A number of different bases of measurement are used to
different degrees, and in varying combination, in the
financial statements.

Measurement: Historical
Cost
 Historical cost is the amount of cash or cash equivalents

paid, or the fair value of the consideration given, to acquire
an asset at the date of acquisition.
Example 1: Syarikat Wawasan paid cash amounting to

RM60,000 to acquire a van.
Explanation: The historical cost of the van is determined
based on the amount of cash paid to acquire the asset.
Therefore, the historical cost of the van is RM60,000.

Measurement: Historical Cost
(cont.)
Example 2: Syarikat Wawasan issued 20,000 units of its

ordinary share (at par value of RM1.00) to acquire a piece of
land. The asking price of the land is RM75,000 while the
market price of the ordinary share on the date of the
transaction is RM3.50 per share.
Explanation: The historical cost of the land is determined
based on fair value of the consideration (ordinary shares)
given to acquire the land at the date of acquisition. Therefore,
the historical cost of the land is RM70,000 (20,000 × RM3.50).
In this example, the market value of the shares is taken as the
fair value.
Measurement: Historical Cost
(cont.)
 For a liability, historical cost is the amount of proceed

received in exchange for the obligation or the amount of
cash or cash equivalents expected to be paid to settle the
liability in the normal course of a business.
Example: Syarikat Wawasan issued a 90-day, 5% note

payable amounting to RM8,000 for the purchase of
inventories.
Explanation: The historical cost of the note payable is
determined based on the amount of cash or cash
equivalents expected to be paid to settle the liability in the
normal course of the business. Therefore, the historical
cost for the notes payable is RM8,000.

Measurement:
Current Cost
 The current cost for an asset is the amount of cash or

cash equivalents that would have to be paid if the same
or equivalent asset was acquired currently.
 The current cost of a liability is the undiscounted amount
of cash or cash equivalents that would be required to
settle the current obligation.
Example: On 1 June 20x4, Syarikat Wawasan bought a
piece of land and paid RM70,000 in cash. On 1 June
20x5, the market value of the land is RM80,000. The
current cost of the land is RM80,000.

Measurement: Realizable Value
 Realizable value of an asset is the amount of cash or cash

equivalents that could currently be obtained by selling the
asset in an orderly disposal.
 Orderly disposal means that the sale is not a forced sale.
In a forced sale the seller may have to accept a
discounted price for the asset.
 The realizable value of a liability is their settlement value,
which is the undiscounted amount of cash or cash
equivalents expected to be paid to satisfy the liability in the
normal course of the business.

Measurement: Realizable Value
(cont.)
Example: On 1 June 20x4, Syarikat Wawasan bought a van

and paid RM60,000 in cash. On 1 June 20x5, the market
value of the van is RM58,000. To sell the van, a cost
equivalent to 2% of the market price is expected to be
incurred. The net realizable value of the van is RM56,840
[RM58,000 – (58,000 × 0.02)].

Measurement: Present Value
 The present value of an asset is the present discounted

value of the future net cash inflows that the asset is
expected to generate in the normal course of business.
 The present value of a liability is the present discounted
value of the future net cash outflows that is expected to
be required to settle the liability in the normal course of
business.

Measurement: Present Value
(cont.)
Example: On 1 June 20x4, Syarikat Wawasan bought a piece of

land for RM70,000. Syarikat Wawasan will pay RM10,000 in cash
in equal instalments over a period of seven years. Since the
payment for the asset will be over several years, the cost of the
van should be stated at its present value. To determine the
present value of the asset, RM10,000 is multiplied by the present
value factor. Assuming the interest rate is 10%, the present value
factor of 10% for seven years is 4.8684. Therefore, the present
value of the land is RM48,684 (RM10,000 × 4.8684).


2.4.3 Capital Maintenance
Concept
 The concept of capital maintenance states that income is only

recognized after capital has been maintained or when there
has been a full recovery of costs.
 Capital maintenance has been reached if the amount of net
assets (assets – liabilities) at the end of a period is unchanged
from the net assets (assets – liabilities) at the beginning of the
period, with any excess amount treated as profit.
 Two concepts of capital maintenance are the financial capital
maintenance and the physical capital maintenance.
 The Conceptual Framework does not prescribe a particular
model of capital maintenance. The choice is left to the
management of an entity to exercise judgment and select the
concept of capital maintenance that provides the most useful
information to the users of financial statements.

Capital Maintenance Concept (cont.)

Capital Maintenance Concept (cont.)

Financial Capital Maintenance
 Under the financial capital maintenance concept, a profit is

earned only if the financial or money amount of the net assets at
the end of the period, exceeds the financial or money amount of
net assets at the beginning of the period, after excluding any
distributions to, and contributions from owners, during the period.
 Financial capital maintenance can be measured in either nominal
monetary units or units of constant purchasing power.
 All price changes affecting the assets and liabilities of the entity
are viewed as profits.
 Based on the example, the profit for the period of RM150,000 for
Syarikat Wawasan is determined based on the financial capital
maintenance concept.
Physical Capital Maintenance
 Under the physical capital maintenance concept, a profit is

earned only if the physical productive capacity or operating
capacity of the entity at the end exceeds the physical
productive capacity or operating capacity at the beginning
of the period, after excluding any distributions to, and
contributions from owners during the period.

Physical Capital Maintenance
(cont.)
 All price changes affecting the assets and liabilities of the

entity are viewed as changes in the measurement of the
physical productive capacity of the entity, and hence, are
treated as capital maintenance adjustments that are part of
equity and not as profit.
 Based on the example, assume that net asset at the end of
the period should be RM540,000 in order to maintain
physical productive capacity as at the beginning of the
period, thus profit for the period under this concept is
RM110,000 (= RM650,000 – RM540,000).


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TOPIC

At the end of this chapter, you should be able to:

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

At the end of this chapter, you should be able to:

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

At the end of this chapter, you should be able to:

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

 Sets out concepts that underlie the preparation and

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

Conceptual Framework for Financial Reporting

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

Concepts of capital maintenance

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

 To provide financial information about the reporting

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

 Government agencies and regulators

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

The guiding principle in determining what information to reportthe

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

 When an item is recognized, it is included in the statement of

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

Example: To recognize a building as an asset

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

 Measurement is the process of determining the monetary

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

 Historical cost is the amount of cash or cash equivalents

Example 1: Syarikat Wawasan paid cash amounting to

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

Example 2: Syarikat Wawasan issued 20,000 units of its

 For a liability, historical cost is the amount of proceed

Example: Syarikat Wawasan issued a 90-day, 5% note

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

 The current cost for an asset is the amount of cash or

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

 Realizable value of an asset is the amount of cash or cash

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

Example: On 1 June 20x4, Syarikat Wawasan bought a van

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

 The present value of an asset is the present discounted

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

Example: On 1 June 20x4, Syarikat Wawasan bought a piece of

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

 The concept of capital maintenance states that income is only

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

 Under the financial capital maintenance concept, a profit is

 Under the physical capital maintenance concept, a profit is

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

 All price changes affecting the assets and liabilities of the

FINANCIAL ACCOUNTING AND REPORTING 1 All Rights Reserved

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