Review of Conceptual Framework and Accounting
Rules
Module 1: Valuation and Concepts
Nature of Conceptual Framework
 A conceptual framework can be defined as a system
of ideas and objectives that lead to the creation of a
consistent set of rules and standards. Specifically in
accounting, the rule and standards set the nature,
function and limits of financial accounting and
financial statements. The main reasons for
developing an agreed conceptual framework are
that it provides:
 a framework for setting accounting standards;
 a basis for resolving accounting disputes;
 fundamental principles which then do not have
to be repeated in accounting standards.
Concepts and Standards
 The overall purpose of accounting standards is to
identify proper accounting practices for the
preparation and presentation of financial
statements.
 Accounting standards create common
understanding between preparers and users of
financial statements particularly on how items, for
example the valuation of assets are treated.
Financial statements shall therefore comply with all
applicable accounting standards.
Status of the conceptual framework
 The Conceptual Framework is not a standard. If
there is a conflict between a standard and the
Conceptual Framework, the requirement of the
standard will prevail.
 The authoritative status of the Conceptual
Framework is depicted in the hierarchy of guidance
shown below:
Hierarchy of reporting standards:
1. Philippine Financial Reporting Standards (PFRS)
2. Judgment
 When making the judgment: Management shall
consider the following:
a. Requirements in other PFRSs dealing with
similar transactions
b. Conceptual Framework
Management may consider the following:
a. Pronouncements issued by other standard-
setting bodies
b. Other accounting literature and industry
practices.
Scope or Territorial Jurisdictions
 The Conceptual Framework is concerned with
general purpose financial reporting, which involves
the preparation of general purpose financial
statements. The Conceptual Framework provides
the concepts that underlie general purpose financial
reporting with regard to the following:
a. The objective of financial reporting
b. Qualitative characteristics of useful financial
information
c. Financial statements and the reporting entity
d. The elements of financial statements
e. Recognition and derecognition Measurement
f. Presentation and disclosure
g. Concepts of capital and capital maintenance
Objectives of the Framework
 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. This objective is the foundation of the
Conceptual Framework. All the other aspects of the
Conceptual framework revolve around this
objective.
Purposes Of The Conceptual Framework
 The Conceptual Framework prescribes the concepts
of general purpose financial reporting. Its purpose is
to: assist he International Accounting Standards
Board (IASB) in developing standards that are based
on consistent concepts;
a. assist preparers in developing consistent
accounting policies when no
b. standard applies to a particular transactions or
when a standard allows a
c. choice of accounting policy; and
 d. assist all parties in understanding and
interpreting the standards.
The Conceptual Framework provides the foundation for
the development of Standards that:
a. promote transparency by enhancing the
international comparability and quality of
financial information.
b. strengthen accountability by reducing the
information gap between providers of capital
and the entity’s management.
c. contribute to economic efficiency by helping
investors identify opportunities and risks
around the world, thus improving capital
allocation. The use of a single, trusted
accounting language lowers the cost of capital
and reduces international reporting costs.
Definition Of Financial Statement Elements
The elements of financial statements are:
 Assets
 Liabilities
 Equity
 Income
 Expenses
Asset
 An asset is “a present economic resource controlled
by the entity as a result of past events. An economic
resource is a right that has the potential to produce
economic benefits.
The definition of an asset has the following three
aspects:
a. Right
b. Potential to produce economic benefits
c. Control
Right
 Asset is an economic resource and an economic
resource is a right that has the potential to produce
economic benefits. Rights have the potential to
produce economic benefits including:
Rights that correspond to an obligation of another
party:
 Right to receive cash, goods or services.
 Right to exchange economic resources with
another party on favourable terms.
