Cfas Reading
Cfas Reading
Cfas Reading
Villaluz
COLEGIO DE SAN JUAN DE LETRAN
A.Y. 2020 – 2021, First Semester
ACC103: Conceptual Framework and Accounting Standards
HANDOUT NO. 1 – Conceptual Framework for Financial Reporting
Figure 1:
Contents of the Conceptual Framework for Financial Reporting
➢ The contents of these chapters will be discussed in detail in this module. This lesson covers the introductory
paragraphs and the first chapter of the conceptual framework.
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AUTHORITATIVE STATUS OF THE CONCEPTUAL FRAMEWORK
If there is a standard or an interpretation that specifically applies to a transaction, the standard or interpretation overrides
the Conceptual Framework.
In the absence of a standard or an interpretation that specifically applies to a transaction, management shall consider the
applicability of the Conceptual Framework in developing and applying an accounting policy that results in information that
is relevant and reliable.
It is to be stated that the Conceptual Framework is not an accounting standard. Nothing in the Conceptual Framework
overrides any specific IFRS. In case where there is a conflict, the requirements of the IFRS shall prevail.
Primary users
➢ The parties to whom general purpose financial reports are primarily directed.
Lenders and other creditors Information which enables them to determine whether their loans, interest thereon and
other amounts owing to them will be paid when due.
Other users
➢ By residual definition, these are the users of financial information other than the primary users.
➢ These users may find the general purpose financial reports useful but these are not directed to them primarily.
Information which enables them to assess the ability of the company to provide
remuneration, retirement benefits and employment opportunities.
Customers Information about the continuance of an entity especially when they have a long-term
involvement with or are dependent on the entity.
Government and its agencies Information of the company to regulate its activities, determine taxation policies and as
a basis for national income and similar statistics.
Fundamental Enhancing
Qualitative Qualitative
Characteristics Characteristics
Faithful
Relevance Verifiability Comparability Understandability Timeliness
representation
Confirmatory
Predictive value Completeness Neutrality Free from error
value
Figure 2:
Qualitative Characteristics of Financial Statements
Relevance
• Refers to the capacity of the information to influence a decision.
• Information has predictive value when it can help users increase the likelihood of predicting or forecasting
outcome of events.
• Information has confirmatory value if it provides feedback about previous evaluations.
• The relevance of information is affected by its nature and materiality.
▪ Materiality is defined by the International Accounting Standards Board (IASB) in the following manner:
Information is material if omitting, misstating or obscuring it could reasonably be expected to influence the
economic decisions that primary users of general-purpose financial statements make on the basis of those
statements which provide financial information about a specific reporting entity.
▪ Simply stated, an information is material if its omission, misstatement and obscuring of the information could
reasonably affect the economic decision of primary users.
➢ Materiality dictates that strict adherence to Generally Accepted Accounting Principles (GAAP) is not
required when the items are not significant enough to affect the evaluation, decision and fairness of the
financial statements. In simple terms, materiality is just a “quantitative threshold”.
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➢ The materiality of an item depends on relative size rather than absolute size. What is material for one
may not be material to another.
➢ There is no uniform quantitative threshold for materiality as it depends on the professional judgment of
an accountant.
✓ An item is material if knowledge of it would affect or influence the decision of the primary users of
the financial statements.
Faithful Representation
• This means that the actual effects of the transactions shall be properly accounted for and reported in the financial
statements.
• The descriptions and figures presented in the financial statements should match what really existed or happened.
• Three ingredients:
(a) Completeness – this requires that relevant information should be presented in a way that facilitates
understanding and avoids erroneous implication.
➢ The standard of adequate disclosure (or the full disclosure principle) means that all significant and
relevant information leading to the preparation of financial statements shall be clearly reported. This is
best described as disclosure of any financial facts significant enough to influence the judgment of informed
users.
(b) Neutrality – the financial statements should not be prepared so as to favor one party to the detriment of
another party.
➢ To be neutral or fair, the information contained in the financial statements must be free from bias.
➢ Neutrality is supported by the exercise of prudence (or conservatism).
✓ Prudence (or conservatism) the exercise of care and caution when dealing with the uncertainties in
the measurement process such that assets or income are not overstated and liabilities or expenses
are not understated.
