1

LECTURE 2
CONCEPTUAL FRAMEWORK OF ACCOUNTING

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2 OUTLINE

1. Financial Statements
2. Elements of Financial Statements
3. Specimen of Financial Statements
4. Accounting Concepts and Conventions
5. Accounting Standards
6. Accounting Policies
7. Accounting Bases

8. Accounting Terms

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3 Financial Statements

 IAS 1 covers the presentation of Financial Statements

 IAS stands for International Accounting Standards
 IAS 1 applies to all general purpose financial statements that are prepared and presented
in accordance with International Financial Reporting Standards (IFRSs).
 General purpose financial statements are those intended to serve users who are not in a
position to require financial reports tailored to their particular information needs. IAS 1
applies to all general purpose financial statements that are prepared and
presented in accordance with International Financial Reporting Standards (IFRSs).
[IAS 1.2]

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4 Objective of Financial Statements

 The objective of general purpose financial statements is to provide information about the
financial position, financial performance, and cash flows of an entity that is useful to a
wide range of users in making economic decisions.
 To meet that objective, financial statements provide information about an entity’s:
1. Assets
2. Liabilities
3. Equity
4. Income and expenses, including gains and losses
5. Contributions by and distribution of owners ( in their capacity as owners)
6. Cash flows

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5 Objective of Financial Statements

 That information, along with other information in the notes, assists users of financial
statements in predicting the entity's future cash flows and, in particular, their timing and
certainty.

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6 Components of Financial Statements

A complete set of financial statements according to IAS 1 includes:

1. a statement of financial position (balance sheet) at the end of the period
2. a statement of profit or loss and other comprehensive income for the period (presented
as a single statement, or by presenting the profit or loss section in a separate statement of
profit or loss, immediately followed by a statement presenting comprehensive income
beginning with profit or loss)
3. a statement of changes in equity for the period
4. a statement of cash flows for the period
5. notes, comprising a summary of significant accounting policies and other explanatory
notes
6. comparative information prescribed by the standard

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7 Going Concern basis of accounting

 The Conceptual Framework notes that financial statements are normally prepared
assuming the entity is a going concern and will continue in operation for the foreseeable
future
 If financial statements are prepared on a going concern basis, this assumes that
the entity will continue in operation for the foreseeable future.
 This informs the user that the entity neither intends to liquidate or materially curtail
the scale of operations.
 The ‘foreseeable future’ is not defined in the Framework Document but under IAS
1 Presentation of Financial Statements, this period is considered to be for a period of
at least 12 months after the reporting date.

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8 Going Concern basis of accounting

 IAS 1 requires management to make an assessment of an entity's ability to continue as a

going concern.
 If management has significant concerns about the entity's ability to continue as a going
concern, the uncertainties must be disclosed.
 If management concludes that the entity is not a going concern, the financial statements
should not be prepared on a going concern basis, in which case IAS 1 requires a series of
disclosures.

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9 Accrual basis of accounting

 IAS 1 requires that an entity prepare its financial statements, except for cash flow
information, using the accrual basis of accounting.
 The accrual basis of accounting stipulates that an entity should recognise the
effects of transactions and other events when they occur and not when they are
paid or when cash is received in settlement.
 In addition, an entity should also recognise these transactions and events in the
financial statements in the period to which they relate.

 By complying with the accruals concept this ensures that the financial statements
inform users of obligations to pay cash in the future and also inform users of the
entity’s obligations to also receive cash in the future.

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10 Consistency of presentation

 The presentation and classification of items in the financial statements shall be

retained from one period to the next unless a change is justified either by a change
in circumstances or a requirement of a new IFRS.

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11 Materiality and aggregation

 Information is material if omitting, misstating or obscuring it could reasonably be

expected to influence decisions that the primary users of general purpose financial
statements make on the basis of those financial statements, which provide
financial information about a specific reporting entity.
 Each material class of similar items must be presented separately in the financial
statements. Dissimilar items may be aggregated only if they are individually
immaterial.
 However, information should not be obscured by aggregating or by providing
immaterial information, materiality considerations apply to all parts of the financial
statements, and even when a standard requires a specific disclosure, materiality
considerations do apply.