 Right to benefit from an obligation of another
party to transfer economic resource is a
specified uncertain future event occurs
Rights that do not correspond to an obligation of
another party:
 Right over physical objects (e.g., right to use a
property or right to sell an inventory)
 Right to use intellectual property
Potential To Produce Economic Benefits
 An economic resource can produce economic
benefits for an entity in many ways. For example,
the asset may be:
a. Sold, leased, transferred or exchanged for other
assets;
b. Used singly or in combination with other assets
to produce goods or provide services;
c. Used to enhance the value of other assets;
d. Used to promote efficiency and cost savings; or
e. Used to settle a liability.
Control
 Control means the entity has the exclusive right
over the benefits of an asset and the ability to
prevent others from accessing those benefits.
Accordingly, if one party controls an asset, no other
party controls the asset.
 Control does not mean that the entity can ensure
the resource will produce economic benefits in all
circumstances. It only means that if the resource
produces benefits, it is the entity who will obtain
those benefits and not another party.
Liability
 Liability is a “present obligation of the entity to
transfer an economic resource as a result of past
events. The definition of a liability has the following
three aspects:
1. Obligation
2. Transfer of an economic resource
3. Present obligation as a result of past events
Obligation
  An obligation is a duty or responsibility that an
entity has no practical ability to avoid. An obligation
is either:
Legal obligation – an obligation that results from a
contract, legislation, or other operation of law; or
Constructive obligation – an obligation that results
from an entity’s actions (e.g., past practice or published
policies) that create a valid expectation on others that
the entity will accept and discharge certain
responsibilities
 An obligation is always owed to another party.
However, it is not a necessary that the identity of
that party is known, for example, an obligation for
environmental damages may be owned to the
society at large.
Transfer Of An Economic Resource
 The liability is the obligation that has the potential
to require the transfer of an economic resource to
another party and not the future economic benefits
that the obligation may cause to be transferred.
Thus, the obligation’s potential to cause a transfer
of economic benefits need not be certain, or even
likely, for example, the transfer may be required
only if a specified uncertain future event occurs.
What is important is that the obligation already
exists and that, in at least one circumstance, it
would require the entity to transfer an economic
resource.
Transfer of an economic resource (continued)
Present Obligation As A Result Of Past Events
 The obligation must be a present obligation that
exists as a result of past events.
A present obligation exists as a result of past events if:
a. The entity has already obtained economic
benefits or taken an action; and
b. As a consequence, the entity will or may have to
transfer economic resource that it would not
otherwise have had to transfer.
Equity
 “Equity is the residual interest in the assets of the
entity after deducting all its liabilities. The definition
of equity applies to all entities regardless of form
(i.e., sole proprietorship, partnership, cooperative,
corporation, non-profit entity, or government
entity).
Income
 Income is “increases in assets, or decreases in
liabilities, that result in increase in equity, other
than those relating to contributions from holders of
equity claims”
Expense
 Expenses are decreases in assets, or increase in
liabilities, that result in decrease of equity, other
than those relating to distributions to holders of
equity claims”

 Consequently, a liability can exist even if the

probability of a transfer of economic resource is
low, although that low probability affects decisions
on whether the liability is to be recognized, how it is
measured, what information is provided.

An obligation to transfer an economic resource may be

an obligation to:

a. Pay cash, deliver goods, or render services;

b. Exchange assets with another party on unfavourable
terms;
c. Transfer assets if a specified uncertain future event
occurs; or
Objectives Of Financial Reporting
d. Issue a financial instrument that obliges the entity to
transfer an economic resource.  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.
Primary users
The objective of financial reporting refers to the
following so called the primary users:
1. Existing and potential investors; and
2. Lenders and other creditors
Decisions about providing resources to the entity
The primary users’ decisions about providing resources
to the entity involve decisions on:
a. Buying, selling or holding investments;
b. Providing or settling loans and other forms of
credit; or
c. Exercising voting or similar rights could
influence management’s actions relating to the
use of the entity’s economic resources.
