Financial Accounting &

Analysis
Conceptual framework of financial
accounting and reporting,
importance, objective of accounts,
qualitative characteristics
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(Conceptual framework of financial accounting and reporting, importance, objective of accounts, qualitative characteristics)

This chapter will teach you about the conceptual framework of financial accounting and
reporting

Learning Objectives

At the end of this topic, you will be able to:

Understand what is conceptual framework of financial
accounting and reporting.
Develop an understanding of the importance of
conceptual framework of financial accounting and
reporting
Identify the objective of the conceptual framework.
Understand the qualitative characteristics of
accounting information.
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(Conceptual framework of financial accounting and reporting, importance, objective of accounts, qualitative characteristics)

Overview of conceptual framework

There are three main levels of Conceptual Framework

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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(Conceptual framework of financial accounting and reporting, importance, objective of accounts, qualitative characteristics)
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(Conceptual framework of financial accounting and reporting, importance, objective of accounts, qualitative characteristics)

What is conceptual framework and it’s need

Conceptual Framework

A conceptual framework is like a constitution. The Accounting Conceptual Framework (ACF) is a set of accounting
objectives and fundamental has been developed by the International Accounting Standards Board (IASB). This is to
ensure that there is uniformity in interpretation across various accounting methodologies.

Necessity of conceptual framework

The ACF clearly defines the objectives and users of the financial statements. This ensures that there is consistency
of comprehension and provides a basis for discussion (and dispute resolution) amongst the practitioners of
accountancy by setting up principles of uniform interpretation of the line elements in financial statements.

It helps the auditors to prepare legible reports that can be understood anywhere and everywhere.

It defines the basic characteristics which make the accounting information useful like the detailing of the elements
of financial statements (Income, assets, liabilities and provisions etc.) and reporting their purpose and standard
comprehension.
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(Conceptual framework of financial accounting and reporting, importance, objective of accounts, qualitative characteristics)

Need for conceptual framework

A standard setting should build on and relate to an established body of concepts and objectives. A soundly
developed conceptual framework should be able to enable the development and issuance of a coherent set of
standards and practices built upon the same foundation.

Such a framework should enhance comparability among the financial statements of  different companies.  Similar
events should be similarly accounted for and reported; dissimilar events should not be.

Then, new and emerging practical problems should be solved more quickly by referring to an existing framework of
basic theory.
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Objective of conceptual framework

While providing information to users of financial statements, the accounting profession has always relied on
general-purpose financial statements. The main purpose of these is to provide useful information to various
user groups at reasonable cost. Behind these objectives is the presumption that the users have a good
understanding of the matters related to business and financial accounting. This is important because it means
that when we have prepared the financial statements, accountants can assume that users have a reasonable
level of competence; this has an impact on the way and the extent to which information is reported.

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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Hierarchy
(Conceptual framework of financial accounting and reporting, importance, objective of accounts, qualitative of
characteristics)
Accounting Qualities
Primary users of Capital Providers (Investors & creditors) And
accounting information Their Characteristics

Constraint
Cost

Persuasive criterion Decision - Usefulness

Fundamental
Relevance Faithful Representation
Qualities

Ingredients of
Predictive Confirmatory Complete Free from
fundamental Materiality Neutrality
Value Value ness error
qualities

Enhancing
qualities Comparability Verifiability Timeliness Understandability
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Fundamental
(Conceptual framework of financial accounting and reporting, importance, objective of accounts, qualitative Quality-
characteristics)
Relevance

Relevance
Fundamental Quality

Predictive Value Confirmatory Value Materiality

Ingredients of the
Fundamental Quality

To be relevant, accounting information must be capable of making a difference in a decision.

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(Conceptual framework of financial accounting and reporting, importance, objective of accounts, qualitative characteristics)

Fundamental Characteristic-Relevance

In accounting, the term relevance means it will make a difference to a decision maker. Relevant information is

capable of making a difference in the decisions made by users. It is capable of making a difference in decisions
if it has predictive value, confirmatory value, or both.

Predictive value helps users in predicting or anticipating future outcomes.\

Confirmatory value enables users to check and confirm earlier predictions or evaluations.

For example, in the decision to replace an equipment that has been used for the past six years, the original cost
of the equipment does not have relevance. In other words, the original cost is irrelevant or is not relevant in the
decision to replace the equipment. What will have relevance are the future amounts, such as the cost of the
new equipment, and the savings that will occur when the old equipment is replaced. 

Another way of expressing relevance is that costs that will differ among alternatives. Costs that will not differ
among alternatives do not have relevance. 
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Fundamental Characteristic-Relevance

In order to have relevance, the accounting information must be timely. Financial statements issued three weeks
after the accounting period ends will have more relevance than financial statements issued several months
after the period ends. Having timeliness and relevance may mean that some precision or reliability is sacrificed.
 

The Relevance of information is affected by its nature and its materiality. 

