CONCEPTUAL FRAMEWORK & ACCOUNTING STANDARDS

Purpose of the Conceptual Framework

• The Conceptual Framework prescribes the concepts for general purpose financial
reporting. Its purpose is to:
a. assist the International Accounting Standards Board (IASB) in developing Standards
that are based on consistent concepts;
b. assist preparers in developing consistent accounting policies when no Standard
applies to a particular transaction or when a Standard allows a choice of accounting
policy; and
c. assist all parties in understanding and interpreting the Standards.

Status of the Conceptual Framework

• The Conceptual Framework is not a PFRS. When there is a conflict between the
Conceptual Framework and a PFRS, the PFRS will prevail.
• In the absence of a standard, management shall consider the Conceptual Framework in
making its judgment in developing and applying an accounting policy that results in useful
information.

Scope of the Conceptual Framework

The Conceptual Framework is concerned with general purpose financial reporting. General
purpose financial reporting involves the preparation of general purpose financial statements.
The Conceptual Framework provides the concepts regarding the following:
1. The objective of financial reporting
2. Qualitative characteristics of useful financial information
3. Financial statements and the reporting entity
4. The elements of financial statements
5. Recognition and derecognition
6. Measurement
7. Presentation and disclosure
8. Concepts of capital and capital maintenance

Objective of general purpose financial reporting

 • The objective of general purpose financial reporting is to provide financial information
about the reporting entity that is useful to primary users in making decisions about
providing resources to the entity.
• The objective of general purpose financial reporting forms the foundation of the
Conceptual Framework.

Primary Users
• Primary users – are those who cannot demand information directly from reporting
entities. The primary users are:
(a) Existing and potential investors
(b) Lenders and other creditors.

• Only the common needs of primary users are met by the financial statements.
Qualitative Characteristics
I. Fundamental qualitative characteristics
(1) Relevance
(a) Predictive value
(b) Feedback value
⮚ Materiality – entity-specific aspect of relevance
(2) Faithful representation
(a) Completeness
(b) Neutrality
(c) Free from error

II. Enhancing qualitative characteristics

(1) Comparability
(2) Verifiability
(3) Timeliness
(4) Understandability

Fundamental vs. Enhancing

 • The fundamental qualitative characteristics are the characteristics that make
information useful to users.
• The enhancing qualitative characteristics are the characteristics that enhance the
usefulness of information

Relevance
• Information is relevant if it can affect the decisions of users.
• Relevant information has the following:
a. Predictive value – the information can be used in making predictions
b. Confirmatory value – the information can be used in confirming past predictions
⮚ Materiality – is an ‘entity-specific’ aspect of relevance.

Faithful Representation
• Faithful representation means the information provides a true, correct and complete
depiction of what it purports to represent.
• Faithfully represented information has the following:
a. Completeness – all information necessary for users to understand the phenomenon
being depicted is provided.
b. Neutrality – information is selected or presented without bias.
c. Free from error – there are no errors in the description and in the process by which
the information is selected and applied.

Enhancing Qualitative Characteristics

1. Comparability – the information helps users in identifying similarities and differences
between different sets of information.
2. Verifiability – different users could reach consensus as to what the information
purports to represent.
3. Timeliness – the information is available to users in time to be able to influence their
decisions.
4. Understandability – users are expected to have:
 a. reasonable knowledge of business activities; and

b. willingness to analyze the information diligently.

Financial statements and the Reporting entity

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:
a. the entity’s ability to generate future net cash inflows; and
b. management’s stewardship over economic resources.

Financial statements and the Reporting entity

Reporting period
• Financial statements are prepared for a specific period of time (i.e., the reporting period)
and include comparative information for at least one preceding reporting period.
Going concern
 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.

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.

Elements of Financial Statements

Asset
 • 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.”
Three aspects in the definition of an asset
1. Right – asset refers to a right, and not necessarily to a physical object, e.g., the right
to use, sell, lease or transfer a building.
2. Potential to produce economic benefits – the right has a potential to produce
economic benefits for the entity that are beyond the benefits available to all others.
Such potential need not be certain or even likely – what is important is that the right
already exists and that, in at least one circumstance, it would produce economic
benefits for the entity.
3. Control – means the entity has the exclusive right over the benefits of an asset and
the ability to prevent others from accessing those benefits.

Liability
• Liability is “a present obligation of the entity to transfer an economic resource as a result
of past events.”
Three aspects in the definition of a liability
1. Obligation – An obligation is “a duty or responsibility that an entity has no practical
ability to avoid.” (CF 4.29) An obligation can be either legal obligation or constructive
obligation.
2. Transfer of an economic resource – the obligation has the potential to require the
transfer of an economic resource to another party. Such potential need not be certain or
even likely – what is important is that the obligation already exists and that, in at least
one circumstance, it would require the transfer of an economic resource.
3. Present obligation as a result of past events – A present obligation exists as a result of
past events if:
o the entity has already obtained economic benefits or taken an action; and
o as a consequence, the entity will or may have to transfer an economic resource that it
would not otherwise have had to transfer.
Executory contracts
• An executory contract “is a contract that is equally unperformed – neither party has
fulfilled any of its obligations, or both parties have partially fulfilled their obligations to an
 equal extent.” (CF 4.56)
• An executory contract establishes a combined right and obligation to exchange economic
resources.
• The contract ceases to be executory when one party performs its obligation.
⮚ If the entity performs first, the entity’s combined right and obligation changes to an

asset.
⮚ If the other party performs first, the entity’s combined right and obligation changes to a

liability.

