CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING AND

ACCOUNTING STANDARDS
CONCEPTUAL FRAMEWORK-OBJECTIVE OF FINANCIAL
REPORTING
BY PROF. CESAR V. RAMIREZ, CPA. MBA, CESO IV, FRIACC, BSA
PROGRAM CHAIR
 LEARNING OUTCOMES

1. To know the nature of the Revised Conceptual Framework

2. To describe the purpose and usefulness of the Conceptual Framework
3. To understand the authoritative status of a Conceptual Framework
4. To understand the objective of financial reporting
5. To know the limitations of financial reporting
 CONCEPTUAL FRAMEWORK
• The Conceptual Framework for Financial Reporting is a complete, comprehensive
and single document promulgated by the International Accounting Standards Board
(IASB).
• The Conceptual Framework is a summary of the terms and concepts that underlie
the preparation and presentation of the financial statements for external users.
• In other words, the Conceptual Framework describes the concepts for general
purpose financial reporting.
• The Conceptual Framework is an attempt to provide an overall theoretical
foundation for accounting.
 CONCEPTUAL FRAMEWORK
• The Conceptual Framework is intended to guide standards-setters, preparers and users of
financial information in the preparation and presentations of financial statements.
• It is the underlying theory for the development of accounting standards and revision of
previously issued accounting standards.
• The Conceptual Framework will be used in future standard setting decision but no changes
will be made for the current IFRS.
• The Conceptual Framework provides the foundation for Standards that:
– Contribute to transparency by enhancing international comparability and quality of financial
information.
– Strengthen accountability by reducing information gap between thee providers of capital and the people
to whom they have entrusted their money.
– Contribute to economic efficiency by helping investors to identify opportunities and risks across the
world.
 PURPOSE OF THE REVISED CONCEPTUAL FRAMEWORK
a. To assist the IASB to develop IFRS based on consistent concepts.
b. To assist preparers of financial statements to develop consistent accounting policy
when the Standard applies to a particular transaction or other event or where an
issue is not yet addressed by an IFRS.
c. To assist preparers of financial statements to develop accounting policy when a
Standard allows a choice of an accounting policy.
d. To assist all parties to understand and interpret thee IFRS.
 AUTHORITATIVE STATUS OF CONCEPTUAL FRAMEWORK
• If there is a standard or an interpretation that specifically applies to a transaction,
the standard or interpretation overrides the Conceptual Framework.
• In the absence of a standard or an interpretation that specifically applies to a
transaction, management shall consider the applicability of the Conceptual
Framework in developing and applying an accounting policy that results in
information that is relevant and reliable.
• However, it is to be stated that the Conceptual Framework is not an IFRS.
• Nothing in the CF overrides any specific IFRS.
• In case where there is conflict, the requirements of the IFRS shall prevail over the CF.
 USERS OF THE FINANCIAL INFORMATION
• Under the CFFR the users of financial information may be classified into two, namely:
1. Primary users, and
2. Other users
• The primary users include the existing and potential investors, lenders and other
creditors.
• The other users include the employees, customers, governments and their agencies,
and the public.
 PRIMARY USERS
• The primary users of financial information are the parties to whom general-purpose
financial reports are primarily directed.
• Such users cannot require reporting entities to provide information directly to them
and therefore must rely on general purpose financial reports for much of the
financial information they need.
• Existing and potential investors are concerned with the risk inherent in and return
provided by their investments.
• The investors need information to help them determine whether they should buy,
hold or sell.
• Shareholders are also interested in information which enables them to asses the
ability of the entity to pay dividends.
 PRIMARY USERS
• Existing and potential lenders and other creditors are interested in information which
enables them to determine whether their loans, interest thereon and other amounts
owing to them will be paid when due.
 OTHER USERS
• Other users are so called because they are parties that may find the general purpose
financial reports useful but the reports are not directed to them primarily.
• Employees are interested to financial information about the stability and profitability
of the entity which enables them to assess the ability of the entity to provide
remuneration, retirement benefits, and employment opportunities.
• Customers have interest in information about the continuance of an entity especially
when they have a long term involvement with or dependent on the entity.
• Government is interested in the allocation of resources and therefore the activities of
the entity, to regulate the entity, determine tax policies, and as basis for national
income and similar statistics.
