Recognition and measurement issue

(Part 1):

Conceptual
Framework
UKAF4023 ACCOUNTING THEORY AND PRACTICES
Learning objectives
At the end of this lecture, the students should be able to:

Understand the importance and objectives of the conceptual framework for

financial reporting in the production of accounting standards.

Describe the qualitative characteristics of useful financial information.

Explain the roles of prudence and substance over form in financial reporting.

Discuss the high-level issues that can make financial information less relevant.

Analyse the off-balance sheet financing issue from a substance versus form
perspective
What are we going to learn in this topic?
01 02
The conceptual Qualitative characteristics of
framework useful financial information

03 04
The roles of prudence and High-level issues
substance over form in and Off-balance sheet
financial reporting financing issue
 01
Conceptual framework
of financial reporting
The Conceptual Framework for Financial Reporting

The Conceptual Framework was issued by the MASB in

November 2011.

The Conceptual Framework is applicable for the preparation

and presentation of financial statements in accordance with
the Malaysian Financial Reporting Standards (MFRS).

The Conceptual Framework is equivalent to The Conceptual

Framework for Financial Reporting as issued by the IASB.
Status and Purpose of The Conceptual Framework
Assist the MASB to develop
MFRS Standards (Standards)
that are based on consistent
concepts;

The Conceptual Assist preparers to

Framework is not a develop consistent
Standard. Nothing in accounting policies when
The purpose of the
the Conceptual no Standard applies to a
Framework overrides Conceptual
particular transaction or
any Standard or any Framework is to: other event, or when a
requirement in a Standard allows a choice
Standard. of accounting policy; and

Assist all parties to understand

and interpret the Standards.
Status and Purpose of The Conceptual Framework
The Conceptual Framework provides the foundation for Standards that:
Strengthen accountability by
reducing the information gap
between the providers of capital
Contribute to transparency by and the people to whom they
enhancing the international have entrusted their money.
comparability and quality of Standards based on the
financial information, enabling Conceptual Framework provide
investors and other market information needed to hold
participants to make informed management to account. As a
economic decisions. source of globally comparable
information, those Standards are
also of vital importance to
regulators around the world.
Contribute to economic efficiency
by helping investors to identify
opportunities and risks across
the world, thus improving capital
allocation. For businesses, the
use of a single, trusted
accounting language derived
from Standards based on the
Conceptual Framework lowers
the cost of capital and reduces
international reporting costs.
The Objective of General Purpose Financial Reporting

v 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.

v Those decisions involve decisions about:

v Buying, selling or holding equity and debt instruments;
v Providing or settling loans and other forms of credit; or
v Exercising rights to vote on, or otherwise influence,
management’s actions that affect the use of the entity’s
economic resources.
The MASB’s Conceptual Framework
(2018)

A structured or coherent
formulation of high-
system of inter-related
quality and consistent
objectives, fundamental
reporting standards
characteristics and
concepts that lead to

to prescribe the nature,

function and limits of
financial accounting
and reporting.

Source: Tan Liong Tong (2022)

Objectives of Conceptual Framework

Users refer to primary

Provide useful users (e.g., investors,
information to users in potential investors,
making their economic lenders and other
decisions creditors), rather than
just users generally.

Source: Tan Liong Tong (2022)

 02
Qualitative characteristics
of useful information
 Source: Chapter 2 of Tan Liong Tong (2019) MASB Conceptual
Framework (2018)

Fundamental Enhancing
Qualitative Qualitative
Characteristics Characteristics

Relevance Faithful Representation Comparability

Useful for decision represent the substance and Consistency within an entity (over
making legal form periods) and other entities

Materiality Verifiability
Completeness
Omission/ misstatement Faithful representation of an
All necessary information
influences decisions economic phenomena

Timeliness
Predictive value Neutrality Fair and not biased.
Available information in time for
Predict future outcome Concept of Prudence
decision making

Confirmatory value Free from Error Understandability

Feedback on previous No error/omissions in description and Precise classification and
evaluations process to produce information presentation of information
Fundamental: Relevance
Relevant information helps to evaluate
past, present or future events.
It has:
• Predictive value – can be used as an
input to processes employed by
users to predict future outcomes
• Confirmatory value - provides
feedback about (confirms or
changes) previous evaluations
• Materiality
❑ Information is material if its omission/
misstatement could influence the
economic decisions of users.
❑ Materiality is an entity-specific aspect
of relevance based on the nature
and/or magnitude of the items to
which the information relates in the
context of financial report.
13
Fundamental: Faithful Representation
• Useful financial information must be relevant and must also faithfully
represent the phenomena or event that it purports to represent:
• Has 3 characteristics:
❑ Complete- All necessary information are included
❑ Neutral- Upholding prudence concept. Fair and not biased.
❑ Free from error- No error/omissions in description and process
to produce information

Note:

Substance over form – Need to present the accounting

information in accordance with their substance and
economic reality and not merely its legal form.