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12 Offsetting

 Assets and liabilities, and income and expenses, may not be offset unless required
or permitted by an IFRS.

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13 Comparative Information

 IAS 1 requires that comparative information to be disclosed in respect of the

previous period for all amounts reported in the financial statements, both on the
face of the financial statements and in the notes, unless another Standard requires
otherwise.
 Comparative information is provided for narrative and descriptive where it is
relevant to understanding the financial statements of the current period.

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14 Reporting

 There is a presumption that financial statements will be prepared at least annually.

 If the annual reporting period changes and financial statements are prepared for a
different period, the entity must disclose the reason for the change and state that
amounts are not entirely comparable.

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15 Elements of Financial Statements

 Financial statements are made up of the following elements:

1. assets;

2. liabilities;

3. equity;

4. income; and

5. expenses.

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16 Assets

 An asset is a resource controlled by the entity as a result of past events from which
future economic benefits are expected to flow.

 ‘Control’ means the ability to restrict the use of the asset – for example inventory
could be stored in a locked warehouse.

 In contrast, if an entity has a highly skilled workforce, it cannot recognise these as

an asset because the entity cannot ‘control’ its workforce – they could leave at any
time.

 Assets are classified into Current and Non-Current Assets.

 Non-current Assets are also known as Fixed Assets.

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17 Assets

 According to IAS 1, current assets are assets that are:

 expected to be realised in the entity's normal operating cycle

 held primarily for the purpose of trading

 expected to be realised within 12 months after the reporting period

 cash and cash equivalents (unless restricted).

 All other assets are non-current.

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18 Current Assets

 Current assets have benefits within one accounting period. They can also
be converted into cash within one accounting period.
 Suppose a firm is into buying and selling books and stationery.
 When the firm purchases the items, it has stock of goods for resale. The
stock is a current asset. If the firm collects cash when the goods are sold,
cash at bank or in hand is also a current asset.
 If, on the other hand, the firm sells the goods on credit, the firm creates
trade debtors in place of cash which will be received later. This trade
debtors, is in the process of converting the goods into cash and therefore a
current asset.

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19 Fixed Assets

 Fixed assets are those assets acquired for retention in the business and not meant for
resale or conversion to cash.
 The benefits to be derived from the use of these assets span more than one accounting
period (more than a year).
 The costs of such assets are material; that is, to qualify as a fixed asset the cost of it
should be significant or substantial. However, what is material depends on the
circumstances of each case.

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20 Fixed Assets

▪ Thus for an asset to qualify as a fixed asset it must meet the following characteristics:
1. The asset acquired should be for retention in the business and not meant for resale or
conversion to cash.
2. The benefits to be derived from the use of the asset should span more than one
accounting period (more than a year).
3. The costs of the asset should be material.
▪ Examples of fixed assets are land and buildings, plant and equipment, furniture and
fittings and motor vehicles.

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21 Fixed Assets

 A fixed asset can be tangible and intangible.

 A tangible fixed asset has a physical existence. It can be touched and moved about.
Examples are land and buildings, plant and machinery, fittings and fixtures, and motor
vehicles.
 These tangible fixed assets are non-wasting because the assets are not depleted as they
are used.
 Some tangible fixed assets are wasting assets as the assets are depleted as they are used.
Examples of such wasting tangible assets are mines (mineral deposits), timber tracks,
quarries and oil wells

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22 Fixed Assets

 Intangible assets are those which have no physical existence.

 The benefits are in the rights attached to the assets.
 Examples include copyrights, goodwill and leases.

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23 Fictitious Asset or Nominal Asset

 Assets have future benefits.

 When the benefits expire the assets cease to exist and become expenses which are then
written off against the revenue of the period.
 But some exceptional expenses incurred in a period may not be considered proper to
have everything written off in that period. So a portion may be deferred to be written off
in the next accounting period(s).
 If this happens, it implied that an entity will be treating the expense as an asset.
 This kind of asset is called Fictitious Asset or Nominal Asset because the asset is not
represented by any real present value.
 Examples include any preliminary expenses incurred by companies before the companies
start business and heavy advertising or promotion expenses.