 OTHER USERS
• Public is affected by the entities in several ways. For example, entities make
substantial contribution to the local economy in terms of employment and patronage
of local suppliers.
 SCOPE OF REVISED CONCEPTUAL FRAMEWORK
1. Objectives of financial reporting.
2. Qualitative characteristics of financial statements
3. Financial statements and reporting entity
4. Elements of financial statements
5. Recognition and derecognition of the elements of financial statements
6. Measurement of the elements of financial statements
7. Presentation and disclosure
8. Concepts of capital and capital maintenance
 OBJECTIVES OF FINANCIAL REPORTING
• The objective of the financial reporting forms the foundation of the Conceptual
Framework (CF)
• The overall objective of the 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.
• The objective of financial reporting is the “ why”, purpose or goal of accounting.
• Financial reporting is the provision of financial information about an entity to
external users that is useful to them in making economic decisions and for assessing
the effectiveness of the entity’s management.
 OBJECTIVES OF FINANCIAL REPORTING
• The principal way of providing financial information to external users is through the
annual financial statements.
• Financial reports also include nonfinancial information such as the description of the
major products and the listing of corporate officers and directors.
• Financial reporting is directed primarily to the existing and potential investors,
lenders and creditors which compose the primary user group who provide capital
resource to the entity; hence , they have the most critical and immediate need for
financial information.
 SPECIFIC OBJECTIVES OF FINANCIAL REPORTING
1. To provide information useful in making decisions about providing resources to the
entity. Thus, making decisions whether or not to buy, sell or hold equity
investments and/or to provide or settle loans and other forms of credits.
2. To provide information useful in assessing the cash flow prospects of the entity.
Payment of dividends and/or loan repayments (principal and interests).
3. To provide information about entity resources, claims and changes in resources and
claims. The financial position of the entity comprising the assets, liabilities and
equity as well as liquidity and solvency of the firm. The financial performance of
the entity that comprise revenues, expenses, net profit/loss.
 USEFULNESS OF FINANCIAL PERFORMANCE
• Helps users understand the return that the entity has produced on the economic
resources.
• Provides an indication on how efficient management is managing these economic
resources.
• Helps in predicting the future returns on these economic resources.
• Useful in assessing the entity’s ability to generate future cash inflows from
operations.
 ACCRUAL ACCOUNTING
• Accrual accounting means that income is recognized when earned regardless of
when received and expense is recognized when incurred regardless of when paid.
• Accrual accounting depicts the effect of transactions on an entity’s economic
resources and claims in the periods occur even if the cash receipts and payments
occur in a different period..
• Information about financial performance measured in accordance with accrual
accounting provides a better basis for assessing past and future performance than
information solely about cash basis of accounting.
 LIMITATIONS OF FINANCIAL REPORTING
a. General purpose financial reports do not and cannot provide all the information to
the primary users.
b. General purpose financial reports do not show the value of the firm but help the
primary users estimate the value of the firm.
c. General purpose financial reports provide common information to the users and
cannot accommodate every request for information.
d. General purpose financial reports are based on estimate and judgment rather than
exact depiction.
 MANAGEMENT STEWARDSHIP
• Helps users to assess management stewardship of the entity’s resources.
• Useful for predicting how management will use the entity’s economic resources in
the future.
• The information can be useful for assessing the entity’s prospects for future net cash
flows.
• For example, management can decide not to dispose or sell investments when prices
are declining in order to avoid realized losses.
 EXERCISES
1. What is meant by Conceptual Framework?
2. What are the purposes of the Revised Conceptual Framework?
3. Explain the authoritative status of the Conceptual Framework.
4. Explain the primary users and their information needs.
5. Explain the other users and their information needs.
6. What is the scope of the Revised Conceptual Framework?
7. Explain financial reporting.
8. What is the overall objective of financial reporting?
9. What are the specific objectives of financial reporting?
10. Explain financial position.
 EXERCISES
11. Explain liquidity and solvency.
12. Explain financial performance.
13. Explain accrual accounting.
14. Explain management stewardship of company’s economic resources.
15. What are the limitations of financial reporting?
 EXERCISES
1. The underlying theme of Conceptual Framework is
a. Decision usefulness.
b. Understandability
c. Timeliness
d. Comparability
2. Users of financial information include which of the following?
a. Creditors
b. Creditors and government agencies
c. Creditors and unions
d. Creditors, government agencies and unions.
