THE CONCEPTUAL FRAMEWORK FOR FINANCIAL Users of Financial Information

REPORTING The users of financial information are classified into:

1. Primary users
Nature of the Conceptual Framework for Financial  The parties to whom general purpose financial
Reporting reports are primarily directed.
 The Conceptual Framework forms the theoretical  The primary users are the following:
foundation of accounting.  Existing and potential investors, and
 It is the underlying theory for the development and  Lenders and other creditors
revision of accounting standards. 2. Other users
 A document that contains:  These are the users of financial information other
 The concepts for general purpose financial than the primary users.
reporting, and  These types of users may find the general-purpose
 Summary of the terms and concepts that financial reports useful but these are not directed to
underlie the preparation and presentation of them primarily.
financial statements.  Other users include, but not limited to, the following:
Purposes of the Conceptual Framework  Employees
 To assist the IASB in the development of existing and  Customers
future accounting standards based on consistent  Government and its agencies
concepts;  Suppliers
 To assist financial statement preparers in the development  General public
of consistent accounting policies when no accounting
standard applies to a particular transaction or event, or PART 2: QUALITATIVE CHARACTERISTICS OF USEFUL
when an accounting standard allows a choice of FINANCIAL INFORMATION
accounting policy or treatment; and Qualitative Characteristics of Useful Financial Information
 To assist all parties in understanding and interpreting the  The qualities (or attributes) that make financial information
accounting standards. useful to the users in making economic decisions.
Authoritative Status of the Conceptual Framework Fundamental Qualitative Characteristics
 The applicability of the Conceptual Framework on a  These characteristics relate to the content (or substance)
particular transaction shall be considered only when there of financial information.
is no accounting standard or interpretation that specifically  For a financial information to be useful, it must be relevant
deals with that particular transaction. and faithfully represent what it purports to represent.
 Note that the Conceptual Framework is not an accounting  The fundamental qualitative characteristics are:
standard. 1) Relevance
 In cases where there is a conflict between an • Refers to the capacity of the information to affect a
accounting standard and the Conceptual Framework, decision.
the requirements of the accounting standard will • Relevant information is capable of making a difference in
prevail over the requirements of the Conceptual decisions if it has predictive value, confirmatory value, or
Framework. both.
Contents of the Conceptual Framework for Financial  Information has predictive value if the
Reporting information can be used as an input to predict
1. The Objective of General-Purpose Financial Reporting future outcomes.
2. Qualitative Characteristics of Useful Financial Information  Information has confirmatory value if it provides
3. Financial Statements and the Reporting Entity feedback about previous evaluations.
4. The Elements of Financial Statements • The relevance of an information is affected by its nature
5. Recognition and Derecognition  Information is material if omitting or misstating it
6. Measurement could influence (or affect) the decisions of
7. Presentation and Disclosure primary users.
8. Concepts of Capital and Capital Maintenance • Materiality dictates that strict adherence to
Overview of the Conceptual Framework accounting standards is no required when the
The following chart provides the structure of the Conceptual items are not significant enough to affect the
Framework for Financial Reporting: decision of a primary user and the fairness of
FIRST LEVEL – The "why"-purpose of accounting the financial statements. In simple terms,
o Objective of Financial Reporting materiality is just a "quantitative threshold".
SECOND LEVEL – The bridge between the first and third level • The materiality of an item depends on relative
o Qualitative Characteristics of Useful Financial Information size rather than absolute size. Meaning, what is
o Elements of Financial Statements material for one may not be material to another.
• There is no uniform quantitative threshold for
THIRD LEVEL – The "how"-Implementation
materiality as it depend on the professional
o Recognition, Measurement, and Disclosure Concepts
judgment of the accountant.
2) Faithful Representation
PART 1: THE OBJECTIVE OF GENERAL-PURPOSE
• The descriptions and figures presented in the financial
FINANCIAL REPORTING
reports should match what really existed (or happened).
Objectives of Financial Reporting
• Three characteristics:
 This forms the foundation of the Conceptual Framework.
(1) Completeness
 The "why" of accounting.
 All information that are necessary for a user to
 This serves as the goal or purpose of accounting.
understand the phenomenon being depicted
 The overall or general objective is to provide financial
must be included and clearly stated in the
information that is useful for decision-making.
reports.
Limitations of Financial Reporting
(2) Neutrality
 General purpose financial reports:
 Being neutral is being fair.
 do not and cannot provide all of the information that
 The information contained in the financial
existing and potential investors, lenders and other
reports should be free from bias. In other words,
creditors need.
the reports should not favor one party to the
 are not designed to show the value of an entity but
detriment of another party.
these reports provide information to help the primary
users estimate the value of the entity. ✓ The financial reports are directed to the
 are intended to provide common information to users common needs of users and not to the
and cannot accommodate every request for particular needs of specific users.
information. Prudence or Conservatism
 are based on estimates and judgments rather than The exercise of care and caution when dealing with
exact depiction. uncertainties in the measurement process. The exercise of
