Module 2 Conceptual Frameworks and Accounting Standards PDF

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CONCEPTUAL FRAMEWORKS AND ACCOUNTING STANDARDS

Course Code: ACC 108


Course Description: Conceptual Frameworks and Accounting Standards
Course: BS Accountancy
Faculty Name: ELVIRA C. BATERINA

Course Description: Conceptual framework is a system of ideas and objectives that lead to the
creation of a consistent set of rules and standards. In accounting the rule and standards set the
nature, function and limits of financial accounting and financial statements. This may also assist
preparers of financial statements in developing accounting policies for transaction or events not
covered by existing standards.

ENVIRONMENTAL AND CONCEPTUAL FRAMEWORK FOR FINANCIAL ACCOUNTING


AND REPORTING

MODULE 2

Conceptual Framework and Theoretical Structure of Financial Accounting and Reporting,


Part l

Learning Objectives

1. Define the conceptual framework and understand its rationale, purpose and scope.
2. Understand the objective of general-purpose financial reporting and the types of useful
information.
3. Describe the limitations of general-purpose financing reporting guide.
4. Identify the fundamental qualitative characteristics of financial information.
5. Know how the qualitative characteristics of financial information can be enhanced.
6. Describe the basic assumption underlying PFRS as well as other environmental
assumption affecting it.

This module is divided into:

 Purposes of the Conceptual Framework


 Overview of the Conceptual Framework
 Scope of the Conceptual Framework
 Objective of General Purpose Financial Reporting
 Types of Useful Information
 Limitation of General Purpose Financial Reporting
 Fundamental Qualitative Characteristics of Financial Information
 Applying the Fundamental Qualitative Characteristics
 Enhancing Qualitative Characteristics
 Underlying Assumption: Going Concern

The conceptual framework provides a strong theoretical foundation and allows for the
systematic adaptation of accounting standards for a changing business environment. It aids in
an organized and consistent manner development of new accounting standards and allows one
to understand and perhaps anticipate future standards.
The Conceptual Framework sets out the fundamental concepts for financial reporting that guide
the Board in developing IFRS Standards. It helps to ensure that the Standards are conceptually
consistent and that similar transactions are treated the same way, so as to provide useful
information for investors, lenders and other creditors.

The Conceptual Framework also assists companies in developing accounting policies when no
IFRS Standard applies to a particular transaction, and more broadly, helps stakeholders to
understand and interpret the Standards.

 PURPOSES OF THE CONCEPTUAL FRAMEWORK

The comprehensive purposes of the Conceptual Framework are:

a) To assist the IASB in the development of future IFRSs and in its review of existing
IFRSs;

b) To assist the Board in promoting harmonization of regulations, accounting standards


and procedures relating to the presentation of financial statements by providing a
basis for reducing the number of alternative accounting treatments permitted by
IFRSs;

c) To assist national standard-setting bodies in developing national standards;

d) To assist preparers of financial statements in applying IFRSs and in dealing with


topics that have yet to form the subject of an IFRSs;

e) To assist auditors in forming an opinion on whether financial statements comply


IFRSs;

f) To assist users of financial statements in interpreting the information contained in


financial statements prepared in compliance with IFRSs; and

g) To provide those who are interested in the work of IASB with information about its
approach to the formulation of IFRSs.

 OVERVIEW OF THE CONCEPTUAL FRAMEWORK

The Conceptual Framework (or “Concepts Statements”) is a body of interrelated


objectives and fundamentals. ... Those concepts provide guidance in selecting
transactions, events and circumstances to be accounted for, how they should be
recognized and measured, and how they should be summarized and reported.

The objectives identify the goals and purposes of financial reporting and the fundamentals
are the underlying concepts that help achieve those objectives

 SCOPE OF THE CONCEPTUAL FRAMEWORK

The Conceptual Framework deals with

(a) The objective of financial reporting;


(b) The qualitative characteristics of useful financial information;
(c) The definition, recognition and measurement of the elements form which
financial statements are constructed; and
(d) Concepts of capital and capital maintenance.