 EXERCISES
3. Which group is not among the external users for whom financial statements are prepared?
a. Customers
a. Suppliers
b. Employees
c. All of the above.
4. Which of the following is an internal user of financial information?
a. Board of directors.
b. Shareholders
c. Bondholders
d. Creditor with long-term contract
 EXERCISES
5. These users require information on risk and reward provided by their investments.
a. Investors
b. Employees
c. Lenders.
d. Customers
6. The primary objective of financial reporting is to provide information to
a. Management
b. Capital providers.
c. Regulatory body
d. government
 CF-QUALITATIVE CHARS. OF FINANCIAL INFORMATION
• LEARNING OUTCOMES
1. To identify the qualitative characteristics of accounting information.
2. To identify the fundamental qualitative characteristics.
3. To identify the enhancing qualitative characteristics
4. To understand the cost constraints on useful information.
 CF-QUALITATIVE CHARS. OF FINANCIAL INFORMATION
• Qualitative characteristics are the qualities and attributes that made financial
accounting information useful to the users.
• The objective in deciding which information to include in financial statements is to
ensure that the information is useful to the users in making economic decisions.
• Under the CF, qualitative characteristics are classified into 1. fundamental qualitative
characteristics and 2. Enhancing qualitative characteristics
 FUNDAMENTAL QUALITATIVE CHARACTERISTICS
• The fundamental qualitative characteristics relate to the content or substance of
financial information which consist of
– Relevance
– Faithful representation
• The most efficient and effective process of applying the fundamental qualitative
characteristics would usually be:
– Identify an economic phenomenon that has the potential to be useful
– Identify the type of information about the phenomenon that would be most relevant and can
be faithfully represented
– Determine whether the information is available.
 FUNDAMENTAL QUALITATIVE CHARACTERISTICS
1. Relevance
– In the simplest terms, relevance is the capacity of the information to influence decisions.
– Information that does not bear on an economic decision is useless.
– For example, the earning per share information is more relevant than book value in
determining the attractiveness of investment.
– Ingredients of relevance are: predictive value and confirmative value
– Predictive value can be used to predict future outcome or forecasting future events.
– Confirmative value provides feedback about previous evaluations. It enables users confirm
or correct earlier expectations.
– Predictive value and confirmative value are interrelated. Example is an interim income
statement which provide feedback about income to date and serves to predict annual
income.
 FUNDAMENTAL QUALITATIVE CHARACTERISTICS
• Materiality also known as doctrine of convenience dictates that strict adherence to
GAAP is not required when the items are not significant enough to affect the
decision.
• It is a threshold linked very closely to relevance. It is a subquality of relevance that
threshold is not provided in the CF.
• Materiality is a relativity which means that it depends on relative size rather than
absolute size. What is material for one entity is immaterial to another entity.
• Materiality depends on good judgment, professional expertise and plain common
sense.
• As a general rule, an item is material if knowledge of it would affect or influence the
decision of the informed users of financial information.
 FUNDAMENTAL QUALITATIVE CHARACTERISTICS
2. Faithful representation means that financial reports represent economic
phenomena or transactions in words and numbers.
• That is, the descriptions and figures must match what really existed or happened.
• It means that the actual effects of the transactions shall be properly accounted for
and reported in the financial statements.
• For example, if the entity reports purchases of P 5 million when the actual amount is
P 8 million, the information would not be faithfully represented.
• To record a sale of merchandise as miscellaneous income would not also be a faithful
representation of the sale of transaction.
 FUNDAMENTAL QUALITATIVE CHARACTERISTICS
• INGREDIENTS OF FAITHFUL REPRESENTATION
1. Completeness
2. Neutrality
3. Free from Error
1. Completeness requires that relevant information should be presented in a way that
facilitates understanding and avoids erroneous implication.
– Completeness is the result of adequate disclosure standard or the principle of full disclosure.
– A completed depiction includes all information necessary for a user to understand the
phenomenon being depicted, including all necessary descriptions and explanations.
– For example a complete depiction of a group of assets would include description of the assets,
numerical description such as cost, current cost, revaluation cost or fair value.