Equity
• “Equity is the residual interest in the assets of the entity after deducting all its liabilities.”
• Equity equals Assets minus Liabilities

Income and Expenses

• Income
Income is “increases in assets, or decreases in liabilities, that result in increases in equity,
other than those relating to contributions from holders of equity claims.”

• Expenses
Expenses are “decreases in assets, or increases in liabilities, that result in decreases in equity,
other than those relating to distributions to holders of equity claims.”

Recognition & Derecognition

The recognition process
• Recognition is the process of including in the statement of financial position or the
statement(s) of financial performance an item that meets the definition of one of the
financial statement 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 either of those statements.
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. (Conceptual Framework 5.12)

However, the presence of one or both of the foregoing does not automatically lead to
the non-recognition of an item. Other factors should also be considered.
Faithful representation
• The level of measurement uncertainty and other factors can affect an item’s faithful
representation, but not necessarily its relevance.

Measurement uncertainty
• Measurement uncertainty exists if the asset or liability needs to be estimated. A high level
of measurement uncertainty does not necessarily lead to the non-recognition of an asset
or liability if the estimate provides relevant information and is clearly and accurately
described and explained.
• However, measurement uncertainty can lead to the non-recognition of an asset or a
liability if making an estimate is exceptionally difficult or exceptionally subjective.
Derecognition
• Derecognition is the removal of a previously recognized asset or liability from the entity’s
statement of financial position.
• Derecognition occurs when the item ceases to meet the definition of an asset or liability.
Unit of account
• Unit of account is “the right or the group of rights, the obligation or the group of
obligations, or the group of rights and obligations, to which recognition criteria and
measurement concepts are applied.”

Measurement bases
1. Historical cost
2. Current value
a. Fair value
b. Value in use and fulfilment value
c. Current cost

Historical cost
• The historical cost of:
a. an asset is the consideration paid to acquire the asset plus transaction costs.
b. a liability is the consideration received to incur the liability minus transaction costs.
• Historical cost is updated over time to depict the following:
✔ Depreciation, amortization, or impairment of assets
✔ Collections or payments that extinguish part or all of the asset or liability
✔ Unwinding of discount or premium when the asset or liability is measured at amortized
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 transaction between market participants at the measurement date.”
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.”
(Conceptual Framework 6.17)
• 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
• The current cost of:
a. 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.”
b. 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.”

Entry values vs. Exit values

• Current cost and historical cost are entry values (i.e., they reflect prices in acquiring an
asset or incurring a liability), whereas fair value, value in use and fulfilment value are exit
values (i.e., they reflect prices in selling or using an asset or transferring or fulfilling a
liability).

Considerations when 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 (e.g.,
measuring an asset at historical cost may lead to the subsequent recognition of
depreciation or impairment, while measuring that asset at fair value would lead to the
subsequent recognition of gain or loss from changes in fair value).
b. The qualitative characteristics, the cost-constraint, and other factors (e.g., a
particular measurement basis may be more verifiable or more costly to apply than the
other measurement bases).

Measurement of Equity
• Total equity is not measured directly. It is simply equal to difference between the total
assets and total liabilities.
• Because different measurement bases are used for different assets and liabilities, total
equity cannot be expected to be equal to the entity’s market value nor the amount that
can be raised from either selling or liquidating the entity.
• Equity is generally positive, although some of its components can be negative. In some
cases, even total equity can be negative such as when total liabilities exceed total assets.

Presentation and Disclosure

• Information is communicated through presentation and disclosure in the financial
statements.
 • Effective communication makes information more useful. Effective communication
requires:
a. focusing on presentation and disclosure objectives and principles rather than on
rules.
b. classifying information by grouping similar items and separating dissimilar items.
c. aggregating information in a manner that it is not obscured either by excessive detail
or by excessive summarization.

Presentation and disclosure objectives and principles

• The objectives are specified in the Standards.
• The principles include:
a. the use of entity-specific information is more useful that standardized descriptions,
and
b. duplication of information is usually unnecessary.

Classification
• Classifying means combining similar items and separating dissimilar items.
• Offsetting of assets and liabilities is generally not appropriate.

Classification of income and expenses

• Income and expenses are classified as recognized either in:
a. profit or loss; or
b. other comprehensive income.
Aggregation
• Aggregation is “the adding together of assets, liabilities, equity, income or expenses that
have shared characteristics and are included in the same classification.”

Concepts of Capital and Capital Maintenance

• Financial concept of capital – capital is regarded as the invested money or invested
purchasing power. Capital is synonymous with equity, net assets, and net worth.
• Physical concept of capital – capital is regarded as the entity’s productive capacity,
e.g., units of output per day.