What

What is
is Financial
Financial Reporting?
Reporting?
Financial Reporting involves the disclosure of financial information
to the various stakeholders about the financial performance and
financial position of the organization over a specified period of time.
These stakeholders include – investors, creditors, public, debt
providers, governments & government agencies.
In case of listed companies the frequency of financial reporting is
quarterly & annual. Typical components of financial reporting are:
1. The financial statements – Balance Sheet, Profit & loss
account, Cash flow statement & Statement of changes in
stock holder’s equity
2. The notes to financial statements
3. Quarterly & Annual reports (in case of listed companies)
4. Prospectus (In case of companies going for IPOs)
5. Management Discussion & Analysis (In case of public
companies)
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 Financial
Financial Reporting
Reporting

 As in any industry, whether manufacturing or service, we have

multiple departments. The functioning of these departments are
linked together by one common thread – Accounting & Finance
department.
 The accounting & financial aspects of each and every department
are recorded and are reported to various stakeholders. There are
two different types of reporting
1) Financial reporting for various stakeholders
2) Management Reporting for internal Management of an organization.

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 Conceptual
Conceptual Framework
Framework for
for Financial
Financial
Reporting
Reporting

Chapter 1

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 Conceptual Framework
for Financial Reporting

LEARNING
LEARNING OBJECTIVES
OBJECTIVES
After studying this chapter, you should be able to:

1. Describe the usefulness of a 5. Define the basic elements of financial

conceptual framework. statements.

2. Describe efforts to construct a conceptual 6. Describe the basic assumptions of

framework. accounting.

3. Understand the objective of financial 7. Explain the application of the basic principles
reporting. of accounting.

4. Identify the qualitative characteristics of 8. Describe the impact that the cost constraint
accounting information. has on reporting accounting information.

2-4
 Conceptual
Conceptual Framework
Framework
 A conceptual framework is a statement of generally
accepted theoretical principles which form the frame of
reference for financial reporting.
 These theoretical principles provide the basis for the
development of new accounting standards and the evaluation
of those already in existence.
 The financial reporting process is concerned with providing
information that is useful in the business and economic
decision-making process.
 Therefore a conceptual framework will form the theoretical
basis for determining which events should be accounted for,
how they should be measured and how they should be
communicated to the user.

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 CONCEPTUAL
CONCEPTUAL FRAMEWORK
FRAMEWORK

Overview of the Conceptual Framework

Three levels:
 First Level = Objectives of Financial Reporting
 Second Level = Qualitative Characteristics and
Elements of Financial Statements
 Third Level = Recognition, Measurement, and
Disclosure Concepts.

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 FIRST
FIRST LEVEL:
LEVEL: BASIC
BASIC OBJECTIVE
OBJECTIVE

OBJECTIVE
To provide financial information about the reporting entity
that is useful to present and potential equity investors,
lenders, and other creditors in making decisions about
providing resources to the entity.

 Provided by issuing general-purpose financial statements.

 Assumption is that users need reasonable knowledge of business
and financial accounting matters to understand the information.

2-7 LO 3
SECOND
SECOND LEVEL:
LEVEL: FUNDAMENTAL
FUNDAMENTAL CONCEPTS
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.

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SECOND
SECOND LEVEL:
LEVEL: FUNDAMENTAL
FUNDAMENTAL CONCEPTS
CONCEPTS

ILLUSTRATION 2-2
Hierarchy of Accounting
Qualities

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ILLUSTRATION 2-7
Conceptual Framework
for Financial Reporting

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Relevance

To be relevant, accounting information must be capable of making

a difference in a decision.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Relevance

Financial information has predictive value if it has value as an input

to predictive processes used by investors to form their own
expectations about the future.
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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Relevance

Relevant information also helps users confirm or correct prior

expectations.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Relevance

Information is material if omitting it or misstating it could influence

decisions that users make on the basis of the reported financial
information.
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 Faithful
Faithful Representation
Representation

ILLUSTRATION 2-7
Conceptual Framework
for Financial Reporting

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Faithful Representation

Faithful representation means that the numbers and descriptions

match what really existed or happened.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Faithful Representation

Completeness means that all the information that is necessary for

faithful representation is provided.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Faithful Representation

Neutrality means that a company cannot select information to favor

one set of interested parties over another.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Faithful Representation

An information item that is free from error will be a more accurate

(faithful) representation of a financial item.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Enhancing Qualities

Information that is measured and reported in a similar manner for

different companies is considered comparable.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Enhancing Qualities

Verifiability occurs when independent measurers, using the same

methods, obtain similar results.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Enhancing Qualities

Timeliness means having information available to decision-makers

before it loses its capacity to influence decisions.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Enhancing Qualities

Understandability is the quality of information that lets reasonably

informed users see its significance.