 FUNDAMENTAL QUALITATIVE CHARACTERISTICS
• Standard of adequate disclosure means that all significant and relevant information
leading to the preparation of financial statements shall be clearly reported.
• The accountant shall disclose a material fact known to him which is not disclosed in
the financial statements but disclosure of which is necessary in order that the
financial statements would not be misleading.
• The standard of adequate disclosure is best described by disclosure of any financial
facts significant enough to influence the judgment of informed users.
• Notes to financial statements- the purpose is to provide the necessary disclosures
required by the PFRS.
 FUNDAMENTAL QUALITATIVE CHARACTERISTICS
2. Neutrality- a neutral depiction is without bias in the preparation or presentation of
financial information.
– A neutral depiction is not slanted, weighted, emphasized, de-emphasized or otherwise
manipulated to increase the probability that financial information will be received favorably or
unfavorably by users.
– The financial information should not favor one party to the detriment of another party.
– The information directed to the common needs of many users and not to the particular needs
of specific users.
– Neutrality is synonymous with the all encompassing principle of fairness.
– To be neutral is to be fair.
 FUNDAMENTAL QUALITATIVE CHARACTERISTICS
• Prudence – the Revised CF has reintroduced the concept of prudence which means the
exercise of care and caution when dealing with the uncertainties in the measurement
process such that assets or income are not overstated and liabilities or expenses are not
understated. Neutrality is supported by the exercise of prudence.
• Conservatism- is synonymous with prudence.
– It means that when alternatives exist, the alternative which has the least effect should be chosen.
– In the simplest words, “ in case of doubt, record any loss and do not record any gain”.
– Example. Inventories are measured at the “lower of Cost and Net Realizable Value”.
– Contingent loss is recognized as “provision” if the loss is probable and measurable.
– Contingent gain is not recognized but disclosed only.
– It is not a license to deliberately understate net income and net assets.
– Example: if an entity has a cash of P 500,000 and reports only P 100,000 this not conservatism but fraud.
 FUNDAMENTAL QUALITATIVE CHARACTERISTICS
– Conservatism is expressed in this way:” Anticipate no profit and provide for probable and
measurable loss.”
– Another expression is: “ Don’t count the chicks until the eggs are hatched”.
– Further expression is: “ No matter how sure the businessman might be in capturing the bird in
the bush, the accountant must see it in the hand.”
• Free from Error
– It means there are no errors or omissions in the description of the phenomenon.
– The process used to produce the reported information has been selected and applied with no
errors in the process.
– It does not mean perfectly accurate in all respects.
– Example: an estimate of an unobservable place or value cannot be determined to be accurate
or inaccurate.
 FUNDAMENTAL QUALITATIVE CHARACTERISTICS
– Measurement uncertainty arises when monetary amounts in financial reports cannot be
observed directly and must instead be estimated.
– Measurement uncertainty can affect faithful representation if the level of uncertainty in
providing an estimate is high.
– The use or reasonable estimate is an essential part of providing financial information and does
not undermine the usefulness of financial information.
– As long as the estimate is clearly and accurately described and explained, even a high level of
measurement uncertainty does not affect the usefulness of the financial information.
• Substance over form
– If information is to represent faithfully the transactions and other events it purports to
represent, it is necessary that the transactions are accounted in accordance with their
substance and reality and not merely their legal form.
 FUNDAMENTAL QUALITATIVE CHARACTERISTICS
– Faithful representation inherently represents the substance of an economic events rather than
the legal form.
– Example: lessee lease property from the lessor.
– The contract is a lease that is popularly understood, in form.
– The terms of the lease provide that the lease transfers ownership of the asset to the lessee by
the end of the lease term.
 ENHANCING QUALITATIVE CHARACTERISTICS
• These relate to the presentation or form of the financial statements.
• Intended to increase the usefulness of the financial statements that is relevant and
faithfully represented.
• These are the following:
– Comparability
– Understandability
– Verifiability
– Timeliness
 ENHANCING QUALITATIVE CHARACTERISTICS
1. Comparability
– Means the ability to bring together for the purpose of noting points of likeness or difference.
– Enables users to identify and understand similarities and dissimilarities among items.
– Comparability within an entity, between and across entities.