 OBJECTIVES 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 existing and
potential investors, lenders, and other creditors in making decisions about providing
resources to the entity (e.g. providing loans to the entity or buying equity ...).

 TYPES OF USEFUL INFORMATION

There are four main financial statements. They are: (1) balance sheets; (2)
income statements; (3) cash flow statements; and (4) statements of shareholders'
equity. Balance sheets show what a company owns and what it owes at a fixed
point in time.

To help external users assess the amounts, timing and any uncertainty about the
future net cash inflows of the company, the following types of information have
been identified:

a. Financial Flexibility. Financial flexibility refers to the ability of a company to


use its financial resources to adapt change. It is used to describe a company's
ability to react to unexpected expenses and investment opportunities.

b. Liquidity and Solvency. Solvency refers to an enterprise's capacity to meet its


long-term financial commitments. Liquidity refers to an enterprise's ability to pay
short-term obligations.

c. Operating Capability. Operating capability is the ability of a company to align


critical processes, resources and technologies according to the overall guiding
vision and customer focused value propositions coupled with the ability to deliver
these processes effectively and efficiently.

d. Investing, Financing and Operating Activities. Investing activities refer to


earnings or expenditures on long-term assets, such as equipment and facilities,
while financing activities are the cash flows between a company and its owners
and creditors from activities such as issuing bonds, retiring bonds, selling stock
or buying back stock

 LIMITATION OF GENERAL PURPOSE FINANCIAL REPORTING

Accounting requires the use of estimates in the preparation of financial


statements where precise amounts cannot be established. Estimates are inherently
subjective and therefore lack precision as they involve the use of management's
foresight in determining values included in the financial statements. Where
estimates are not based on objective and verifiable information, they can reduce the
reliability of accounting information.

Measurability. Accounting only takes into account transactions that are capable
of being measured in monetary terms. Therefore, financial statements do not
account for those resources and transactions whose value cannot be reasonably
assigned such as the competence of workforce or goodwill.

Limited predictive value. Financial statements present an account of the past


performance of an entity. They offer limited insight into the future prospects of an
enterprise and therefore lack predictive value which is essential from the point of
view of investors.
Fraud and error. Financial statements are susceptible to fraud and errors which
can undermine the overall credibility and reliability of information contained in
them. Deliberate manipulation of financial statements that is geared towards
achieving predetermined results (also known as 'window dressing') has been a
unfortunate reality in the recent past as has been popularized by major
accounting disasters such as the Enron Scandal.

 FUNDAMENTAL QUALITATIVE CHARACTERISTICS FOR FINANCIAL INFORMATION


Relevance and faithful representation are categorized as the fundamental qualitative
characteristics of financial reporting information and the guiding concepts that apply
throughout the revised Conceptual Framework.
Fundamental Quality Relevance. Relevant financial information is capable of
making a difference in the decision made by users if it has:
 Predictive Value
 Confirmatory Value

Predictive Value. Financial information has predictive value if it can be used


as an input to processes employed by users to predict future outcomes. The
information helps users to increase the likelihood of correctly forecasting the
outcome of past and present events.
Confirmatory Value. Financial information has confirmatory value if it provides
feedback about (confirms or change) previous evaluations. The information
helps users to confirm or correct earlier predictions.
Relevant information has confirmatory value if it provides both feedback
value and predictive value at the same time. Feedback on past events helps
confirm or correct earlier expectations. Such information can then be used to
help predict future outcomes.
Fundamental Quality: Faithful Representation
Faithful representation. Faithful representation is the second fundamental
quality that makes accounting information useful for decision-
making. This means that the numbers and descriptions must be in
agreement between a measurement and the economic activity or item being
measured.
Information must faithfully represent the substance of what it represent
and is to the maximum extent possible, complete, neutral, free from
error and is affected by level of measurement uncertainly.
Completeness. Completeness means that all information necessary for
a user to understand the economic activity or a phenomenon must be
depicted, including all necessary descriptions and explanations.
Neutrality. Neutrality means that an enterprise cannot select information
to favor one set of interest parties over another. Neutrality is supported by
the exercise of prudence which does not allow for overstatement or
understatement of assets, liabilities, income or expenses.
Free from Errors. Faithfull representation does not imply total freedom
from error because a number of financial reporting measures involve
estimates of various types that incorporate management’s judgment.
Measurement uncertainly. Measurement Uncertainty relates to the
margin of doubt that exists for the result of any measurement, as well as
how significant the doubt is, but does not prevent from being useful.