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 Basic
Basic Elements
Elements

ILLUSTRATION 2-7
Conceptual Framework
for Financial Reporting

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 SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements

Asset A resource controlled by the entity as a

result of past events and from which
future economic benefits are expected to
Liability flow to the entity.

Equity

Income

Expenses
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 SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements

Asset
A present obligation of the entity arising
from past events, the settlement of which
Liability
is expected to result in an outflow from the
entity of resources embodying economic
Equity benefits.

Income

Expenses
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 SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements

Asset

Liability

Equity The residual interest in the assets of the

entity after deducting all its liabilities.

Income

Expenses
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 SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements

Asset

Liability

Equity Increases in economic benefits during the

accounting period in the form of inflows or
enhancements of assets or decreases of
Income
liabilities that result in increases in equity,
other than those relating to contributions
Expenses from equity participants.
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 SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements

Asset

Liability

Equity Decreases in economic benefits during the

accounting period in the form of outflows
Income or depletions of assets or incurrences of
liabilities that result in decreases in equity,
other than those relating to distributions to
Expenses
equity participants.
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 SECOND LEVEL: BASIC ELEMENTS
Exercise 2-4: Identify the qualitative characteristic(s) to be used
given the information provided. Characteristics
(a) Qualitative characteristic being Relevance
displayed 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.
Materiality
(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
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 SECOND LEVEL: BASIC ELEMENTS
Exercise 2-4: 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) Four qualitative characteristics that Materiality
enhance both relevance and faithful Timeliness
representation.
Verifiability
(h) An item is not reported because its Understandability
effect on income would not change a
Comparability
decision.
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 SECOND LEVEL: BASIC ELEMENTS
Exercise 2-4: Identify the qualitative characteristic(s) to be used
given the information provided. Characteristics
(i) Neutrality is a key ingredient of this Relevance
fundamental quality of accounting Faithful representation
information. Predictive value
(j) Two fundamental qualities that make Confirmatory value
accounting information useful for Neutrality
decision-making purposes.
Materiality
(k) Issuance of interim reports is an Timeliness
example of what enhancing
Verifiability
ingredient?
Understandability
Comparability
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THIRD
THIRD LEVEL:
LEVEL: RECOGNITION,
RECOGNITION, MEASUREMENT,
MEASUREMENT,
AND
AND DISCLOSURE
DISCLOSURE CONCEPTS
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
3. Monetary unit 3. Expense recognition
4. Periodicity 4. Full disclosure
5. Accrual

ILLUSTRATION 2-7
Conceptual Framework for
Financial Reporting

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 THIRD
THIRD LEVEL:
LEVEL: ASSUMPTIONS
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 activities into

time periods.

Accrual Basis of Accounting – transactions are recorded in the

periods in which the events occur.
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 THIRD
THIRD LEVEL:
LEVEL: BASIC
BASIC PRINCIPLES
PRINCIPLES

Measurement Principles
 Historical Cost is generally thought to be a faithful
representation of the amount paid for a given item.

 Fair value is defined as “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.”

 IASB has given companies the option to use fair value as the
basis for measurement of financial assets and financial
liabilities.
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 THIRD
THIRD LEVEL:
LEVEL: BASIC
BASIC PRINCIPLES
PRINCIPLES

Measurement Principles
IASB established a fair value hierarchy that provides insight into
the priority of valuation techniques to use to determine fair value.
ILLUSTRATION 2-4

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 THIRD
THIRD LEVEL:
LEVEL: BASIC
BASIC PRINCIPLES
PRINCIPLES

Revenue Recognition
When a company agrees to perform a service or sell a product to
a customer, it has a performance obligation.

Requires that companies recognize revenue in the accounting

period in which the performance obligation is satisfied.

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THIRD
LEVEL:
BASIC
PRINCIPLES
Illustration: Assume
the Airbus (DEU) signs
a contract to sell
airplanes to British
Airways (GRB) for
€100 million. To
determine when to
recognize revenue,
Airbus uses the five
steps for revenue
recognition shown at
right.
ILLUSTRATION 2-5
The Five Steps of
2-38
Revenue Recognition
 THIRD
THIRD LEVEL:
LEVEL: BASIC
BASIC PRINCIPLES
PRINCIPLES

Expense Recognition - Outflows or “using up” of assets

or incurring of liabilities during a period as a result of delivering
or producing goods and/or rendering services. ILLUSTRATION 2-6
Expense Recognition

“Let the expense follow the revenues.”

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 THIRD LEVEL: BASIC 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

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 THIRD LEVEL: COST CONSTRAINT

Cost Constraint
Companies must weigh the costs of providing the information
against the benefits that can be derived from using it.

 Rule-making bodies and governmental agencies use cost-

benefit analysis before making final their informational
requirements.
 In order to justify requiring a particular measurement or
disclosure, the benefits perceived to be derived from it
must exceed the costs perceived to be associated with it.

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Summary of
the Structure

ILLUSTRATION 2-7
Conceptual Framework
for Financial Reporting

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