Chapter 2

BCIT FMGT 3110
Chapter 2
Conceptual Framework Underlying Financial
Reporting
1 stsiang BCIT FMGT 3110
Learning Objectives
1. Indicate the usefulness and describe the main
components of a conceptual framework for financial
reporting
2. Identify the qualitative character tics of accounting
information
3. Define the basic elements of financial statements
4. Describe the foundational principles of accounting
5. Explain the factors that contribute to choices and/or
bias financial reporting decisions
6. Discuss current trends in standard setting for the
conceptual framework
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BCIT FMGT 3110
Conceptual Framework(#1)
AcSB’s and IASB’s accounting standards are principal based so
need a conceptual framework
Conceptual framework: coherent system of interrelated

objectives and fundamentals that are the foundation of
developing standards and rules
• Roles of a conceptual framework:
i. Create standards based on established concepts
ii. Provide assistance in solving new and emerging practical
problems
iii. Increase users’ understanding of and confidence in
financial reporting
iv. Enhance comparability among different companies’
financial statements
• First level: the building blocks,

identifies goals and purposes
• Second level: characteristics

that make accounting
information useful
• Third level: principles used in

establishing and applying
accounting standards
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BCIT FMGT 3110
A new framework by IASB in March 2018
(effective Jan 1, 2020)
The conceptual framework may have changed

but it does not necessary override specific IFRS
Objective of Financial Reporting is to communicate
information that is:
• Useful to users; and
• Useful in making decisions about how to allocate
resources
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BCIT FMGT 3110
Management stewardship – how well management
is using entity resources to create and sustain value.
General purpose financial statements – basic

statements that give information that meets the
needs of key users
Most useful information in a manner

whereby benefits exceed cost


information useful

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BCIT FMGT 3110
Qualitative Characteristics of
Useful Information (#2)
There are two Fundamental Qualitative

characteristics.
Relevance
• Information that makes a difference in decision
making
• Has predictive and feedback/confirmatory value
• Materiality
o Information that makes a difference to decision marker
o Consider impact on any sensitive #
o Qualitative factors must be considered
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BCIT FMGT 3110
Representational Faithfulness
• Economic substance over legal form
• Transparency – representing economic reality
• To be representational faithfulness: info must be:
• Completeness – include all pertinent information
• Neutrality – information does not favour one interested
party over another
• Freedom from error – reliability
• Mgmt must make estimates and use judgement
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To ensure information has relevance and
representational faithfulness:
1. Identify the economic event or transaction

2. Identify the type of information that would be
relevant and can be faithfully represented
3. Assess whether the information is available
• Cost over benefit
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BCIT FMGT 3110
Enhancing Qualitative Characteristics
1. Comparability
• Information measured and reported in a similar way
(company to company and year to year)
2. Verifiability
• Independent users achieve similar results
3. Timeliness
4. Understandability
• Allows users with reasonable knowledge to understand the
information
• Presented with enough information to be clear
13
Trade-offs
(to providing all relevant information and present the
information to reflect economic substance)
Cost vs benefit relationship
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BCIT FMGT 3110
Define the basic elements of

financial statements (#3)


information useful

15

financial statement (#3)
Basic elements of financial statements include
the following:
• Assets
• Liabilities
• Equity
• Revenues/Income
• Expenses
• Gains/Losses
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BCIT FMGT 3110

ASSETS’ essential characteristics:
1. Represent a present economic resource – the
right to use an asset that produces economic
benefit or has the potential to produce
economic benefits
2. Entity has control over that resource – ability
to use the asset and receive economic
benefits (legal ownership)
3. Resources results from a past transaction or
events
17

LIABILITIES’ essential characteristics:
1. Represent a present duty or responsibility
• Contractual obligations or statutory requirements
• Constructive obligations (i.e. product warranties)
• Equitable obligations (i.e. severance)
2. Obligates the entity to transfer an economic
resource
3. Obligation results from a past transaction or
event
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BCIT FMGT 3110