 prudence means that: PART 3: FINANCIAL STATEMENTS AND THE REPORTING
✓ Assets and income are not overstated. ENTITY
✓ Liabilities and expenses are not understated. Objective of financial statements
 To provide information about a reporting entity's assets,
(3) Free from error liabilities, equity, income and expenses.
 This means there are no errors or omissions in • Assets, liabilities and equity are presented in the
the description of the phenomenon or statement of financial position.
transactions. • Income and expenses are presented in the statement of
 This does not necessarily mean perfectly financial performance.
accurate in all aspects. Reporting period
Substance over form  The period when financial statements are prepared for
This concept states that if information is to represent faithfully financial reporting.
the transactions and other events it purports to represent, it is  Financial statements are prepared at least annually.
necessary that the transactions and other events are accounted Optionally, it may be prepared on an interim basis (i.e.,
for in accordance with their economic substance and not merely three months, six months, nine months).
their legal form.  Financial statements also provide comparative information
If there will be a conflict between the economic substance and for at least one preceding period.
legal form of a particular transaction, the economic substance of ……………………………………………………………………
that transaction will prevail over its legal form. Perspective adopted in financial statements
 Financial statements provide information about
transactions and other events viewed from the perspective
Enhancing Qualitative Characteristics of the reporting entity as a whole, not from the perspective
These characteristics are intended to increase the usefulness of the primary users.
of financial information. Going concern assumption
 The enhancing qualitative characteristics are: (V.C.U.T.)  Financial statements are prepared on the assumption that
(1) Verifiability the reporting entity will continue in operation for the
(2) Comparability foreseeable future.
(3) Understandability  It is assumed that the entity has no intention to liquidate or
(4) Timeliness stop operations.
Verifiability ………………………………………………………………………
 An information is verifiable if it is supported by evidence Reporting entity
that an accountant would look into and arrive at the same An entity that is required or chooses to prepare financial
conclusion. statements. It can be a single entity or a portion of an entity, or
 Can either be: can comprise more than one entity.
✓ Direct verification - verifying an information through The following can be considered a reporting entity:
direct observation such as counting cash. ✓ Sole proprietorship, partnership, or corporation;
✓ Indirect verification - checking the inputs to a model, ✓ Parent company;
formula or other technique and recalculating the outputs ✓ The parent and its subsidiaries (or group) as single reporting
using the same methodology. entity;
Example: Verifying the valuation of inventory by checking ✓ Two or more entities without parent and subsidiary
the inputs (quantities and costs) and recomputing it. relationship as single reporting entity (ie., home office and
Comparability branch)
 This characteristic enables users to identify and Types of financial statements
understand similarities and differences among items. (1) Consolidated financial statements
 This term is not synonymous to uniformity. • These are the financial statements prepared when
Consistency the reporting entity comprises both the parent and its
 Refers to the use of the same methods for the same subsidiaries.
items, either from period to period within a company or  The parent is the company that exercises
in a single period across companies. control over its subsidiaries.
 Related to comparability but not synonymous.  The parent obtains control over a subsidiary by
 Comparability is the goal and consistency helps to way of acquiring majority ownership interest
achieve that goal. (e.g., more than 50%) in the voting common
stocks of the subsidiary.
Understandability • Provides information about the assets, liabilities,
 Information should be presented in a form that users equity, income and expense of both the parent and
understand. its subsidiaries as a single reporting entity.
 Some transactions and events are complex and difficult to (2) Unconsolidated financial statements
understand. Excluding information about these might • These are the financial statements prepared when
make the information in the report easier to understand. the reporting entity is the parent company only.
However, the reports will result to incomplete information • Provides information about the parent company's
and therefore might mislead the users. assets, liabilities, income and expenses and not
 This characteristic is very essential because if a relevant those of the subsidiaries.
and faithfully represent information is not understood by (3) Combined financial statements
users, that information is rendered useless. • These are the financial statements prepared when
Timeliness the reporting entity comprises two or more entities
 This means having the information available to users in that are not linked by a parent and subsidiary
time to be capable influencing their decisions. relationship such as home office and branch.
 Generally, the older the information, the less useful it is.
PART 4: THE ELEMENTS OF FINANCIAL STATEMENTS
Cost constraint Elements of financial statements
 Cost is a pervasive constraint on the information that can  Refers to the quantitative information reported in the
be provided by financial reporting. financial statements.
 Reporting financial information imposes costs, and it is The following chart summarizes the elements of financial
important that those costs are justified by the benefits of statements:
reporting that information. Elements of Financial Statements
• This concept is known as cost-benefit consideration. Elements of Financial Elements of Financial
• The benefit derived from the information should exceed Position Performance
the cost in obtaining the information.
Asset Income
Liability Expense
 Equity Recognition
 The process of capturing for inclusion in the financial
Asset statements an item that meets the definition of one of the