(More explanation on prudence concept and substance

over form will be in the next section)

14
Enhancing: Comparability
• Information that is measured and reported in a similar manner
for different companies is considered comparable.
• Comparability is the qualitative characteristic that enables
users to identify and understand similarities in, and
differences among items.
• Thus, comparability does not relate to a single item

15
Enhancing: Verifiability

§ Helps assure users that information

faithfully represents the economic phenomenon
§ Verification can be direct or indirect
§ Direct - verifying an amount or other
representation through direct observation. E.g.,
Counting cash.
§ Indirect - checking the inputs to a model,
formula or other technique and recalculating
the outputs using the same methodology.

16
Enhancing: Timeliness
• Having information available to
decision-makers in time to be capable
of influencing their decisions
• Generally, the older the information,
the less useful it is.
• However, some information may
continue to be timely long after the
end of a reporting period
• E.g., Information to identify trends

17
Enhancing: Understandability

Classifying, characterizing and presenting

information clearly and concisely makes it
understandable.

Include financial information in a manner that is easy to

understand.

Should not report incomplete & potentially misleading

information.

18
Accounting Concepts and Assumptions

Going Accrual Separate

Time period
concern concept entity

Historical Money
Matching Consistency
cost measurement

19
 Accounting Concepts and Assumptions
Going concern Accrual concept Matching Separate entity

• A going concern • Accrual basis vs • Determining the • The activities of the

entity prepare the cash basis . expenses used up to business is captured
accounts on the • Revenue and obtain the revenue in the financial
assumption that the expense are is referred to as statement; i.e.,
entity will continue recognized and matching expenses affairs of business
in operation for the recorded when against revenues. must be kept
foreseeable future earned and when separate from
incurred, and NOT owners.
when cash is
received/paid

20
 Accounting Concepts and Assumptions
Time period Money measurement Historical cost Consistency

• Businesses can divide • All business • The price, established • Refers to the use of
its economic activities transactions that are by the exchange the same methods for
into time periods & measured in terms of transaction similar items, either
can prepare Financial money, which is a from period to period
Statements at regular common denominator within a reporting
interval of 12 months. as it is relevant, entity or in a single
simple, period across entities.
understandable and • Company applies the
useful. same accounting
treatment to similar
events from period to
period.
• For e.g., depreciation
method.

21
 03
Prudence and substance
over form
Faithful representation
● Financial information is useful if it faithfully represent the phenomena or event
that it purports to represent. Faithful representation can be seen through its
completeness, neutrality and free from error.
● The IASB decided to reinstate explicit references to prudence and substance
over form in 2018 Conceptual Framework
a. Prudence is introduced in support of the principle of neutrality for the purposes of
faithful representation. Prudence is understood here as the exercise of caution when
making judgements under conditions of uncertainty. Users find this concept
important as they feel that it should help counteract the natural optimistic bias of
management. By acknowledging neutrality and prudence, the Framework includes
all conceptual underpinnings for the development of IFRSs.
b. The IASB concluded that substance over form was not a separate component of
faithful representation. If financial statements represented a legal form that differed
from the economic substance, then they could not result in a faithful representation.
Roles of Prudence and Substance Over Form
in Financial Reporting
● Prudence is related to neutrality. Prudence is the inclusion of a degree of caution
in the exercise of the judgements needed in making the estimates required under
conditions of uncertainty, (e.g. decisions relating to bad debts and allowances for
doubtful debts) such that assets or income are not overstated and liabilities or
expenses are not understated.

● Very often accountants have to use their judgement to decide which figure to
take for an item. Suppose a debt has been owing for quite a long time, and no
one knows whether it will ever be paid. Should the accountant be optimistic and
think that it will be paid, or be more pessimistic?
Roles of Prudence and Substance Over Form
in Financial Reporting
● It is the accountant's duty to see that people get the proper facts about a business. The
accountant should make certain that assets are not valued too highly. Similarly,
liabilities should not be shown at values that are too low. Otherwise, people might
inadvisedly lend money to a business, which they would not do if they had been
provided with the proper facts.