Information on Economic resources, Claims, and
Changes
General purpose financial reports provide information
on a reporting entity’s:
Financial position – information on economic resources
(assets) and claims against the reporting entity
(liabilities and equity); and
Changes in economic resources and claims –
information on financial performance (income and
expense) and other transactions and events that lead to
changes in financial position.
Collectively, these are referred to under the Conceptual
Framework as economic phenomena.
Economic resources and Claims
 Information about the nature and amounts of an
entity’s economic resources (assets) and claims
(liabilities and equity) can help users to identify the
entity’s financial strengths and weaknesses. That
information can help users in assessing the entity’s:
a. Liquidity and solvency;
b. Needs for additional financing and how
successful it is likely to be in obtaining that
financing; and
c. Management’s stewardship on the use of
economic resources.
Liquidity refers to an entity’s ability to pay short-term
obligations while solvency refers to an entity’s ability to
meet its long-term obligations.
Changes in economic resources and claims
Changes in economic resources and claims result from:
a. Financial performance (income and expense);
and
b. Other events and transactions
 Information on financial performance helps users
assess the entity’s ability to produce returns from
its economic resources. Return provides an
indication on how well management has efficiently
and effectively used the entity’s resources
Information about use of the entity’s economic
resources
 Information on how efficiently and effectively the
entity’s management has discharged its
responsibilities to use the entity’s economic
resources helps users assess the entity’s
management’s stewardship. This information also
helps in predicting how efficiently and effectively
the entity’s resources will be used in future periods,
thus helping in the assessment of the entity’s
prospects for future net cash flows.
Recognition principles
The recognition process
 Recognition is the process of including in the
financial position or the statements of financial
performance an item that meets the definition of
one of the financial statements elements (i.e., asset,
liability, equity, income or expense). This involves
recording the item in words and in monetary
amount and including that amount in the totals of
 those statements. The amount at which an asset, a
liability or equity is recognized in the statement of
financial position is referred to as its carrying
amount. Recognition links the elements, the
statements of financial performance as follows:
The statements are linked because the recognition of
one element (or a change in its carrying amount)
requires the recognition or derecognition of another
elements.
Examples:
Sometimes the recognition of income results in the
simultaneous recognition of related expense. This
simultaneous recognition of income and expense is also
called “matching of costs and income” (matching
concept)
 Recognition of income resulting in an increase
in asset.
 Recording a sale increases both
cash/receivables (asset) and sales (income)
 Recognition of income resulting in a decrease in
liability.
 Earning an unearned income decreases
unearned income (liability) and increases
income.
 Recognition of expense resulting in an increase
on liability
 Accruing unpaid salaries increases both salaries
expense and salaries payable (liability).
 Recognition of expense resulting in a decrease
in assets.
 Payment for supplies expense increases
supplies expense decreases cash.
Recognition criteria
An item is recognized if:
a. It meets the definition of an asset, liability,
equity, income or expense; and
b. Recognizing it would provide useful
information, i.e., relevant and faithfully
represented information.
Relevance
The recognition of an item may not provide relevant
information if, for example:
a. It is uncertain whether an asset or liability
exists; or
b. An asset or liability exists, but the probability of
an inflow or outflow of economic benefits is
low.
Faithful Representation
The recognition of an item is appropriate if it provides
both relevant and faithfully represented information.
The level of measurement uncertainty and other factors
(i.e., presentation and disclosure) affect an item’s
faithful representation.
Recognition Principles
Measurement uncertainty
 An asset or liability must be measured for it to be
recognized. Often, measurement requires
estimation and thus subject to measurement
uncertainty. The use of reasonable estimates is an
essential part of financial reporting and does not
necessarily undermine the usefulness of
information. However, an exceptionally high
measurement uncertainty can affect the faithful
representation of an item and one or more of the
following circumstances exist:
a. There is an exceptionally wide range of possible
outcomes and each outcome is exceptionally
difficult to estimate.
b. The measure is highly sensitive to small changes in
estimates of the probability of different outcomes.
c. The measurement requires exceptionally difficult or
exceptionally subjective allocations of cash flows
that do not relate solely to the asset or liability
being measured.