– Within the entity, comparability also known as horizontal or intracomparability. Quality of
information that allows comparisons within a single entity through time or from one
accounting period to the next.
– Between and across entities, is comparability where quality of information allows
comparison between two or more entities engaged in the same industry. It is also known as
intercomparability or dimensional comparability.
– For information to be comparable, like things must look alike and different things must look
different.
 ENHANCING QUALITATIVE CHARACTERISTICS
• Consistency –implicit in the qualitative characteristics of comparability is the
principle of consistency.
• Consistency is not the same as comparability.
• Consistency broadly refers to the use of the same method for the same item, either
from period to period within an entity or in a single period across entities.
• Comparability is the goal and consistency helps to achieve that goal.
• Consistency in a limited sense is the uniform application of accounting method from
period to period within an entity.
• On the other hand, comparability is the uniform application of accounting method
between and across entities in the same industry.
 ENHANCING QUALITATIVE CHARACTERISTICS
– It is inappropriate for an entity to leave accounting policies unchanged when better and
acceptable alternative exist. But there is need for disclosure of any change made.
• Understandable
– Understandability requires that financial information must be comprehensible or intelligible to
be most useful.
– Information presented in understandable terminology and in simplest terms.
– But the complex economic activities make it impossible to reduce them to simplest terms.
– The users should have an understanding of complex economic activities, the financial
accounting process and the terminology in financial statements.
– Financial statements cannot realistically be understandable to anyone.
– Financial reports are prepared for users who have reasonable knowledge of business and
economic activities.
 ENHANCING QUALITATIVE CHARACTERISTICS
• Verifiability
– It implies consensus
– Financial information are factual and supported by evidences
– Financial information is verifiable when it provides results that would be substantially duplicated by
using the same measurement method.
– Verification can be direct and indirect.
– Direct verification means verifying an amount or other representation through direct observation.
Example is counting cash.
– Indirect verification means checking the inputs to a model, formula or other technique and recalculating
the inputs using the same methodology.
– Example: verifying the carrying amount of inventory by checking the inputs in quantities and costs and
recalculating the ending inventory using the same cost flow assumption such as the FIFO.
 ENHANCING QUALITATIVE CHARACTERISTICS
• Timeliness
– Means that financial information must be available or communicated early enough when a
decision is to be made.
– Relevant and faithfully represented financial information furnished after a decision is made is
of no value at all or useless.
– Example: the most important attribute of quarterly or interim financial information is its
timeliness.
• Cost constraint on useful information
– Cost is a pervasive constraint on the information that can be provided by financial reporting
– It is important that such cost is justified by the benefit derived from the financial information.
– The benefits derived should exceed the costs incurred which is based on judgment.
 EXERCISES
1. What is the meaning of qualitative characteristics of financial information?
2. What is the fundamental qualitative characteristics?
3. What is the enhancing qualitative characteristics?
4. Explain the most effective and efficient process of applying the fundamental qualitative
characteristics.
5. Explain relevance.
6. What are the two ingredients of relevance?
7. Explain predictive value.
8. Explain confirmatory value.
9. When is an item material?
10. Explain the new definition of materiality?
 EXERCISES
11. What are the factors that may be considered in determining materiality?
12. Explain the fundamental qualitative characteristics of faithful representation.
13. What are the three ingredients of faithful representation?
14. Explain completeness of information.
15. What is the standard of adequate disclosure?
16. Explain notes to financial statements in relation to completeness of the financial
information.
17. Explain neutrality of financial information.
18. What is prudence?
19. Explain conservatism.
20. Explain free from error financial information.
 EXERCISES
21. Explain the effect of measurement uncertainty to usefulness of financial information.
22. Explain the concept of substance over form.
23. What are the enhancing qualitative characteristics?
24. Enumerate the four enhancing qualitative characteristics.
25. Explain comparability.
26. Explain comparability within a single entity.
27. Explain comparability between and across entities.
28. What is consistency?
29. Distinguish consistency from comparability.
30. Explain understandability.
 EXERCISES
31. Explain verifiability.
32. Distinguish direct verification and indirect verification.
33. Explain timeliness.
34. Explain the cost constraint in useful financial information.
35. What is the rule on cost constraint?
END OF PRESENTATION
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