CONFRAS – Notes 2

THE CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

BASIC CONCPETS
The Conceptual Framework
- Is a complete, comprehensive, and single document promulgated by the International
Accounting Standards Board (IASB)
- Summary of the terms and concepts that underlie the preparation of financial statements
for external users
- Describes the concepts for general purpose of financial reporting
- Attempt to provide theoretical foundation for accounting

Purposes
✔ Primary Purpose: to serve as a guide in the development of future PFRS and in
addressing issues not included in existing PFRS

✔ Specific Purposes
o To assist FRSC in developing future PFRS and reviewing existing IFRS; and in
promoting harmonization of regulations, accounting standards and procedures
relating to FS presentation;
o To assist preparers of FS in interpreting the information in FS;
o To assist auditors in forming an opinion as to whether the FS conforms with
PFRS; and
o To provide information to whose who are interested to work in FRSC

Authoritative Status
- The Conceptual Framework is not PFRS/IFRS and does not override any specific
standard
- The requirements of PFRS shall prevail over Conceptual Framework in case where
there is a conflict
- Applicability of Conceptual Framework shall be considered when there is no standard
interpretation specifically related to reporting issues under consideration

Underlying Theme
- Decision Usefulness: the usefulness of information in making economic decisions

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Underlying Assumptions
❖ Going Concern – views entity as continuing in operation in the foreseeable future; it is
the foundation of cost principle; it is also called the “continuity assumption”
❖ Accrual Basis of Accounting – recognizes income and expenses as against the cash
basis principle

Accrual Basis Cash Basis

Revenue is recognized when: earned Cash is received
Expense is recognized when: incurred Cash is paid

Inherent Assumptions
❖ Entity Concept – views entity is viewed separately from its owners
❖ Time Period Principle – also called periodicity concept; an entity’s life is divided into
series of reporting period; commonly encompasses 12 months which may be classifies
as calendar year (starts on January 1 and ends on December 31) or fiscal year
o Calendar year – A 12-month period that ends on December 31
o Natural Business Year – A 12-month period that ends on any month when the
business at its lowest or slack season
o Fiscal Year – A 12-month period that starts from any other month than January
o Interim Period – shorter than a full fiscal year; e.g., weekly, monthly, quarterly

❖ Monetary Unit Principle – the Philippine Peso must be used as a common unit of
measurement; it also assumes that the purchasing power of peso is constant

SCOPE OF THE CONCEPTUAL FRAMEWORK

Chapter 1: Objective of General Purpose Financial Reporting

❖ Financial reporting refers to the communication of financial information to users through

annual financial statements or other means
❖ The objective of 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
o Buying, selling or holding equity and debt instruments;
o Providing or settling loans and other forms of credit; or

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 o Exercising rights to vote on, or otherwise influence, management’s actions that
affect the use of the entity’s economic resources

*Note: Throughout the document, the term ‘financial reporting’ refers to general purpose
financial reporting unless indicated otherwise

Users of Financial Information

Classification User Concern(s)
Investors Risk and return of investment; Dividends
Lenders and other Creditors Liquidity and solvency
External Employees Stability and profitability
Customers Continuity
Government Regulatory
Public Various
Internal Management Operational

❖ Existing and potential investors, lenders and other creditors are the only primary users of
financial reporting as they are the primary providers of resources to the entity.
❖ Primary users need information about the economic resources of the entity, claims
against the entity and changes in those resources and claims to assess:
o The entity’s prospects for the future net cash inflows; and
o How effectively and efficiently management has discharged their responsibilities
to use the entity’s existing resources.

Limitations of Financial Reporting

❖ General purpose financial reports do not and cannot provide all information that every
user may need.
❖ They provide information to help users estimate the value of the entity and not its exact
value as these financial reports are based on estimate and judgement rather than exact
depiction.

Chapter 2: Qualitative Characteristics of Useful Financial Information

❖ Necessary to identify the types of information that are likely to be most useful to the
users can be classified as fundamental or enhancing

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Fundamental Qualitative Characteristics
❖ Related to the content or substance of information; Information must be relevant and
faithfully represented to be useful.