Derecognition
 Derecognition is the opposite of recognition. It is
the removal of a previously recognized asset or
liability from the entity’s statement of financial
position.
 Derecognition occurs when the item no longer meet
the definition of an asset or liability, such as when
the entity loses control of all or part of the asset, or
no longer has a present obligation for all part of the
liability. On derecognition, the entity:
 Derecognizes the assets or liabilities that have
expired or gave been consumed, collected, fulfilled
or transferred (i.e., transferred component), and
recognizes any resulting income and expenses.
 Continues to recognize any assets or liabilities
retained after derecognition (i.e., retained
component). No income or expense is normally
recognized on the retained component unless there
is a change in its measurement basis. After
derecognition, the retained component becomes a
unit of account separate from the transferred
component.
Measurement Or Valuation Basis
Measurement
 Recognition requires quantifying an item in
monetary terms, thus necessitating the selection of
an appropriate measurement basis.
 The application of the qualitative characteristics,
including the cost constraint, is likely to result in the
selection of different measurement bases for
different assets, liabilities, income and expenses.
Accordingly, the standards prescribe specific
measurement bases for different types of assets,
liabilities, income and expenses.
Measurement bases
The Conceptual Framework describes the following
measurement bases:
a. Historical cost
b. Current value
c. Fair value
d. Value in use and fulfilment value
e. Current cost
Historical cost
 The historical cost of an asset is the consideration
paid to acquire the asset plus transaction cost. The
historical of liability is the consideration received to
incur the liability minus transaction costs. In cases
where it is not possible to identify the cost, such as
on transactions that are not on market terms, the
resulting asset or liability is initially recognized at
current value.
Current value
Current value measures reflect changes in values at the
measurement date.
Current value measures bases include the following:
a. Fair value
b. Value in use for assets and fulfilment value for
liability
c. Current cost
Fair Value
 Fair value is the “price that would be received to sell
an asset, or paid to transfer a liability, in an orderly
transactions between market participants at the
measurement date.”
 Fair value reflects the perspective of market
participants. Accordingly, it is not an entity-specific
measurement.
 Fair value can be measured directly by observing
prices in an active market or indirectly using
measurement techniques. Fair value is not adjusted
for transaction costs.
Value in use and fulfilment value
 Value in use is “the present value of the cash
flows, or other economic benefits, that an entity
expects to derive from the use of an asset and
from its ultimate disposal.
 Fulfilment value is “the present value of the
cash, or other economic resources, that an
entity expects to be obliged to transfer as it
fulfils a liability.
Current cost
 Current cost of an asset is “the cost of an equivalent
asset at the measurement date, comprising the
consideration that would be paid at the
measurement date plus the transaction costs that
would be incurred at that date.
 Current cost of a liability is “the consideration that
would be received for an equivalent liability at the
measurement date minus the transaction costs that
would be incurred at that date.”
Consideration When A Selecting A Measurement Basis
When selecting a measurement basis, it is important to
consider the following:
a. The nature of information provided by a
particular measurement basis; and
 b. The qualitative characteristics, the cost
constrain, and other factors
Qualitative Characteristics Of Decision-Useful
Information
The Conceptual Framework classifies the qualitative
characteristics into the following:
Fundamental qualitative characteristics – these are the
characteristics that make information useful to users.
They consist of the following:
a. Relevance
b. Faithful representation
Enhancing qualitative characteristics – these are the
characteristics that enhance the usefulness of
information. They consist the following:
a. Comparability
b. Verifiability
c. Timeliness
d. Understandability
Relevance
 Information is relevant if it can make a
difference in the decisions of users.
Relevant information has the following:
Predictive value – the information can help the users in
making predictions about future outcomes.
