Conceptual Framework and Accounting Standards

OVERVIEW for CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS

Definition of Accounting

 Accounting is the process of identifying, measuring, and communicating economic information

to permit informed judgment and decisions by users of information. AAA (American Association
of Accountants)

Three important activities included in the definition of accounting

 Identifying – the process of analyzing events and transactions to determine whether or not they
will be recognized in the books.
 Measuring – involves assigning numbers, normally in monetary terms, to the economic
transactions and events.
 Communicating – the process of transforming economic data into useful accounting
information, such as financial statements and other accounting reports for dissemination to
users.

Types of Events:

 External Events – events which involve an entity and an external party.

 Exchange (reciprocal transfer) – reciprocal giving and receiving.
 Non-reciprocal transfer – “one way” transaction.
 External events other than transfer – an event that involves changes in economic resources
or obligations of an entity caused by an external party or an external source but does not
involve transfers of resources or obligations.
 Internal Events - events which do not involve an external party.
 Production – the process by which resources are transformed into finished goods.
 Casualty – an unanticipated loss from disasters or other similar events.

Measurement Bases

 Historical Cost – price based on past exchange

 Current Cost – price based on current exchange
 Realizable (settlement) Value – net cash that could currently obtained by selling the asset in an
orderly disposal.
 Present Value – price based on future exchange
 Fair Value – 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.
 Fair Value less Cost to Sell – Cost to sell are the incremental costs directly attributable to the
disposal of an asset excluding finance costs and income tax expense.
 Revalued Amount – is the asset’s fair value at the date of the revaluation less any subsequent
accumulated depreciation and subsequent accumulated impairment loss.
 Inflation-adjusted Cost – amounts adjusted to the measuring unit current at the reporting date.
Conceptual Framework and Accounting Standards

Basic Purpose of Accounting

 The basic purpose of accounting is to provide information about economic activities intended to
be useful in making economic decisions.

Types of Accounting Information Classified as to User’s Needs:

 General Purpose of Accounting Information – designed to meet the common needs of the most
statement users. This information governed by the Philippine Financial Reporting Standards
(PFRS).
 Special Purpose of Accounting Information – designed to meet the specific needs of particular
statement users. This information is provided by other types of accounting, e.g., managerial
accounting, tax basis accounting, etc.

Basic Accounting Concepts

 Going Concern Assumption – the entity is assumed to carry on its operations for an indefinite
period of time.
 Separate Entity/Entity Concept – the entity is separated from its owners.
 Stable Monetary Unit – amounts in financial statements are stated in terms of a common unit of
measure changes in purchasing power is ignored.
 Time Period/Periodicity – the life of a business is divided into series of reporting periods.
 Materiality Concept – information is material if its omission or misstatement could influence
economic decisions.
 Cost Benefit (Reasonable Assurance/Persuasive Constraint/Cost Constraint) – the cost of
processing and communicating information should not exceed the benefits to be derived from
it.
 Accrual Basis of Accounting – effects of transactions are recognized when they occur (and not as
cash or its equivalent is received or paid) and they are recognized in the accounting periods to
which they relate.
 Historical Cost Concept (Cost Principle) – the value of an asset is to be determined on the basis
of acquisition cost.
 Concept of Articulation – all of the components of a complete set of financial statements are
interrelated.
 Full Disclosure Principle – financial statements provide sufficient detail to disclose matters that
make a difference to users, yet sufficient condensation to make the information understandable,
keeping in mind the cost of preparing and using it.
 Consistency Concept – financial statements are prepared on the basis of accounting principles
which are followed consistently from one period to the next.
 Matching (Associating Cause and Effect) – cost are recognized as expenses when the related
revenue is recognized.
Conceptual Framework and Accounting Standards

 Entity Theory – the accounting objective is geared towards the proper income determination. It
emphasizes the income statement and is exemplified by the equation “Assets + Liabilities =
Capital”.
 Proprietary Theory – the accounting objective is geared towards the proper valuation of assets.
It emphasizes the importance of the balance sheet and is exemplified by the equation “Assets +
Liabilities = Capital”.
 Residual Equity Theory – this theory is applicable where there are two classes of shares issued,
ordinary and preferred. The equation is “Assets + Liabilities – Preferred Shareholder’s Equity =
Ordinary Shareholder’s Equity”.
 Fund Theory – the accounting objective is the custody and administration of funds.
 Realization – the process of converting non-cash assets into cash or claims to cash.
 Prudence (Conservatism) – the inclusion of a degree of caution in the exercise of the judgments
needed in making the estimates required under conditions of uncertainty, such that assets or
income are not overstated and liabilities or expenses are not understated.