1. Relevance – capacity to make a difference in the decisions made by users; It must have
the following ingredients
a. Predictive Value which helps in the forecasting outcome of events; and/or
b. Confirmatory Value which enables users to confirm or change previous forecasts

❖ Materiality
o entity-specific aspect of relevance, also called “Doctrine of Convenience”
o information is material if omitting, misstating or obscuring it could influence
decisions of users
o based on the nature and/or magnitude of items

2. Faithful Representation – information provides a true, correct, and complete depiction

of the economic phenomena it purports to represent; its ingredients/underlying
characteristics are :
a. Completeness – includes all information necessary for a user to understand the
phenomenon, including descriptions and explanations; also called “Principle of
Full Disclosure”

b. Neutrality – without bias in selection or presentation; supported by prudence

which is the exercise of caution when making judgements

c. Free From Error – no errors or omissions in the description and process;

estimates are described clearly and accurately as being an estimate

Supplementary Concepts under Fundamental Qualitative Characteristics

● Substance Over Form – the substance of an economic phenomenon must be
represented instead of its legal form only

● Conservatism – selects alternative with least favorable impact on equity

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Enhancing Qualitative Characteristics
- Enhance the usefulness of information; address its form or presentation

1. Comparability – helps identify similarities in, and differences among, items about the
entity for different periods (intra-comparability) or as compared with other entities (inter-
comparability)
❖ Consistency – different from comparability; refers to the use of same methods for
similar events from period-to-period

2. Verifiability – assures faithful representation; different knowledgeable and independent

observers could reach consensus; can be direct (e.g., counting cash) or indirect

3. Timeliness – information is available in time to influence decision-makers

4. Understandability – classifying, characterizing, and presenting information clearly and

concisely

The Cost Constraint

❖ Cost – a pervasive constraint on information that can be provided by financial reporting
❖ Simply means that benefits of reporting such information should be greater than the
costs incurred in obtaining it.

Chapter 3: Financial Statements and the Reporting Entity

Objective and Scope of Financial Statements
● Financial statements aim to provide information about entity’s assets, liabilities, equity,
income and expenses
● Such information is provided in:
o The statement of financial position;
o The statement of financial performance; and
o Other statements and notes

Reporting Period
- FS are prepared for a specifies period of time and provide comparative information for at
least one (1) preceding reporting period to identify changes and assess trends

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Perspective Adopted and Going Concern Assumption
- Information about transactions and other events provided in FS are viewed from the
perspective of the reporting entity as a whole
- FS are prepared normally on the assumption that the entity is a going concern and will
continue to operate for the foreseeable future.

The Reporting Entity

- FS are prepared for a specified period of time and provide comparative information for at
least one (1) preceding reporting period to identity changes and assess trends.

Perspective Adopted and Going Concern Assumption

- Information about transactions and other events provided in FS are viewed from the
perspective of the reporting entity as a while
- FS are prepared normally on the assumption that the entity is a going concern and will
continue to operate for the foreseeable future

Chapter 4: Elements of Financial Statements

❖ Broad classes into which financial assets of transactions are other events grouped

Definition of Elements Directly Related to Financial Position

1. Asset
- Present economic resource controlled by the entity as a result of past event wherein its
cost can be measured reliably;
- An asset is also a right that has the potential to provide future economic benefits

2. Liability
- A present obligation to transfer an economic resource at a future date as a result of a
past event, the settlement of which is expected to result in an outflow of economic
resources

3. Equity
- The residual interest of the entity’s owner/s after deducting liabilities from assets; also
called net assets or claims against entity

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Mishe Ghail M. Coz

Made by:
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Definition of Elements Directly Related to Financial Performance
1. Income
- An increase in assets or decrease in liabilities that result in increases in equity, other
than those relating to distributions to equity owners
- Compromise both revenue (arises from ordinary course of business) and gains (other
items that meet the definition of income)

2. Expense
- A decrease in assets or increase in liabilities that result in decreases in equity, other
than those relating to distributions to equity owners
- Encompasses both ordinary expense and losses

Chapter 5: Recognition and Derecognition

Recognition – process of reporting on the FS an item that meets the definition of an element
and satisfies the following criteria;
o It is probable that any future economic benefit associated with it will flow to or
from the entity; and
o Its cost or value can be reliably measured
❖ The criteria above apply to assets, liabilities, income, and expenses
❖ Recognition of items may not always provide relevant information if, for example;
o It is uncertain if an asset or liability exist; or
o An asset or liability exist but the probability of an inflow or outflow of economic
benefits is low
❖ Recognition of income occurs simultaneously with recognition of increases in assets or
decrease in liabilities. Likewise, recognition of expenses occurs simultaneously with the
recognition of an increase in liabilities or decrease in assets.

