CHAPTER 7 CONCEPTUAL FRAMEWORK Presentation and disclosure Concepts of capital TECHNICAL KNOWLEDGE To know the guideline in the presentation and disclosure of financial information. To understand presentation and disclosure as an effective communication tool. To define the two concepts of capital. To determine net income under the financial capital and physical capital concept.pRESENTATION AND DISCLOSURE The presentation and diselosure can be an effectiv® ‘omunication tool about the information 10 financial guatements. 1 its assets. 4 reporting entity communicates information abow' jabilities, equity, income and expenses by presenting disclosing information in the financial statements. Effective communication of information in financial statements makes the information more relevant and contributes to /aithful representation of an entity's assets liabilities, income and expenses. Effective communication of information in financial statements also enhances the understandability and comparability of information in the statements. Effective communication in financial statements is supported by not duplicating information in different parts of the financial statements. Duplication is usually unnecessary and can make financial statements less understandable. Classification Classification is the sorting of assets, liabilities, equity, income and expenses on the basis of shared or similar characteristics. Classifying dissimilar assets, liabilities, equity, income and expenses can obscure relevant information, reduce understandability and comparability and may not provide a faithful representation of financial information For example, it could be appropriate to classify an asset or & liability into current and noncurrent. It may be necessary to classify components of equity separately if such components are subject.to legal, regulatory and other requirements. Thus, ordinary share capital, preference share capital, share premium and retained earnings should be disclosed separately. | 187Classification of income and expenses Income and expenses are classified a8 componenes of foss and components of other comprehensive income. PTofy The Revised Conceptual Framework has introduced th, statement of financial performance to refer to the stare *™ of profit or loss together with the statement presenting om tr comprehensive income. The statement of profit or loss is the primary sour, information about an entity's financial performance for the reporting period. All income and expenses should be appropriately Classifieg and included in the statement of profit or loss. However, there are certain items of income and expen, that are presented outside of profil or loss but included in other comprehensive income. The components of other comprehensive income are subsequently recycled or reclassified to profit or loss op retained earnings. Aggregation Aggregation is the adding together of assets, liabilities, equity, income and expenses that have similar or shared d are included in the same classification. characteristics an more useful by summarizing Aggregation makes information aggregation may conceal a large volume of detail. However, some of the detail. Hence, a balance should be made so that relevant information is not obscured either by a large amount of insignificant detail or by excessive aggregation. the statement of financial position and ite ized 0 Typically, statement of financial performance provide summarize! condensed information. financial More detailed information is provided in the notes to statements 138yr _spITAL MAINTENANCE ( qnancial performance of an entity in determined using sproaches, namely transaction approach and capital sph ance approach. P me nen yal transaction approach is the traditional preparation of income statement. gpital maintenance approach means that net income only after the capital used from the beginning of the od 18 maintained. ~ pero yer words, net income is the amount an entity can vibute to its owners and be as "well-off" at the end of the seat gs at the beginning. spe distinction between return of capital and return on capital important to the understanding of net income. shareholders invest in entity to earn a return on capital or an Sount in excess of their original investment. Return of capital is an erosion of the capital invested in the entity The Conceptual Framework considered two concepts of capital maintenance or well-offness, namely financial capital and physical capital, Financial capital Under a financial capital concept, such as invested money or invested purchasing power, capital is synonymous with net assets or equity of the entity. Financial capital is the monetary amount of the net assets contributed by shareholders and the amount of the increase in net assets resulting from earnings retained by the entity. Financial capital is the traditional concept based on historical “stand adopted by most entities. 