Common Branches of Accounting

 Financial Accounting/Financial Reporting – focuses on general purpose of financial statements.

 Management Accounting – focuses on special financial reports geared towards the needs of an
entity’s management.
 Cost Accounting – the systematic recording and analysis of the cost of materials, labor, and
overhead incident to production.
 Auditing – a systematic process of objectively obtaining and evaluating evidence regarding
assertions about economic actions and events to ascertain the degree of correspondence
between these assertions and established criteria and communicating results to interested
users.
 Tax Accounting – the preparation of tax returns and rendering tax advice, such as determination
of tax consequences of certain proposed business endeavors.
 Government Accounting – the accounting for the national government and its instrumentalities,
focusing attention on the custody of public funds and the purpose to which such funds are
committed.

Four Sectors in the Practice of Accountancy

1. Practice in Public Accountancy

2. Practice in Commerce and Industry
3. Practice in Education/Academe
4. Practice in the Government

Accounting Standards in the Philippines

 Philippine Financial Reporting Standards (PFRS) are standards and interpretations adopted by
the Financial Reporting Standards Council (FRSC).
Conceptual Framework and Accounting Standards

They compromise:

 Philippine Financial Reporting Standards (PFRS)

 Philippine Accounting Standards (PASs)
 Interpretations

CONCEPTUAL FRAMEWORK

Based on the Revised Conceptual Framework

Purpose of Conceptual Framework

The Conceptual Framework for the Financial Reporting prescribes the concept for general purpose
financial reporting. Its purpose is to:

 Assist the IASB in developing Standards that are based on consistent concepts;
 Assist preparers in developing consistent accounting principles when no Standard allows a
choice of accounting
 Assist all parties in understanding and interpreting the Standards.

Status of the Conceptual Framework

The Conceptual Framework is not a Standard. If there is no conflict between a Standard and the
Conceptual Framework, the requirement of the standard will prevail.

Effective Date and Transition

 The amendments are effective for annual periods beginning on or after 1 January 2020, with
earlier application permitted.
 The amendments should be applied retrospectively unless retrospective application would be
impracticable or involve undue cost or effort.

Scope of the Conceptual Framework

The Conceptual Framework is concerned with general purpose financial reporting.

Why Conceptual Framework has been revised?

In revising the Conceptual Framework, the Board sought a balance between providing high-level
concepts and providing enough detail for the Conceptual Framework to be useful to the Board and
others. The Board view the Conceptual Framework as a practical tool to help it develop Standards.
Hence, the Conceptual Framework includes concepts that help Board develop Standards and also
discusses the factors the Board needs to consider in making judgments when application of the concepts
does not lead to a single answer.

Previous Conceptual Framework Revised Conceptual Framework

Conceptual Framework and Accounting Standards

 Issued in 1989 and partly revised in 2010

 Useful, but incomplete and needed improvement

Revised Conceptual Framework

 A comprehensive set of concepts for financial reporting

Main Changes

The revised Conceptual Framework introduces the following main improvements:

New
Concepts on measurement, including factors to be considered when
Measurement
selecting a measurement basis
Concepts on presentation and disclosure, including when to classify
Presentation and Disclosure
income and expenses in other comprehensive income
Guidance on when assets and liabilities are removed from financial
Derecognition
statements

Updated
Definitions Definition of an asset and a liability
Recognition Criteria for including assets and liabilities in financial statements

Clarified
Measurement
Prudence Stewardship Substance Over Form
Uncertainty

Chapter 1: The objective of General Purpose of Financial Reporting

 This chapter sets out the objective of general purpose financial reporting (financial reporting),
what information is needed to achieve that objective and who the primary users (users) of
financial reports are.
 The objective of financial reporting is the foundation of the Conceptual Framework.