Materiality: Information is material if omitting it, or misstating it could influence decisions that users make on
the basis of financial information about a specific reporting entity. 

Materiality is an aspect of relevance which is entity-specific. It means that what is material to one entity may
not be material to another. It is relative. Information is material if it is significant enough to influence the
decision of users. Materiality is affected by the nature and magnitude (or size) of the item. 
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Fundamental
(Conceptual framework of financial accounting and reporting, importance, objective of accounts, qualitative Quality-
characteristics)
Faithful Representation
Faithful Representation

Fundamental Quality

Completeness Neutrality Free from error

Ingredients of the
Fundamental Quality

Faithful representation means that the numbers and descriptions depict the real information, what really
existed or happened.
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(Conceptual framework of financial accounting and reporting, importance, objective of accounts, qualitative characteristics)

Fundamental Characteristic-Faithful Representation

The Financial reports represent economic events in words and numbers. The financial information in the
financial reports should represent what it is meant to represent. Which means that it should show what really is
existing (Example: Balance Sheet which is a Position of Assets and Liabilities) and what really
happened (Example: Profit & Loss statement which is Position of Income and expenditure), as the case may
be.  

There are three characteristics of faithful representation:  

1. Completeness: Depiction of all necessary information for a user to understand the phenomenon being
depicted. It includes all necessary descriptions and explanations (adequate or full disclosure of all necessary
information),  
2. Neutrality: Depiction without bias in the selection or presentation of Financial information must not be
manipulated in any way in order to influence the decision of users. (fairness and freedom from bias), We often
refer to a term called True and Fair View in Accounting.
3. Free from error: This means there are no errors and inaccuracies in the description of the phenomenon and
no errors made in the process by which the financial information was produced. (no inaccuracies and
omissions). That does not mean no inaccuracies can arise, particularly in case of making estimates. The
standards expect that the estimates are made on a realistic basis and not arbitrarily. 
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Enhancing Qualities

Fundamental
Qualities Relevance Faithful Representation

Ingredients of
fundamental Predictive Confirmatory Complete Free from
Materiality Neutrality
qualities Value Value ness error

Enhancing
Comparability Verifiability Timeliness Understandability
qualities
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(Conceptual framework of financial accounting and reporting, importance, objective of accounts, qualitative characteristics)

Enhancing Qualities
Enhancing Qualitative Characteristics distinguish more useful information from less useful information.

The Enhancing Qualitative Characteristics are divided into 4 attributes.

1. Comparability 
2. Verifiability
3. Timeliness
4. Understandability

Comparability

Comparability is the Qualitative characteristic which enables the users to identify and understand similarities
and differences among items. Information about a reporting entity is more useful if it can be compared with
similar information about other entities and with similar information about other entities and with similar
information about the same entity for another period or date.  
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(Conceptual framework of financial accounting and reporting, importance, objective of accounts, qualitative characteristics)

Enhancing Qualities
Consistency vs. Comparability

Consistency is not the same as Comparability. Consistency refers to the use of the same methods for the same
items (Consistency of Treatment) either from period to period within a reporting entity or in a single period
across entities. Users must be able to distinguish between different accounting policies in order to be able to
make a valid comparison of similar items in the accounts of different entities.

Verifiability

A company's accounting results are verifiable when they're reproducible, so that an independent accountant
can produce the same result the company did, given the same data and assumptions
Verifiability helps assure that Information faithfully represents the economic events it is representing. It means
that different knowledgeable and observers could reach the same conclusion that a particular picture is a
Faithful Representation.  Verifiability isn't about determining whether the assumptions a company makes are
correct. Rather, it's about determining whether the accounting result the company reaches is according to the
data, given the assumptions that have been made.
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(Conceptual framework of financial accounting and reporting, importance, objective of accounts, qualitative characteristics)

Enhancing Qualities
The Financial Accounting Standards Board, which writes the rules for the U.S. accounting profession, says that
verifiability provides assurance that "accounting measures represent what they purport to represent." It's not
enough for a company to say the answer is "2." It also has to show you the "1 + 1" on the other side of the
equation. If this is not proved the data is not verifiable

Timeliness

The timeliness of accounting information refers to the provision of information to users quickly enough for
them to take action. Information becomes obsolete and useless if it is not reported within time. Usually the
Acts specify the time for preparation and presentation of Financial reports.

Understandability

Understandability requires the financial information to be understandable or comprehensible to users with

reasonable knowledge of business and economic activities. To be understandable, information should be
presented clearly and concisely. However, it is improper to exclude complex items just to make the reports
simple and understandable
(Financial Accounting & Analysis)
(Conceptual framework of financial accounting and reporting, importance, objective of accounts, qualitative characteristics)

Summary

In this topic, you learnt:

Understand what is conceptual framework of financial

accounting and reporting.
Develop an understanding of the importance of
conceptual framework of financial accounting and
reporting
Identify the objective of conceptual framework.
Understand the qualitative characteristics of
accounting information.