 APPLYING THE FUNDAMENTAL QUALITATIVE CHARACTERISTICS


Reporting financial information that is relevant and faithfully represents what it purports to
represent helps users to make decisions about which they are more confident. If financial
information is to be useful, it must be relevant (i.e. it is capable of making a difference in
the decisions made by users because it has predictive value, confirmatory value or both
and faithfully represents what it purports to represent).
Financial information without the fundamental qualitative characteristics of relevance and
faithful representation is not useful, and it cannot be made useful by being more
comparable, verifiable, timely or understandable.
 ENHANCING QUALITATIVE CHARACTERITICS
Relevance and faithful representation are categorized as the fundamental qualitative
characteristics of financial reporting information. The enhancing qualitative
characteristics on
the other hand include comparability, verifiability, timeliness and understandability.

Comparability. An enhancing qualitative characteristic is comparability. IASB


(2008) defines comparability as the quality of information that enables users to
identify similarities in and differences between two sets of economic phenomena.
Information that is measured and reported in a similar manner for different
companies is considered comparable.
Consistency, although related to comparability, is not the same as comparability.
Consistency refers to the use of the same methods for same items, either from
period to period within a reporting entity or in a single period across entities.
Comparability is the goal, consistency helps to achieve the goal.
Verifiability. Verifiability means that different knowledgeable and independent
observers or users could reach consensus although not necessarily complete
agreement that a particular depiction is a faithful representation. It occurs when
independent measures using the same methods obtain similar results.
Verification can be direct or indirect . Direct verification means verifying an
amount or other representation through observation, for example, by counting
cash Indirect verification means checking the inputs to a model, formula or other
technique and recalculating the output using the same methodology.
Timeliness. The last enhancing qualitative characteristic discussed in the is
timeliness. The IASB (2010) conceptual framework defines timeliness as having
information available to decision makers before it loses its capacity to influence
decisions (IASB, 2010). In specific terms, timeliness relates to the decision
usefulness of financial reports. It refers to the time it takes to reveal the
information in annual reports. It is usually measured in terms of the number of
days it takes for the auditor to sign the accounts after book-year end.
Understandability. Understandability will increase when information is
classified, characterized, and presented clearly and concisely to enable users
comprehend their meaning. Understandability is usually measured using five
items which include: 1) how well-organised the information in the annual reports
is presented; 2) disclosure of information in notes to the account; 3) presentation
of certain information in tables and graphs; and 4) whether the financial
statements are devoid of technical jargons and 5) the inclusion of a glossary of
unfamiliar terminologies.

 UNDERLYING ASSUMPTION: GOING CONCERN

The going concern assumption is a basic underlying assumption of accounting. For


a company to be a going concern, it must be able to continue operating long enough to
carry out its commitments, obligations, objectives, and so on. In other words, the
company will not have to liquidate or be forced out of business.
The financial statements are normally prepared on the assumption that an enterprise is a
going concern and will continue in operation for the foreseeable future.

References:

Balatbat Cabrera Ma. E. , Royo Ocampo Reynaldo, B. Cabrera Gilbert Anthony, (2018-2019 Edidtion)
Conceptual Framework and Accounting Standards.

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