- When alternatives exist, the alternative which has the least effect on equity shall be chosen.
(c) Free from error – this means there are no errors or missions in the description of the phenomenon or
transactions.
• If information is to represent faithfully the transactions it purports to represent, it is necessary that the
transactions are accounted for in accordance with their economic substance and reality and not merely their legal
form. This is called the concept of substance over form.
➢ If there is a conflict between substance and form, the economic substance of the transaction shall prevail over
the legal form.
Verifiability
• This means that different knowledgeable and independent observers could reach consensus that a particular
depiction is a faithful representation.
• The information is verifiable if it is supported by evidence that an accountant would look into and arrive at the
same conclusion.
Comparability
• It enables users to identify and understand similarities and dissimilarities among items.
• This may be made within an entity or between and across entities.
➢ Comparability within an entity is the quality information that allows comparisons within a single entity from
one accounting period to the next. This is known as intracomparability.
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➢ Comparability between or across entities is the quality of information that allows comparisons between two
or more entities engaged in the same industry. This is known as intercomparability.
• Consistency refers to the use of the same method for the same item, either from period to period within an entity
or in a single period across entities.
➢ This is not synonymous to comparability.
➢ Comparability is the goal and consistency helps to achieve that goal.
Understandability
• Information should be presented in a form and expressed in terminology that a user understands.
• An essential quality of the information provided in financial statements is that it is readily understandable by
users.
• Understandability is very essential because a relevant and faithfully represented information may prove useless
if it is not understood by users.
Timeliness
• This means having the information available to decision makers in time to influence their decisions.
• Relevant information may lose relevance if there is undue delay in the reporting.
COST CONSTRAINT
• Cost is a pervasive constraint on the information that can be provided by financial reporting.
• Reporting financial information imposes cost and it is important that such cost is justified by the benefit derived
from the financial information.
➢ The benefit derived from the information should exceed the cost incurred in obtaining the information. This
is known as the cost-benefit consideration.
➢ Assessing whether the cost of reporting outweighs or falls short of the benefit to be derived is a matter of
professional judgment.
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3. Combined financial statements
➢ These are the financial statements when the reporting entity comprises two or more entities that are not
linked by a parent and subsidiary relationship.
REPORTING PERIOD
• The period when financial statements are prepared for general purpose financial reporting.
• Financial statements are prepared at least annually. Optionally, it may be prepared on an interim basis (i.e., three
months, six months, nine months).
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Elements of
financial
statements
Elements of Elements of
Financial Financial
Position Performance
Figure 3:
Classification of Elements of Financial Statements
Asset
• Under the Conceptual Framework, an asset is defined as 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. Rights that have the
potential to produce economic benefits may take the following forms:
1. Rights that correspond to an obligation of another entity
(a) Right to receive cash;
(b) Right to receive goods or services;
(c) Right to exchange economic resources with another party on favorable terms; and
(d) Right to benefit from an obligation of another party if a specified uncertain future event occurs.
Liability
• Under the Conceptual Framework, a liability is defined as present obligation of an entity to transfer an economic
resource as a result of past events.
• Essential characteristics:
(a) The entity has an obligation
(b) The obligation is to transfer an economic resource.
(c) The obligation is a present obligation that exists as a result of past event.
➢ An obligation is a duty or responsibility that an entity has no practical ability to avoid.
✓ Can either be legal or constructive.
❖ Obligation may be legally enforceable as a consequence of a binding contract or statutory
requirement.
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❖ Constructive obligation arises for normal business practice, custom and a desire to maintain good
business relations or act in an equitable manner.
• Obligations to transfer an economic resource as a result of past event include:
✓ Obligation to pay cash;
✓ Obligation to deliver goods;
✓ Obligation to provide services at some future time;
✓ Obligation to exchange economic resources with another party on unfavorable terms; and
✓ Obligation to transfer an economic resource if specified uncertain future event occurs.
Equity
• The residual interest in the assets of an entity after deducting all of the liabilities.
Income
• Defined as increases in assets or decreases in liabilities that result in increases in equity, other than those relating
to contributions from equity holders.
• Income encompasses both revenue and gains.