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24 Liabilities

 A liability is a present obligation of the entity arising from past events, settlement of
which is expected to result in an outflow of resources embodying economic
benefits.
 Liabilities can be subdivided into the long-term and current.

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25 Liabilities

 According to IAS 1, current liabilities are those:

1. expected to be settled within the entity's normal operating cycle
2. held for purpose of trading
3. due to be settled within 12 months
4. for which the entity does not have the right at the end of the reporting period to
defer settlement beyond 12 months.
 Other liabilities are non-current.

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26 Long-term liabilities

 Long-term liabilities are external claims, against the resources of an entity, whose
discharge is more than one accounting period from the balance sheet date.
 If an entity has obtained a loan of $500,000 which is payable in five years it is an example
of a long-term liability. If, however, the loan should be paid within or in one year, then the
loan moves from a long-term to a current liability.

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27 Current Liabilities

 Current liabilities are external claims, against the resources of an entity, whose discharge
is within one accounting period from the balance sheet date.
 Normally current liabilities consist of amount owing to trade creditors, expenses owing
like rent, utilities, taxes payable and dividends payable to shareholders.

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28 Equity

 Equity is the residual interest in the assets of the entity after deducting all its
liabilities.
 The equity is made of share capital and reserves in the case of a company.
 Equity could also be termed as:
 Shareholders’ funds
 Net assets
 Net worth

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29 Income

 Income is increases in economic benefits during the reporting period in the form of
inflows (or enhancements) of assets or decreases of liabilities that result in
increases in equity other than those relating to contributions from equity
participants.
 Income can include both revenue and gains even though they may be included in
equity rather than the statement of comprehensive income (for example a
revaluation surplus).
 An example of a contribution from equity participants is the purchase of additional
shares.

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30 Income

 Revenue refers to the inflow of assets that an entity receives in exchange of goods and
services provided to customers as a result of the major or central operations of the
business entity.
 If an entity is selling books and stationery, the cash or trade debtors which result from
sales made to customers represents sales revenue. If the entity is an agent selling on
behalf of his principal for commission, then the commissions receive form the revenue,
receipts or inflow from the principal business operations.
 If an entity’s principal operation is selling books and stationery but also helps distribute
some publications and receives commissions, then such commissions will be treated as
other incomes just like rent received from subletting part of the business building to some
tenants.

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31 Income

 Gains on the other hand are inflows of assets from transactions that are incidental to the
major activities carried on by an entity.
 For example, if an entity pays trade creditors early enough to qualify for cash discount,
these discounts received will be treated as gains.
 Fixed assets are not meant for sale, but it may happen that for some reason, an entity will
dispose of a fixed asset. If the entity realize more than the book value, the excess is
treated as a gain.
 Revenues are therefore the inflows resulting from carrying out the main or major activity
of a business entity while gains result from transactions that are only incidental to the
main activities of an entity.

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32 Expenses

 Expenses are decreases in economic benefits during the reporting period in the
form of outflows (or depletions) of assets or incurrences of liabilities that result in
decreases in equity other than those relating to distributions to equity participants.
 Expenses are conceptually similar to revenues except that whereas revenues are inflows,
expenses are outflows. That is to say that expenses are outflows or the using up of assets
as a result of the major or central operations of a business entity.
 Similarly, losses are like gains except that losses are decreases in assets while gains are
increases in assets, as a result of transactions that are only incidental to the major
operations.

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33 Expenses

▪ Examples of losses include:

1. Bad debts which are owings by trade debtors but which cannot be recovered and therefore
written off as bad. It should be noted that the business would have exhausted all avenues to
collect the debt and has come to the conclusion that the debt cannot be collected. Such debts
are irrecoverable debts.
2. Discount allowed which are amounts lost or given up because, according to the terms of sales,
the trade debtors pay within a stipulated period and qualify for a deduction off the amounts
owing. The rationale behind granting discounts to debtors is to encourage them to pay up their
debts early so that the business entity can do further business with the amounts collected from
the debtors.
3. Receiving less, in amount, than the book value of a fixed asset which is disposed off; that is,
realizing an amount or asset which is less than the book value of a fixed asset on disposal.