EQUITY’s essential characteristics:
• Residual interest in an entity that remains in
an entity after deducting its liabilities from
its assets
• Net worth
• Consists of shares, retained earnings plus [in
IFRS: accumulated other comprehensive
income]
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Element ASPE IFRS
Revenues/Income Increases in economic resources, Increases in assets or
which result from ordinary decreases in liabilities other
operations. than those relating to
contributions from
shareholders.
Expenses Decreases in economic resources No distinction between
that result from ordinary revenue- ordinary revenue-generating
generating activities. activities and losses.
Gains/Losses Increases/Decreases in equity from Revenues and gains are
an entity’s peripheral or incidental grouped together under
transactions except Income, and expenses and
revenues/expenses and owner’s losses are grouped together
activity. under Expenses.
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BCIT FMGT 3110

IFRS ASPE
Statement of financial performance Income statement
or
statement of profit and loss and (OCI does not exist)
Statement of other comprehensive income*
Statement of financial position Balance sheet
Statement of changes in shareholders’ equity Statement of retained earnings
Statement of cash flows Cash flow statement
 Other comprehensive income (OCI) includes all changes in equity except for net
income and owner’s investment and distributions.
Example is foreign exchange translations; investment gain and losses; pension
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Foundational Principles (#4)


information useful

22
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BCIT FMGT 3110
Describe the foundational

principles of accounting (#4)
Foundational principles are details to

implement the objective of the financial
reporting.
It is the “when” and “how” financial elements and

events should be
• Recognized
• Measured
• Presented/disclosed
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Does it meet the definition
of an element? Objective #3
When can we recognize the

element?
How can we measure it?
How should it be
presented and what
should be disclose?
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BCIT FMGT 3110

Recognition/ Measurement Presentation/Disclosure
Derecognition
Economic entity
assumption Periodicity assumption Full disclosure principle
Monetary unit
Control
assumption
Revenue recognition and
Going concern
realization principles
assumption
Historical cost principle

Matching principle
Fair value principle and

value in use
25

Recognition/derecognition
Elements of financial statements are recognized
when:
• They meet the definition of an element
• Provide users with relevant information that
faithfully represents the underlying transaction
or event
No probability or measurement criteria – rather use

the concept of useful (fundamental qualities)
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BCIT FMGT 3110

Derecognition
Economic entity Periodicity assumption Full disclosure principle
assumption
Control Monetary unit

assumption
Revenue recognition and Going concern
realization principles assumption
Matching principle Historical cost principle

value in use
27

Economic Entity Assumption
• Means an economic activity can be identified
with a particular until of accountability
(company, division, an individual)
• Legal entities can be merged into an
economic entity for financial reporting Parent
purposes Division 1
Division 2
• “unit” of accountability
Sub 2 Sub 3
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BCIT FMGT 3110

Control
• Important factor in determining entities to be
consolidated and included in an economic entity
• Criteria under IFRS:
i. Having power over investee
ii. Exposure, or rights, to variable returns from involvement with investee;
iii. Ability to use power over investee to affect amount of investor’s returns
• Criteria under ASPE:
i. Continuing power to determine strategic decisions without others
ii. Demonstrably distinct:
a) Can the entity be unilaterally dissolved by the company?
b) Do others have a more than 10% ownership interest?
29

Revenue Recognition & Realization Principles
• Revenue recognized when:
Risks and rewards have passed or the earnings
process is substantially complete
Revenue is measurable, and
Revenue is collectible (realized or realizable)
• Revenues are realized when products (goods or services),
merchandise, or assets are exchanged for cash (or claims to
cash)
• ASPE - “income statement approach”
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BCIT FMGT 3110

Revenue recognition Principles (IFRS)
5-step approach:
1. Identify the contract with the customer
2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the price to each performance obligation
5. Recognize revenue when each performance obligation is
satisfied
• “balance-sheet approach” – cover in chapter 6
31