189 DeeNet income under financial capital Under the financial capital concept, net income occurs «, the nominal amount of the net assets at the end of the hen exceeds the nominal amount of the net assets at the begi, °° ef the period, after excluding distributions to contmbutions by owners during the period.” ang Illustration lowing assets, liabilities and other financial data, to the current year January December 3) 1,500,000 2,500,000 1,000,000 1,200,000 stments during the year 400,000 's paid during the year 300,000 Additional im Divid Computation of net income Net assets - December 31 1,300,000 Add: Dividends paid 300,000 1,600,000 500,000 400,000 900,000 700,000 amount of nef assets is “the excess of total assets abilities” on this approach is also known as the net 140ysical capital capital is the quantitative measure of the physical | cap pnaecgve capacity to produce goods and services. “ yaical productive capacity may be based on, for example, output per day or physical capacity of productve assets to foods and services. rh pr 1 =o . cept require that productive assets be measured at Teen cst, rather than historical cost. sdectve assets include inventories and property, plant nd equipment urrent costs for these productive assets must b. ‘The cured in order that physical capital is also maintained. mainte ly, physical capital is equal to the net assets of the entity expressed in terms of current cost. cal concept of capital should be adopted if the main concern of users 18 the operating capability of the entity, meaning, the resource or fund needed to achieve that operating capability or capacity. The physi Under this concept, net income occurs “when the physical productive capital of the entity at the end of the year exceeds the physical productive capital at the beginning of the period, also after excluding distributions to and contributions from owners during the period.” Illustration Assume in the previously given illustration, the net assets fP500,000 on January 1 had a current cost of P800,000 by reason of inflationary condition. Netagsets - December 31 1,300,000 dd: Dividends paid 300,000 Foal 1,600,000 #8. Net assets at current cost, January 1 300,000 Additional investments 400,000 1,200,000 Netincome 400,000 141“" QUESTIONS - Explain presentation and disclosure as an Pffectiy, communication tool. Explain classification of assets, liabilities and equity. Explain classification of income and expenses, What is aggregation? Explain capital maintenance? Distinguish return on capital and return of capital, Explain financial capital. . Explain the net income under the financial capita) concept. Explain physical capital. . Explain the net income under the physical capital concept.> oBLEMS ntl Multiple choice (Conceptual Framework) nt achieves pe oble’ Pe resentation and disclosure requireme 1b The f the following, except a effective communication tool + Aire relevant and faithfully represented financial . , mation . informé Indability and comparability of information Understandabiy Financial position, financial performance and cas! « 8 ows jis the sorting of assets, liabilities, equity, income and 3 expenses with similar characteristics. Classification Summarization ’ Interpretation 4. Recognition a 3 all of the following can considered appropriate classification, except | a Current and noncurrent assets | p. Current and noncurrent liabilities | «. Ordinary share capital and preference share capital | a. Offsetting asset and liability 4 Income and expenses are classified as Profit or loss and other comprehensive income Profit loss and retained earnings Retained earnings and other comprehensive income Ordinary and extraordinary 5, What is the new term to describe the statement of profit or loss together with the statement showing other comprehensive income. . Income statement . Statement of profit or loss seen of other comprehensive income Statement of financial performance 143 aProblem 7-2 Multiple choice (Conceptual Framewor)) 1. Pinanctal capital is defined as a Net assets in monetary terms. : b. Net assets in terms of physical productive capacity, ©. Legal capital d_ Share capital issued and outstanding. The physical capital maintenance vanrept requires the adoption of which measurement basis? to a. Historical cost b. Current cost c. Fair value d. Present value Which concept is applied to net income and other comprehensive income? a Financial capital b Physical capital Legal capital d. Borrowed capital Which statement regarding the term profit is true? * Profit is any amount over and above that required to maintain the capital at the beginning of the period. b Profit is equal to income minus expenses. Profit is the equivalent of net income under IFRS. d All of these statements are true about the term profit. der the financial capital concept, net income occurs > nominal amount of net assets at year-end Productive capital at year-end increased ng any distributions to and contributions owners The nominal amount of net assets at year-end increased after excluding distributions to an’ ntributions from owners. i The physical productive es 1 The physical productive capital at year-end increased 144