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34 Specimen of Financial Statements

 Balance Sheet
 Format
 Preparation
 Models or Style of Presentation
 Balance Sheet of Sole Proprietorship
 Balance Sheet of companies

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35 Statement of Profit or Loss and Other
Comprehensive Income
 Profit or loss is defined as "the total of income less expenses, excluding the
components of other comprehensive income".
 Other comprehensive income is defined as comprising "items of income and
expense (including reclassification adjustments) that are not recognised in profit or
loss as required or permitted by other IFRSs".

 Comprehensive income for the period = Profit or Loss + Other Comprehensive Income

 All items of income and expense recognised in a period must be included in profit
or loss unless a Standard or an Interpretation requires otherwise.

 Some IFRSs require or permit that some components to be excluded from profit or
loss and instead to be included in other comprehensive income.

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36 Examples of items recognised outside
of profit or loss
 Changes in revaluation surplus where the revaluation method is used under IAS
16 Property, Plant and Equipment and IAS 38 Intangible Assets
 Remeasurements of a net defined benefit liability or asset recognised in
accordance with IAS 19 Employee Benefits (2011)
 Exchange differences from translating functional currencies into presentation
currency in accordance with IAS 21 The Effects of Changes in Foreign Exchange
Rates
 Gains and losses on remeasuring available-for-sale financial assets in accordance
with IAS 39 Financial Instruments: Recognition and Measurement

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37 Examples of items recognised outside
of profit or loss
 The effective portion of gains and losses on hedging instruments in a cash flow hedge
under IAS 39 or IFRS 9 Financial Instruments
 Gains and losses on remeasuring an investment in equity instruments where the entity
has elected to present them in other comprehensive income in accordance with IFRS 9

 The effects of changes in the credit risk of a financial liability designated as at fair value
through profit and loss under IFRS 9.

 In addition, IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors

requires the correction of errors and the effect of changes in accounting policies to be
recognised outside profit or loss for the current period.

 he effects of changes in the credit risk of a financial liability designated as at fairGains

and losses on remeasuring an investment in equity instruments where the entity has
elected to present them in other comprehensive income in accordance with IFRS 9

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38 Statement of Cash Flows

 IAS 7 is on Statement of Cash Flows

 Specimen of Statement Cash Flows
 Explanations

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39 Statement of Changes in Equity

 IAS 1 requires an entity to present a separate statement of changes in equity. The

statement must show:
 total comprehensive income for the period, showing separately amounts
attributable to owners of the parent and to non-controlling interests
 the effects of any retrospective application of accounting policies or restatements
made in accordance with IAS 8, separately for each component of other
comprehensive income
 reconciliations between the carrying amounts at the beginning and the end of the
period for each component of equity, separately disclosing:

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40 Statement of Changes in Equity

1. profit or loss

2. other comprehensive income*

3. transactions with owners, showing separately contributions by and distributions to owners

and changes in ownership interests in subsidiaries that do not result in a loss of control

 To* An analysis of other comprehensive income by item is required to be presented

either in the statement or in the notes.anges resulting from transactions with
owners in their capacity as owners"

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41 Statement of Changes in Equity

 The following amounts may also be presented on the face of the statement of
changes in equity, or they may be presented in the notes:
1. Amounts of dividends recognised as distributions
2. The related amount per share.

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42 Notes to the Financial Statements

1. Present information about the basis of preparation of the financial statements and the
specific accounting policies used

2. Disclose any information required by IFRSs that is not presented elsewhere in the financial
statements and

3. Provide additional information that is not presented elsewhere in the financial statements
but is relevant to an understanding of any of them

▪ Notes are presented in a systematic manner and cross-referenced from the face of
the financial statements to the relevant note.

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 END OF PART ONE OF
43
LECTURE 2
THANK YOU/CONTACT: email: eddie.yeboah401@gmail.com

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