Objective of Financial Reporting

To provide financial information that is useful to users in making decisions relating to providing
resources to the entity
User’s decisions involved decisions about
Buying, selling or holding equity Providing or settling loans and Voting, or otherwise influencing
or debt instruments other forms of credit management’s actions
To make these decisions, users asses
Management’s stewardship of the entity’s
Prospects for future net cash to the entity
economic resources
To make both these assessments, users need information about both
Conceptual Framework and Accounting Standards

The entity’s economic resources, claims against the entity and changes in those resources and claims
How efficiently and effectively management has discharged its responsibilities to use the entity’s
economic resources

Chapter 2: Qualitative Characteristics of Useful Financial Information

This chapter discusses what makes financial information useful

In this Chapter, IFRS Framework describes 2 types of characteristics for financial information to be
useful:

 Fundamental Qualitative Characteristics are relevance and faithful representation.

 Enhancing Qualitative Characteristics are comparability, verifiability, timeliness and
understandability.

Chapter 3: Financial Statements and the Reporting Entity

This chapter describes the objective and scope of financial statements and provides a description of the
reporting entity.

 An entity that is required, or chooses to prepare financial

statements
Reporting Entity
 Not necessarily a legal entity – could be a portion of an
entity or comprise more than one entity
 A particular form financial reports that provide information
Financial Statements about the reporting entity’s assets, liabilities, equity, income
and expenses.

Consolidated Financial Unconsolidated Financial

Combined Financial Statements
Statements Statements
Provide information about Provide information about Provide information about
assets, liabilities, equity, income assets, liabilities, equity, income assets, liabilities, equity, income
and expenses of both the parent and expenses of the parent only. and expenses of two or more
and its subsidiaries as a single entities that are not all linked by
reporting entity. a parent-subsidiary relationship.

Chapter 4: The Elements of Financial Statements

This chapter defines the five elements of financial statements – an asset, a liability, equity, income and
expenses.

Previous Definition of an Asset Revised Definition of an Asset

A resource controlled by the entity as A present economic controlled by
a result of past events from which the entity as a result of past events.
Conceptual Framework and Accounting Standards

future economic benefits are expected An economic resource is a right that

to flow to the entity. has the potential to produce
economic benefits.

 Separate definition of an economic resource – to

clarify that an asset is the economic resource, not the
ultimate inflow or economic benefits.
 Deletion of “expected flow” – it does not need to be
Main changes in the definition of an
certain, or even likely ,that economic benefits will
asset
arise,
 A low probability of economic benefits might affect
recognition decisions and the measurement of the
asset.

Previous Definition of a Liability Revised Definition of a Liability

A present obligation of the entity A present obligation of the entity to
arising from past events, the transfer an economic resource as a
settlement of which is expected to result of past events.
result in an outflow from the entity of An obligation is a duty or
resources embodying economic responsibility that the entity has no
benefits practical ability to avoid.

 Separate definition of an economic resource – to

clarify that a liability is the obligation to transfer the
economic resources, not the ultimate outflow of
Main changes in the definition of a economic benefits.
liability  Deletion of “expected flow” – with the same
implications as set out above for an asset
 Introduction of the “no practical ability to avoid”
criterion to the definition of obligation

The right(s) or obligation(s), or groups of rights and obligations,

Unit of Account to which recognition criteria and measurement concepts are
applied.

Selecting the Unit of Account

Relevance
 A unit of account is selected to provide
relevant information about the asset or
liability and any related income and
expenses.
Faithful Representation
 A unit of account is selected to provide a
faithful related representation of the
substance of the transaction or other event
from which the asset, liability and any
related income and expenses have arisen.

Revised Definition of Income Revised Definition of Expenses

Increases in assets, or decreases in liabilities, that Decreases in assets, or increases in liabilities, that
result in increase in equity, other than those result in decrease in equity, other than those
relating to contributions from holders of equity relating to distributions to holders of equity claims.
Conceptual Framework and Accounting Standards

claims.

Chapter 5: Recognition and Derecognition

This chapter discusses criteria for including assets and liabilities in financial statements (recognition) and
guidance on when to remove them (derecognition).

The process of capturing for inclusion in the statement of financial

position or the statement(s) of financial performance item that
Recognition
meets the definition of an asset, a liability, equity, income or
expenses.

Recognition is appropriate if it results in both relevant information about assets, liabilities, equity,
income and expenses and a faithful representation of those items, because the aim is to provide
information that is useful to investors, lenders, and other creditors.

