A conceptual framework is a group of ideas or principles used to plan or decide something.

It can be seen as a set of

guiding principles that is, those ideas or concepts that influence and direct decisions being made in a particular area.

Accounting Conceptual Framework

 The Conceptual Framework is a normative theory.
 It prescribes the basic principles that are to be followed in preparing financial statements.
 So, an accounting conceptual framework can be described as “a coherent system of concepts, which are guidelines to the
accounting standards and practices used for financial reporting”.

Objectives of the Accounting Conceptual Framework

The International Accounting Standards Board (IASB) describes the conceptual framework as a practical tool that:
a) assist the IASB to develop IFRS Standards that are based on consistent concepts;

b) assist preparers to develop consistent accounting policies when no Standard applies to a particular transaction or
other event, or when a Standard allows a choice of accounting policy; and

c) assist all parties to understand and interpret the Standards

Difference between the conceptual framework and the accounting standards

Conceptual Framework Accounting Standards

Principles in the Conceptual Framework are general concepts

Accounting standards provide specific requirements
designed to provide guidance, and apply to a wide range of
for a particular area of financial reporting.
decisions relating to the preparation of financial reports.

For example:
The accounting standard on inventory (e.g. IAS 2
For example:
Inventories) outlines the definition of what is
The Conceptual Framework defines what an asset is and
considered inventory and what costs are included and
when it should be included in the financial statements.
also requires these assets to be measured at the lower
of cost and net realizable value.

Reporting Focus
 The Conceptual Framework is concerned with General Purpose Financial Statements.
 These can be defined as financial reports intended to meet the needs of users who are not in a position to require an
entity to prepare reports tailored to their particular information needs.
 The Conceptual Framework does not need to be applied in the preparation of special purpose financial reports which are
reports prepared to meet the needs of particular users.
 Special purpose financial reports normally contain specialized information designed for users who have the power to ask
for the information they need such as:
o Some significant lenders
o Taxation authorities
o Management
Components of the Conceptual Framework
 The Framework addresses:
o the objective of general-purpose financial reporting
o qualitative characteristics of useful financial information
o financial statements and the reporting entity
o the elements of financial statements
o recognition and derecognition
o measurement
o presentation and disclosure
o concepts of capital and capital maintenance

The objective of financial reporting

 Stewardship or accountability focuses on the duty of the managers of an entity. They are entrusted with the resources of
the entity. Stewardship (or accountability) requires the managers to provide a report to the providers of the resources to
explain how well they have managed them.

 Stewardship and decision usefulness do not necessarily conflict, as they are parallel objectives with different emphasis
Stewardship is more related to the past transactions, while decision usefulness is more oriented towards the future
transactions.

• The Conceptual Framework does not include Accountability as a separate objective giving primacy to decision usefulness.

According to the Conceptual Framework

• 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.

• Those decisions involve buying, selling or holding equity and debt instruments, and providing or settling loans and other
forms of credit.
Users
 It is important to consider who the users are and what information they need, given that the purpose of financial
statements is to provide them with useful information.
 The Conceptual Framework identifies a limited range of primary users of financial statements. They include:
o existing and potential investors
o lenders
o other creditors
Users’ Information needs
 The information in financial reports is limited mainly to financial information.
 This is normally in the form of the Financial Statements and associated notes.
 The Conceptual Framework explicitly states that the General-purpose financial reports are not designed to show the
value of a reporting entity; but they provide information to help existing and potential investors, lenders and other
creditors to estimate the value of the reporting entity.
 The Conceptual Framework acknowledges Individual primary users have different, and possibly conflicting, information
needs and desires. However, the purpose is to provide the information set that will meet the needs of the maximum
number of primary users.

Underlying assumption

The going concern assumption

 It states that ‘the financial statements are normally prepared on the assumption that an entity is a going concern and
will continue in operation for the foreseeable future ‘.

 The going concern assumption has a direct impact on both the recognition and measurement of items in the financial
statements.

 If the entity is not expected to continue in business, then the economic benefits in particular items, such as long-term
prepaid insurance, would no longer be expected to be received, so they could not be recognized as assets.

 The reported values of assets would also need to be reconsidered.

 For example, if the business is to close, inventory may not realize its ‘normal’ selling price. Where the assumption that
the entity is a going concern is inappropriate, this basis should not be used and this would need to be disclosed.

Qualitative characteristics of useful financial information

Qualitative characteristics are properties that financial information must have to be included in the financial reports, in
order to ensure that the information provided is of adequate quality to help users make decisions.