Confirmatory value (feedback value) – the information
can help users in confirming their previous predictions.
Materiality
 Information is material if omitting, misstating or
obscuring it could reasonably be expected to
influence decisions that the primary users of a
specific reporting entity’s general purpose financial
statements make on the basis of those financial
statements.
 Materiality is an entity specific aspect of relevance,
meaning materiality depends on the facts and
circumstances surrounding a specific entity. Hence,
materiality is a matter of judgment.
Faithful Representation
Faithful representation means the information provides
a true, correct and complete depiction of the economic
phenomena that it purports to represent. Depicting only
the legal form would not faithfully represent the
economic phenomenon. Faithfully represented
information has the following characteristics:
Completeness – all information (in words and numbers)
necessary for users to understand the phenomenon
being depicted is provided. These include description of
the nature of the item, numerical depiction, description
of the numerical depiction and explanations of
significant facts surrounding the item.
Neutrality – information is selected or presented
without bias. Information is not manipulated to increase
the probability that users will receive it favourably.
Neutrality is supported by prudence, which is the use of
caution when making judgments under conditions of
uncertainty, such that assets or income are not
overstated and liabilities or expenses are not
understated.
Free from error – this does not mean that the
information is perfectly accurate in all aspects. Free
from error means there are no errors in the description
and in the process by which the information is selected
and applied. If the information is an estimate, that fact
should be described clearly. Including an explanation of
the process used in making that estimate.
Qualitative Characteristics Of Decision-Useful
Information Enhancing Qualitative Characteristics
Comparability
Comparability means the ability to bring together for
the purpose of noting points of likeness and
difference. Comparable information presents
similarities and dissimilarities. Comparability may be
made within an entity or across entities. To be more
useful, the financial information shall be compared with
similar information of previous periods (intra-
comparability), or with information produced by other
entities (inter-comparability/dimensional
comparability).
Verifiability
 Verifiability means that different knowledgeable
and independent observers could reach consensus,
although not necessarily complete agreement, that
a particular depiction is a faithful representation. In
other words, verifiability implies consensus. The
financial information is verifiable in the sense that it
is supported by evidence so that an accountant that
would look into the same evidence would arrive at
the same economic decision or conclusion.
Qualitative characteristics of decision-useful
information
Enhancing qualitative characteristics (continued)
Timeliness
 Timeliness means having information available to
decision makers in time to influence their decisions.
 Timeliness is an important enhancing qualitative
characteristics because “relevant and faithfully
represented financial information furnished after a
decision is made is useless or of no value.”
Understandability
 Understandability requires that financial
information must be comprehensible or intelligible
if it is to be useful. Accordingly, the information
should be presented in a form and expressed in
terminology that a user understands. An essential
quality of the information provided in financial
statements is that it is readily understandable by
users. Understandability is very essential because a
relevant and faithfully represented information may
prove useless if it is not understood by users.
Concept Of Capital And Capital Maintenance
The Conceptual Framework mentions two concepts of
capital, namely:
Financial concept of capital – capital is regarded as the
invested money or invested purchasing. Capital is
synonymous with equity, net assets, or net worth.
Physical concept of capital – capital is regarded as the
entity’s productive capacity, e.g., units of output per
day.
 The choice of an appropriate concept is based on
user’s need. Thus, if users are primarily concerned
with the maintenance of nominal invested capital or
purchasing power of invested capital, the financial
concept should be used; whereas, if their primary
concern is the entity’s operating capability, the
physical concept should be used. Most entities
adopt the financial concept of capital in preparing
their financial statements.
Concept of Capital and capital maintenance
The concept chosen affects the determination of profit.
In this regard, the concepts of capital give rise to the
following concepts of capital maintenance:
Financial capital maintenance – under this concept,
profit is earned if the net assets at the end of the period
exceeds the net assets at the beginning of the period,
after excluding any distributions to, and contributions
from, owner during the period. Financial capital
maintenance can be measured In either nominal
monetary unit or units of constant purchasing power.