 A present economic resource controlled by the entity as a elements of financial statements.
result of past events. • Only items that meet the definition of an asset, liability,
• An economic resource is a right that has the potential to income, or expense are recognized in the financial statements.
produce economic benefits. Rights that have the potential Recognition criteria
to produce economic benefits may take the following  Only items that meet the definition of the elements of
forms: financial statements are recognized in the financial
• Rights that correspond to an obligation of another entity statements.
 Right to receive cash; • The amount at which an asset, a liability or equity is
 Right to receive goods or services; recognized in the statement of financial position is referred
 Right to exchange economic resources with to as its carrying amount.
another favorable terms; and Derecognition
 Right to benefit from an obligation of another  The removal of all or part of a recognized asset or liability
party if a specified uncertain future event from the statement of financial position.
occurs.  Normally occurs when an item no longer meets the
• Rights that do not correspond to an obligation of definition of an asset or a liability.
another entity • An asset is derecognized when the entity loses control
 Right over physical objects, such as property, of the asset.
plant and equipment or inventories • A liability is derecognized when the entity no longer has
 Right to intellectual property a present obligation for the liability.
• Rights established by contract or legislation
Liability PART 6: MEASUREMENT
 Present obligation of an entity to transfer an economic Measurement
resource as a result of events.  The process of quantifying the elements recognized in the
 For a liability to exist, all of the following must be satisfied: financial statements.
 The entity has an obligation. Measurement bases
 The obligation is to transfer an economic (a) Historical cost
resource. – The entry price (or value) to acquire an asset or incur a
 The obligation is a present obligation that exists liability.
as a result of past event. o The historical cost of an asset is the costs
……………………………………………………………………… incurred in acquiring ( creating) the asset,
Obligation comprising the amount paid to acquire ( create)
 A duty or responsibility that an entity has no practical the asset plus transaction costs.
ability to avoid. o The historical cost of a liability is the amount
 Can either be legal or constructive. received to incur the liability minus transaction
• Obligation may be legally enforceable as a costs.
consequence of a binding contract or statutory – The historical cost of an asset is updated over time to
requirement. depict, if applicable
• Constructive obligation arises for normal business (a) Depreciation or amortization;
practice, custom and desire to maintain good business (b) Settlement;
relations or act in an equitable manner. (c) Impairment; and
………………………………………………………………………… (d) Accrual of interest to reflect any financing component
 Obligations to transfer an economic resource as a result of of the asset
past event include: – The historical cost of a liability is updated over time to
 Obligation to pay cash; depict, applicable:
 Obligation to deliver goods; (a) By satisfying an obligation to pay (full or partial) or by
 Obligation to provide services at some future satisfying an obligation to deliver goods;
time; (b) Inflation; and
 Obligation to exchange economic resources (c) Accrual of interest to reflect any financing component
with another party on unfavorable terms; and of the liability
 Obligation to transfer an economic resource if (b) Current value
specified uncertain future event occurs. – This measure provides information about assets,
Equity liabilities and relate income and expenses, using
 The residual interest in the assets of an entity after information updated to reflect conditions the measurement
deducting all of the liabilities date.
Income – This includes the following :
 Defined as increases in assets or decreases in liabilities (a) Fair value
that result in increases equity, other than those relating to • The price that would be received to sell an asset, or paid
contributions from owners. to transfer a liability, in an orderly transaction between
 Scope of income: mark participants at the measurement date.
• Revenue – Income arising from the ordinary course of • This can be observed directly using market price of the
business. asset liability in an active market.
• Gains – represent other items that meet the definition of • In cases where the fair value cannot be directly
income and do not arise in the ordinary course of measured, entity can use present value of cash flows.
business. (b) Value in use for asset
Expense • The present value of the cash flows or other economic
 Defined as decreases in assets or increases in liabilities benefits that an entity expects to derive from the use of an
that result in decreases in equity, other than those relating asset and from It's ultimate disposal.
to distributions to owners. (c) Fulfillment value for liability
 Scope of expense: encompasses losses as well as those • The present value of the cash, or other economic
expenses that arise in the course of the ordinary regular resources, that an entity expects to be obliged to transfer
activities. as it fulfils a liability.
• Regular expenses – Those expenses incurred in the ………………………………………………………………………
ordinary course of business. Transaction costs on value in use and fulfillment value
• Loss – Those expenses do not arise in the ordinary  Both value in use and fulfilment value do not include
course of business. transaction costs incurred on acquiring an asset or
incurring a liability since they are based on future cash
PART 5: RECOGNITION AND DERECOGNITION flows.
 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.
…………………………………………………………………………
Selecting a measurement basis
 The IASB did not mandate a single measurement basis
because the different measurement bases could produce
useful information under different circumstances.
 Historical cost is the measurement basis most commonly
adopted in preparing financial statements.
…………………………………………………………………………