Matching Principle
This principle requires that costs and expenses incurred to earn revenue shall be reported in the
same period. Applications of the matching principle are as follow:
❖ Cause and Effect Association – expense in recognized when revenue is already
recognized as such expenses are presumed to be directly associated with specific
revenues (e.g., casualty losses, officer’s salaries, administrative and selling expenses)
also called the “the strict matching concept”

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 ❖ Systematic and Rational Allocation – expenses are allocated over the accounting
period/s benefitted (e.g., depreciation, amortization, prepaid expenses)
❖ Immediate Recognition – used when first two are not applicable; costs are expensed
outright (e.g., casualty losses, officer’s salaries, administrative and selling expenses)
❖ Derecognition – removal of all or part of a recognized asset or liability from entity’s
statement of financial position when the item no longer meets the definition of an asset
or liability
o An asset or liability is derecognized when it has:
▪ Expired or have been consumed
▪ Collected;
▪ Fulfilled; or
▪ Transferred
o On derecognition, any resulting income or expense are recognized.
o Any assets or liabilities retained after the derecognition shall continue to be
recognized.

Chapter 6: Measurement
Measurement – process of quantifying or assigning monetary amounts to elements that are to
be recognized and reported in financial statements; various measurement are bases are being
applied, including:
1. Historical Cost
o Most used; it is the purchase price at the time of recognition; it is the amount of
consideration paid plus transaction cost
o Also called “past purchase exchange price”
o Example: An equipment bought for P10,000 would still be reported at its original
cost less accumulated depreciation even if its fair value today is P5,000
2. Current Value
o Uses updated information to reflect current conditions at measurement date
o Sub-measurement bases under current value include:
● Fair Value – price that would be received to sell an asset, or paid to
transfer a liability, in an orderly transaction between participants in an
active market
● Value in Use – the present value of the cash flows, or other economic
benefits, that entity expects to derive from use of asset and from its
ultimate disposal

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 ▪ Fulfillment Value, on the other hand is the PV of cash flows, or
other economic resources, that entity expects to be obliged to
transfer as it fulfils a liability

● Current Cost
▪ Current Cost of an Asset – basis is the cost of an equivalent asset
at the measurement date, includes the consideration that would
be paid plus transaction costs that would be incurred
▪ Current Cost of a Liability – consideration that would be received
for an equivalent liability minus transaction costs to be incurred at
the date of measurement

Note: ENTRY VALUES include historical cost and current cost while EXIT VALUES are fair
value, value in use and fulfillment value

3. Net Realizable (Settlement Value)

o Amount that would be received upon sale of an asset minus selling costs;
commonly used in measuring inventory and accounts receivable
o Formula: NRV = Expected selling price – Total production of selling costs
4. Present Value (Discounted)
o Current value of a future sum of money given a specified rate of return
o Based on the concept that future cash flows are discounted at the discount rate
o Formula: : PV = FV / (1 + r ) n
● Future Value, on the other hand, is the value of an asset at a specified
date in the future based on assumed rate of growth

Chapter 7: Presentation and Disclosure

Presenting and disclosing information in FS communicated information about entity’s assets,
liabilities, equity, income, and expenses. Effective communication of such makes information
more relevant and faithfully represented
❖ The requirements for effective communication include:
o Focusing on presentation and disclosure objectives and principles instead of rules;
o Classifying information by grouping similar items and separating dissimilar items; and
o Aggregating information that is not obscured by unnecessary detail or excessive
aggregation.

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Made by:
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Chapter 8: Concepts of Capital and Capital Maintenance
Concepts of Capital
1. Financial Capital – includes invested money or purchasing power; capital is regarded as
net assets or equity of the entity
2. Physical Capital – refers to the operating capability or productive capacity of entity
usually based on units of output per day

Concepts of Capital Maintenance

1. Financial Capital Maintenance – There is profit if the amount of net assets at the end of
the period exceeds amount of the same at the beginning of the period
o End Financial Capital > Beg. Financial Capital = PROFIT
2. Physical Capital Maintenance – Profit is earned if productive capacity at the end of the
period exceeds productive capacity at the beginning; adopts current cost as basis of
measurement
o End Physical Capital > Beg. Physical Capital = PROFIT

References:
International Accounting Standards Board (IASB). (2018). Conceptual Framework for Financial
Reporting 2018. Retrieved from
https://www.ifrs.org/content/dam/ifrs/publications/pdfstandards/english/2021/issued/par
t-a/conceptual-framework-for-financial-reporting.pdf
Various review materials in Financial Accounting and Reporting

Edited by:
Mishe Ghail M. Coz

Made by:
Anne Gwyneth S. Reyes (2021)