Recognition Criteria
Relevance Faithful Representation
 Whether recognition of an item results in  Whether recognition of an item results in a
relevant information may be affected by, faithful representation may be affected
for example: by, for example:
1. Low probability of a flow of 1. Measurement uncertainty
economic benefits 2. Recognition inconsistency
2. Existence uncertainty (accounting mismatch)
3. Presentation and disclosure

Cost Constraint
Cost constrains recognition decisions, just as it constrains other financial decisions.

The removal of all or part of a recognized asset or liability from

Derecognition
an entity’s statement of financial position.

Derecognition normally occurs

For an Asset For a Liability
When the entity loses control of all or part of When the entity no longer has a present
the recognized asset obligation for all or part of the recognized
liability.

Derecognition aims to faithfully represent both

 Any assets and liabilities retained after the transaction that led to the derecognition.
 The change in the entity’s assets and liabilities as a result of that transaction.
Conceptual Framework and Accounting Standards

Chapter 6: Measurement

This chapter describes various measurement bases and discusses factors to be considered when
selecting a measurement basis.

Historical Cost Measurement Bases

 Historical cost provides information derived at least in part from the price of the transaction
or other event that gave rise to the item being measured.
 Historical cost of assets is reduced if they become impaired and historical cost of liabilities is
increased if they become onerous.
 One way to apply a historical cost measurement basis to financial assets and financial
liabilities is to measure them at amortized cost.

Current Value Measurement Bases

 Current value provides information updated to reflect conditions at the measurement date.
 Current value measurement bases include:
 The price that would be received to sell an asset, or paid
to transfer a liability, in an orderly transaction between
Fair Value market participants at the measurement date.
 Reflects market participant’s current expectations about
the amount, timing and uncertainty of future cash flows.
Value in Use (for assets)  Reflects entity-specific current expectations about the
Fulfillment Value (for amount, timing and uncertainty of future cash flows
liabilities)
 Reflects the current amount that would be:
Current Cost 1. Paid to acquire an equivalent asset
2. Received to take on an equivalent liability

The factors to be considered when selecting a measurement basis are relevance and faithful
representation, because the aim is to provide information that is useful to investors, lenders, and other
creditors.

Factors to consider to selecting a measurement basis

Relevance
Relevance of information provided by a measurement basis is affected by:
Characteristics of the Asset or Liability
 The variability of cash flows
 Sensitivity of the value to market
factors or other risks
 For example, amortized cost cannot
provide relevant information about a
derivative
Relevance
Contribution to Future Cash Flows
 Whether cash flows are produced
directly or indirectly in combination
with other economic resources
 The nature of the entity’s business
activities
 For example, if assets are used in
combination to produce goods and
services, historical cost can provide
relevant information about margins
achieved in a period.
Conceptual Framework and Accounting Standards

Whether a measurement basis can provide faithful representation is affected by:

Measurement Consistency
 If financial statements contain
measurement inconsistencies
(accounting mismatch), those financial
statements may not faithfully
represent some aspects of entity’s
financial position and financial
performance.
Measurement Uncertainty
 Does not necessarily prevent the use
of a measurement basis that provides
relevant information
 But if too high might make it necessary
to consider selecting a different
measurement basis

Cost Constraints
Cost constrains the selection of a measurement basis, just as it constrains other financial reporting
decisions.

Chapter 7: Presentation and Disclosure

This chapter includes concepts on presentation and disclosure and guidance on including income and
expenses in the statement of profit or loss and other comprehensive income

The Statement of Profit or Loss

 The statement of profit or loss is the primary source of information about an entity’s
financial performance for the reporting period.
 Profit or Loss could be a section of a single statement of financial performance or a separate
statement.
 The statement(s) of financial performance include(s) a total (subtotal) for profit or loss.
 In principle, all income and expenses are classified and included in the statement of profit or
loss.

Other Comprehensive Income

 In exceptional circumstances, the Board may decide to exclude from the statement of profit
or loss income or expenses arising from a change in current value of an asset or a liability
and include those income and expenses in other comprehensive income.
 The Board may make such a decision when doing so would result in the statement of profit
or loss providing more relevant information or a more faithful representation.

Recycling
 In principle, income and expenses included in other comprehensive income in one period
are recycled to the statement of profit or loss in s future period when doing so results in the
statement of profit or loss providing more relevant information or a more faithful
representation.
 When recycling does not result in the statement of profit or loss providing more relevant
information or a more faithful representation, the Board may decide income and expenses
included in other comprehensive income are not to be subsequently recycled.