Physical capital maintenance – under this concept,
profit is earned only if the entity’s productive capacity
at the end of the period exceeds the productive
capacity at the beginning of the period, after excluding
any distributions to, and contributions from, owners
during the period.
The concept of capital maintenance is essential in
distinguishing between a return on capital and a return
of capital. Only inflows of assets in excess of the amount
needed to maintain capital is regarded as return on
capital or profit.
Capital Maintenance Adjustments
 The revaluation or restatements of assets and
liabilities results in increases or decreases in equity.
Although these increases or decreases meet the
definition of income or expenses, they are not
recognized in profit or loss under certain concepts
of capital maintenance. Accordingly, these items are
included in equity as capital maintenance
adjustments or revaluation reserves.
Reporting Entity And Financial Statements
Reporting period
 Financial statements are prepared for a specified
period of time and provide information on assets,
liabilities and equity that existed at the end of the
reporting period, or during the reporting period,
and income and expenses for the reporting period.
Comparative Information
 To help users of financial statements in evaluating
changes and trends, financial statements also
provide comparative information for at least one
preceding reporting period.
Forward Looking Presentation
 Financial statements are designed to provide
information about past events. Information about
possible future transactions and other events is
included in the financial statements only if it relates
to the past information presented in the financial
statements and is deemed useful to users of
financial statements.
Perspective Adopted Financial Statements
 Information in financial statements is prepared
from the perspective of the reporting entity, not
from the perspective of any particular group of
financial statements user.
Going Concern Assumption
 Financial statements are normally prepared on the
assumption that the reporting entity is a going
concern, meaning the entity has neither the
intention nor the need to end its operations in the
foreseeable future. If it is not the case, the entity’s
financial statements are prepared on another bases
(e.g., measurement at realizable values rather than
mixture of costs and values.
Reporting Entity And Financial Statements
The reporting entity
 A reporting entity is one that is required, or
chooses, to prepare financial statements, and is not
necessarily a legal entity. It can be a single entity or
a group or combination of two or more entities.
 Sometimes, an entity controls another entity. The
controlling entity is called a parent, while the
controlled entity is called subsidiary. If a reporting
entity comprises both the parent and subsidiaries,
the reporting entity’s financial statements are
referred to as consolidated financial statements. If a
reporting entity is the parent alone, the reporting
entity’s financial statements are referred to as
unconsolidated financial statements. If a reporting
entity comprises two or more entities that are not
linked by a parent-subsidiary relationship, the
reporting entity’s financial statements are referred
to as combined financial statements.
Consolidated And Unconsolidated Financial
Statements
 Consolidated financial statements provide
information on a parent and its subsidiaries viewed
as a single reporting entity. Consolidated financial
statements are not designed to provide information
on any particular subsidiary; that information is
provided on the subsidiary’s own financial
statements.
 Consolidated information enables users to better
assess the parents prospects for future cash flows
because the parent’s cash flows are affected by the
cash flows of its subsidiaries. Accordingly, when
consolidation is required, unconsolidated financial
statements cannot be used as substitute for
consolidated financial statements. However, a
parent may nonetheless be required or choose to
prepare unconsolidated financial statements in
addition to consolidated financial statements.
Objective And Scope Of Financial Statements
 The objective of general purpose financial
statements is to provide financial information
about the reporting entity’s assets, liabilities,
equity, income and expenses that is useful in
assessing:
 The entity’s prospects for future net cash
inflows; and
 Management’s stewardship over economic
resources.
That information is provided in the:
a. Statement of financial position (for recognized
assets, liabilities and equity);
b. Statement(s) of financial performance (for
income and expenses);
c. Other statements and notes (for additional
information on recognized assets and liabilities,
information on unrecognized assets and
liabilities, information on cash flows,
information on contributions from/distributions
to owners,