Matching Principle
• Expenses are matched with revenues that they
produce
• “cause and effect relationship” between money spent
to earn revenues
• If the expense benefits future periods and meets the
definition of asset, it is recorded as an asset
• This asset is then systematically and rationally
matched to future revenues through
amortization/depreciation
Remember the conceptual framework – usefulness
32 Qualitative characteristics - relevant
stsiang BCIT FMGT 3110
32
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BCIT FMGT 3110

Derecognition
assumption

assumption

value in use
33

Measurement
• All elements must be measurable to be
recognized
• Accrual accounting – measuring will required
the use of estimates (i.e. useful lives)
• Use of estimate give rise to uncertainty
oMeasurement uncertainty: when a value cannot be
objectively measured (can’t get a value)
oExistence uncertainty: does the asset or liability
meet the recognition criteria
oOutcome uncertainty: difficulty in determining
future outflows and inflows.
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BCIT FMGT 3110

Measurement Determine level of
uncertainty that is
acceptable for
recognition
Measurement uncertainty Use appropriate

Existence uncertainty measurement tool
Outcome uncertainty Disclose sufficient info to
describe the uncertainty
35

Measurement
• Measurement basis – historical costs, value
in use and current values
• Decision should be based on most useful
information (relevant that is faithfully
represents the event)
IFRS uses historical costs or current value (which
includes fair value, value in use or current cost)
o Value in use – present value of future weighted average
cashflow
o Current cost – value entity willing to pay
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BCIT FMGT 3110

Measurement
• Periodicity Assumption
o Economic activity of an entity can be divided into
artificial time periods for reporting purposes
o i.e. one quarter, and one year
o With technology, investors want more on-line, real-time
financial information to ensure relevant information
37

Measurement
• Monetary Unit Assumption
o Money is the common unit of measure of economic
transaction
o Monetary unit is relevant, simple and understandable,
universally available and useful
o In Canada and US, the dollar is assumed to be stable in
value (so ignore price level change)
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BCIT FMGT 3110

Measurement
• Going Concern Assumption
o Assumption that a business enterprise will continue to
operate in foreseeable future
o Expectation of continuing long enough to meet their
objectives and commitments
o Management must look out at least 12 months from
balance sheet date
o Liquidation accounting – net realizable value
o Full disclosure is required of any material uncertainties
of continuing as a going concern
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Measurement
• Historical Cost Principle
o Transactions are measured at the amount of cash paid
or the fair value of initial transaction
o 3 basic assumptions of historical cost
1) Represents a value at a point in time
2) Results from reciprocal exchange
3) Exchange includes an outside arm’s-length party
o Initial recognition for non-financial assets includes laid-
down costs (i.e. transportation and installation costs)
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BCIT FMGT 3110

Measurement
• Historical Cost Principle
o Challenges:
1. Non-monetary transaction (no cash in exchange)
2. Non-monetary, non reciprocal transaction (i.e. donation)
3. Related party transactions (use exchange value or cost)
oAlso apply to financial instruments (ie bonds,

notes)
41

Measurement
Fair Value Principle Historical Cost Principle
Relevance (predictive
Fundamental and feedback value)
Qualitative
Representational
Characteristics
faithfulness (neutrality
and freedom from error)
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BCIT FMGT 3110

Measurement
• Fair Value Principle
o IFRS – use of standardized fair value measurements
o IFRS “price that would be received to sell an asset or
paid to transfer a liabilities in an orderly transaction
between market participants at the measurement date”
o ASPE “amount of consideration that would be agreed

upon in an arm’s length transaction between
knowledgeable, willing parties who are under to
compulsion to act”
43

Measurement
• Fair Value Principle
o Fair value option – financial instruments are measured
at fair value with gains and losses booked to income
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BCIT FMGT 3110

Derecognition
assumption

assumption

value in use
45

Full Disclosure Principle
• Follow general practice of providing
information that is important enough to
influence an informed user’s judgement and
decisions
• Objective of financial reporting – useful info
46
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BCIT FMGT 3110

Condensed
Detailed
enough
enough
(understandable)
Where is the disclosure?