● The accountant should always exercise caution when dealing with uncertainty while, at
the same time, ensuring that the financial statements are neutral - that gains and
losses are neither overstated nor understated - and this is known as prudence.
Roles of Prudence and Substance Over Form
in Financial Reporting
● Substance over form must be applied, in that transactions and other events that
information purports to represent must be accounted for and presented in accordance
with their substance and economic reality and not merely their legal form.
● The legal form of a transaction can differ from its real substance. Where this happens,
accounting should show the transaction in accordance with its real substance which is,
basically, how the transaction affects the economic situation of the business. This
means that accounting in this instance will not reflect the exact legal position
concerning that transaction.
Roles of Prudence and Substance Over Form
in Financial Reporting
● Example: accounting for non-current assets being bought through a leasing
agreement.
a. From a legal point of view, the car does not belong to the business until (i) all the
instalments on the lease have been paid and (ii) an option has been taken up
whereby the business takes over legal possession of the car.
b. From an economic point of view, you have used the car for business purposes, just
as any other car owned by the business which was paid for immediately has been
used. In this case, the business will show the car being bought under a leasing
agreement in its ledger accounts and statement of financial position as though it
were legally owned by the business. It will also include an account in its ledger
for the amount still to be paid and include it among the liabilities at the period
end.
● In this way, therefore, the substance of the transaction has taken precedence
over the legal form of the transaction.
 04
High level issues and
Off-balance sheet financing issue
What are 'off balance sheet transactions'?
● The term 'off balance sheet transactions' is usually used to describe those
transactions which meet the objective of off-balance sheet financing.

● 'Off balance sheet finance' has been defined as 'the funding or refinancing of a
company's operations in such a way that, under legal requirements and existing
accounting conventions, some or all of the finance may not be shown on its balance
sheet'.

● However, they can involve more than this; firstly, assets as well as liabilities are
normally removed (or excluded) from a company's balance sheet; secondly, an off
balance sheet transaction is likely also to have an impact on the profit and loss
account.
What are 'off balance sheet transactions'?
● Financial events in the 21st century raise questions about the role of
modern day managers. Do they really work as the stewards of their
shareholders, or at some point, self interests consumed their motivation?

● In Part 3 of this topic, we are going to study some cases to look at some
application of off balance sheet transactions that lead to business failure.
Off balance sheet transaction
● As a response to the financial crisis, the IASB has issued three standards:
IFRS 10, Consolidated Financial Statements, IFRS 11, Joint Arrangements
and IFRS 12, Disclosure of Interests in Other Entities.

● The standards bring into broad alignment the accounting treatment for off
balance sheet activities in IFRS and US GAAP.

● The issuance of these standards completes IASB’s improvements to the

accounting requirements for off balance sheet activities and joint
arrangements.
 Off balance sheet transaction
IFRS 10 Consolidated
Financial Statements
• builds on existing
principles by identifying the
concept of control as the
determining factor in
whether an entity should
be included within the
consolidated financial
statements of the parent
company.
• The standard provides
additional guidance to
assist in the determination
of control where this is
difficult to assess.
IFRS 11 Joint Arrangements
• provides for a more
realistic reflection of joint
arrangements by focusing
on the rights and
obligations of the
arrangement, rather than
its legal form (as is
currently the case).
• The standard addresses
inconsistencies in the
reporting of joint
arrangements by requiring
a single method to account
for interests in jointly
controlled entities.
IFRS 12 Disclosure of
Interests in Other Entities
• is a new and
comprehensive standard
on disclosure requirements
for all forms of interests in
other entities, including
joint arrangements,
associates, special
purpose vehicles and other
off balance sheet vehicles.
Other issues
● Leasing provides an important and flexible source of financing for many companies.
However, the old lease accounting Standard (IAS 17 Leases) makes it difficult for
investors and others to get an accurate picture of a company’s lease assets and
liabilities, particularly for industries such as the airline, retail and transport sectors.

● Listed companies using IFRS Standards or US GAAP are estimated to have around
US$3.3 trillion of lease commitments; over 85 per cent of which do not appear on
their balance sheets*. That is because leases to date have been categorised as either
‘finance leases’ (which are reported on the balance sheet) or ‘operating leases’ (which
are disclosed only in the notes to the financial statements).

● IFRS 16 lease replaces IAS17 effective 1 January 2019. Early application is permitted
for companies that also apply IFRS 15 Revenue from Contracts with Customers.
 Old - IAS 17
Classification Classification is based on who bears the
risks and rewards of the assets under
lease.
Accounting Only Finance leases are recognised as
assets with operating leases being an
expense only.
Operating leases have less complex
accounting treatment
Lease and service contracts under an
operating lease are generally not required segregated from assets as the treatment
for analysis as accounting treatment is
probably accounted for in the same way lie form part of the asset, but will remain an
as an expense).
New - IFRS 16
The classification is based on who has the
'Right-of use' of the asset.
All leases are recognized as assets
All leases will be treated in the same way.
potentially resulting in significantly greater
volume and complexity of work in Finance
teams.
This will include calculation of balance
sheet amounts for assets and financial
liabilities, associated depreciation and
amortisation as well as increased record
keeping requirements.
Service components of leases must be
will differ and the service element will not
expense item. This may also require further
complex calculation to split the elements.
 Thank You!
Please prepare your answer for the tutorial in
advance to constantly check your understandability
of the course!

Next: Topic 4 Part 2