PART 7: PRESENTATION AND DISCLOSURE

Presentation and Disclosure
 A reporting entity communicates information about its
assets, liabilities, equity, income and expenses by
presenting and disclosing Information in the financial
statements.
 This can be achieved by classification and aggregation of
assets, liabilities, equity, income and expenses.
 Classification is the sorting of assets, liabilities,
equity, income and expense on the basis of shared or
similar characteristics.
 Offsetting is generally not appropriate. Income
and expenses are classified either:
(a) In the statement of profit or loss; or
(b) In other comprehensive income
 Aggregation is the adding together of assets,
liabilities, equity, income and expenses that have
similar or shared characteristics and are included in
the same classification.
 This makes information more useful by
summarizing a large volume detail.

PART 8: CONCEPTS OF CAPITAL AND CAPITAL

MAINTENANCE
Concept of Capital
 A financial concept of capital is adopted by most entities in
preparing their financial statements.
• Under this concept of capital, capital is synonymous with
the net assets equity of the entity.
 Under a physical concept of capital, capital is regarded as
the productive capacity of the entity based on, for
example, units of output per day.

Concept of Capital Maintenance

(a) Financial capital maintenance
 Under this concept, a profit is earned only if the amount of
the net assets a the end of the period exceeds the amount
of net assets at the beginning of the period, after
excluding any distributions to, and contributions from
owners during the period.
(b) Physical capital maintenance
 Under this concept a profit is named only if the physical
productive capacity (or operating capability) of the entity at
the end of the period exceeds the physical productive
capacity at the beginning of the period, after excluding any
distributions to, and contributions from, owners during the
period.
…………………………………………………………………………
Required measurement basis to be adopted
 The physical capital maintenance concept requires the
adoption of the current cost basis of measurement
 The financial capital maintenance concept, however, does
not require the use of a particular basis of measurement.
…………………………………………………………………………