• Within the body of financial statements
• Notes of the financial statements
• Supplementary information (MD&A)
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BCIT FMGT 3110

Notes of financials:
oAmplify or explain the items presented in the main
body of the statements
IFRS Conceptual framework provides general

guidance for disclosure:
• Entity specific information over general information
• Duplication inhibits usefulness
49

MD&A – six disclosure principles:
1. Provide a view through management’s eyes
2. Supplement and complement information in the FS
3. Provide fair, complete and balanced information that is
material to decision-makers
4. Outline key trends, risks, and uncertainties that may
affect the company in the future and provide information
on the quality of earnings and cashflow
5. Explain management’s plan for long and short term goals
6. Be understandable, relevant, comparable, verifiable,
timely
50
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BCIT FMGT 3110

MD&A – 5 key elements:
1. Core business
2. Objectives and Strategy
3. Capability to deliver results
4. Results and Outlook
5. Key performance measures and indicators
IFRS – general trend towards increased disclosure to achieve greater
transparency
51
Conceptual Framework (#1-4)
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BCIT FMGT 3110
Choice and bias in financial

reporting decisions(#5)
IFRS and ASPE are principles-based
Objective of financial reporting is to provide
reliable, decision-relevant financial info for users
to make capital allocation decisions
Pro: consistency (principles)
flexibility (address all scenarios)
Con: too flexible
use of judgement (lack of comparability)
Neutrality becomes great importance
53

Financial Engineering
• Legally structuring a transaction so that it meets
the company’s financial reporting objectives
• Structured financing – creating instruments so the
financial reporting objectives are within GAAP
• Moving to be viewed as potential fraudulent
activity
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BCIT FMGT 3110

Fraudulent Financial Reporting
• Portray something that is not there
• Should not be influenced by external pressures
• Budgets may negative influence inappropriate
decisions
• May happen with a weak internal controls and
governance
55
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BCIT FMGT 3110

1 stsiang BCIT FMGT 3110

2 stsiang BCIT FMGT 3110

Conceptual framework: coherent system of interrelated

3 stsiang BCIT FMGT 3110

• First level: the building blocks,

• Second level: characteristics

• Third level: principles used in

4 stsiang BCIT FMGT 3110

The conceptual framework may have changed

5 stsiang BCIT FMGT 3110

6 stsiang BCIT FMGT 3110

General purpose financial statements – basic

Most useful information in a manner

7 stsiang BCIT FMGT 3110

• First level: the building blocks,

• Second level: characteristics

• Third level: principles used in

8 stsiang BCIT FMGT 3110

There are two Fundamental Qualitative

9 stsiang BCIT FMGT 3110

10 stsiang BCIT FMGT 3110

11 stsiang BCIT FMGT 3110

1. Identify the economic event or transaction

12 stsiang BCIT FMGT 3110

13 stsiang BCIT FMGT 3110

14 stsiang BCIT FMGT 3110

Define the basic elements of

• First level: the building blocks,

• Second level: characteristics

• Third level: principles used in

15 stsiang BCIT FMGT 3110

Define the basic elements of

16 stsiang BCIT FMGT 3110

Define the basic elements of

17 stsiang BCIT FMGT 3110

Define the basic elements of

Define the basic elements of

19 stsiang BCIT FMGT 3110

Define the basic elements of

20 stsiang BCIT FMGT 3110

Define the basic elements of

21 stsiang BCIT FMGT 3110

Foundational Principles (#4)

• First level: the building blocks,

• Second level: characteristics

• Third level: principles used in

22 stsiang BCIT FMGT 3110

Describe the foundational

Foundational principles are details to

It is the “when” and “how” financial elements and

Describe the foundational

When can we recognize the

How can we measure it?

24 stsiang BCIT FMGT 3110

Describe the foundational

Historical cost principle

Fair value principle and

25 stsiang BCIT FMGT 3110