 There are two fundamental qualitative characteristics that must be in the financial information They are relevance
and faithful representation. To be useful for decision making information must have both of the two fundamental
characteristics.

 There are four Enhancing qualitative characteristics: Comparability, verifiability, timeliness and
understandability. They represent qualitative characteristics that enhance the usefulness of information that is
relevant and faithfully represented.
Relevance
 Relevant financial information is capable of making a difference in the decisions made by users.
 The relevance characteristic aims to ensure that financial information that could make a difference in decisions is included.
 This fundamental qualitative characteristic outlines why the financial information is needed. It is linked directly to the
purpose of financial reports that is, to provide information useful to users in making decisions.
 Financial information is capable of making a difference in decisions if it has predictive value, confirmatory value or both.
o predictive value: Financial information has predictive value if it can be used as an input to processes employed by
users to predict future outcomes.

o confirmatory value: Financial information has confirmatory value if it provides feedback about (confirms or changes)
previous evaluations.

 The predictive value and confirmatory value of financial information are interrelated. Information that has predictive value
often also has confirmatory value.
 For example, revenue information for the current year, which can be used as the basis for predicting revenues in future
years, can also be compared with revenue predictions for the current year that were made in past years. The results of
those comparisons can help a user to correct and improve the processes that were used to make those previous
predictions.
 A related aspect of relevance is materiality. Materiality is the quality of information if its omission or misstatement could
influence the economic decisions of users taken on the basis of the financial reports.
 Materiality is an entity-specific aspect of relevance based on the nature or magnitude, or both, of the items to which the
information relates in the context of an individual entity’s financial report.

Faithful representation
 The purpose of faithful representation is to make sure that users can ‘trust’ the financial information that is provided in
financial reports
 In Conceptual Framework it replaces reliability as a qualitative characteristic.

 Faithful representation requires making sure that what is shown in the financial reports corresponds to the actual events
and transactions that are being represented.

 Accounting standards often require us to consider the substance over form (economic substance) - that is, requiring items
to be accounted for and presented in accordance with their substance and economic reality and not merely their legal
form.

 To be a perfectly faithful representation, a depiction would have three characteristics. It would be complete, neutral and
free from error.

o A complete depiction: including all information necessary for a user to understand the phenomenon being
depicted, including all necessary descriptions and explanations (All relevant information about an event or
phenomena are included in the financial reports, if these are to be useful for decision making).
o A neutral depiction is free of bias in the selection or presentation of financial information.
  Neutrality is supported by the exercise of prudence (conservatism). Prudence is the exercise of caution when
making judgements under conditions of uncertainty.

 The exercise of prudence means that assets and income are not overstated and liabilities and expenses
are not understated.

 However, the exercise of prudence does not allow for the understatement of assets or income or the
overstatement of liabilities or expenses.

o Freedom from error: means that there are no errors or omissions in the description of the phenomenon. Financial
information should be free from error. When using estimates, these should be made on a reasonable basis.

 When monetary amounts in financial reports cannot be observed directly and must instead be estimated, measurement
uncertainty arises. The use of reasonable estimates is an essential part of the preparation of financial information and
does not undermine the usefulness of the information if the estimates are clearly and accurately described and
explained.

Enhancing Qualitative Characteristics

- Information about a reporting entity is more useful if it can be compared with similar information
about other entities and with similar information about the same entity for another period or
another date.
Comparability
- Achieved with consistent measurement and presentation of items over time and between entities
(although comparability is not the same as consistency).
- Verifiability means that different knowledgeable and independent observers could reach consensus,
although not necessarily complete agreement.

- It also refers to that Information can be supported or confirmed so that users are confident in
Verifiability
relying on the information.

- Verification of information can be direct (e.g. counting inventory) or indirect (the latter in the case
of estimates).
- Users need information on a timely basis.

- Timeliness means having information available to decision makers in time to be capable of

Timeliness
influencing their decisions. Generally, the older the information is the less useful it is

- This may sometimes conflict with verifiability, since the latter may need some time.
- Understandability: Users should be able to understand the financial information, taking into account
that they are assumed to have reasonable knowledge.
Understandability
- Financial reports are prepared for users who have reasonable knowledge of business and economic
activities, and will conduct a diligent review and analysis of the information.
Cost Constraint on Financial Information
 Reporting financial information imposes costs, and it is important that those costs are justified by the benefits of
reporting that information
 Standard setters and entities shall assess if the benefits of reporting particular information are likely to justify the costs
incurred to provide and use that information.