➢ Revenue arises in the course of the ordinary regular activities.
➢ Gains represent other items that meet the definition of income and do not arise in the course of the ordinary
regular activities.
Expense
• Defined as decreases in assets or increases in liabilities that result in decreases in equity, other than those relating
to distributions to equity holders.
• Expense encompasses losses as well as those expenses that arise in the course of the ordinary regular activities.
➢ Losses do not arise in the course of the ordinary regular activities.
CONCEPT OF RECOGNITION
• According to the Conceptual Framework, recognition is the process of capturing for inclusion in the financial
statements an item that meets the definition of an asset, liability, equity, income or expense.
• Only items that meet the definition of an asset, liability, income, or expense are recognized in the financial
statements.
(2) Systematic and rational allocation – Under this principle, some costs are expensed by simply allocating
them over the periods benefited.
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➢ Costs incurred will benefit future periods and that there is an absence of a direct or clear association
of the expense with specific revenue.
➢ When economic benefits are expected to arise over several accounting periods and the association
with income can only be indirectly determined, expenses are recognized on the basis of systematic
and allocation procedures.
➢ Examples:
(a) Depreciation
(b) Amortization
(c) Allocation of prepaid expenses
(3) Immediate recognition – Under this principle, the cost incurred is expensed outright because of
uncertainty of future economic benefits or difficulty of reliably associating certain costs with future
revenue.
➢ An expense is recognized immediately:
(a) When an expenditure produces no future economic benefit.
(b) When cost incurred does not qualify or ceases to qualify for recognition as an asset.
➢ Examples:
(a) Officers’ salaries
(b) Administrative expenses
(c) Advertising expenses
DERECOGNITION
• Defined as the removal of all or part of a recognized asset or liability from the statement of financial position.
• Normally occurs when an item no longer meets the definition of an asset or a liability.
MEASUREMENT
• Quantifying in monetary terms the elements in the financial statements.
• Categories:
(a) Historical cost
- The entry price or value to acquire an asset or incur a liability.
- This measure provides monetary information about assets, liabilities and related income and expenses,
using information derived, at least in part, from the price of the transaction or other event that gave rise
to them.
- The historical cost of an asset is updated over time to depict, if applicable:
(a) The consumption of part or all of the economic resource that constitutes the asset (depreciation or
amortization);
(b) Payments received that extinguish part or all of the asset;
(c) The effect of events that cause part or all of the historical cost of the asset to be no longer recoverable
(impairment); and
(d) Accrual of interest to reflect any financing component of the asset.
- The historical cost of a liability is updated over time to depict, if applicable:
(a) Fulfilment of part or all of the liability, for example, by making payments that extinguish part or all of
the liability or by satisfying an obligation to deliver goods;
(b) The effect of events that increase the value of the obligation to transfer the economic resources
needed to fulfil the liability to such an extent that the liability becomes onerous. A liability is onerous
if the historical cost is no longer sufficient to depict the obligation to fulfil the liability; and
(c) Accrual of interest to reflect any financing component of the liability.
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(b) Current value
- This measure provides monetary information about assets, liabilities and related income and expenses,
using information updated to reflect conditions at the measurement date.
- This includes the following:
(a) 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.
- This can be observed directly using market price of the asset or liability in an active market.
- In cases where fair value cannot be directly measured, an entity can use present value of cash
flows.
(b) Value in use for asset – 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.
(c) Fulfillment value for liability – The present value of the cash, or other economic resources, that an
entity expects to be obliged to transfer as it fulfils a liability.
NOTE: Because value in use and fulfilment value are based on future cash flows, they do not include transaction costs
incurred on acquiring an asset or taking on a liability. However, value in use and fulfilment value include the present value
of any transaction costs an entity expects to incur on the ultimate disposal of the asset or on fulfilling the liability.
(d) Current cost – 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. The current cost of 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.
CONCEPTS OF CAPITAL
• A financial concept of capital is adopted by most entities in preparing their financial statements. Under a financial
concept of capital, such as invested money or invested purchasing power, capital is synonymous with the net
assets or equity of the entity.
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• Under a physical concept of capital, such as operating capability, capital is regarded as the productive capacity of
the entity based on, for example, units of output per day.
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