Module 2: CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

Conceptual Framework in Accounting 2. Information Needs of Investors, Lenders, and Creditors

1. Definition and Purpose ● Depend on returns expected by investors,
● A conceptual framework in accounting refers to a lenders, and creditors.
system of ideas and objectives that establish ● Expectations are based on future net cash
consistent rules and standards for financial inflows, management's stewardship, and
accounting and statements. assessment of economic resources.
● It sets the nature, function, and limits of financial ● Require information about economic resources,
accounting practices. claims against the entity, and management's
2. Variability in Financial Accounting Methods effectiveness.
● Different companies and countries utilise varying 3. Primary Users of Financial Reports
methods of financial accounting and reporting, ● Existing and potential investors, lenders, and
often influenced by their business models. creditors are the primary users of general
● For instance, companies operating under purpose financial reports.
distributorship models recognize sales when ● They rely on financial reports for necessary
goods are dispatched, while consignment sale financial information.
models only record sales upon customer ● Financial reports are based on estimates,
purchase. judgements, and models.
3. Importance of a Conceptual Framework
● Provides a foundation for establishing accounting Limitations and Evolution of Financial Reporting
standards and resolving disputes. 1. Challenges in Achieving Ideal Financial Reporting
● Eliminates the need to reiterate fundamental ● Financial reporting is based on estimates,
principles in accounting standards. judgements, and models rather than exact
● Ensures consistency in financial reporting, aiding depictions.
investors in comparing company performances. ● The ideal vision of financial reporting outlined in
the Conceptual Framework may not be fully
Role of International Accounting Standards Board achieved in the short term.
(IASB) ● Time is required to understand, accept, and
1. Revised Conceptual Framework for Financial Reporting implement new ways of analysing transactions.
● The IASB issued the revised Conceptual 2. Importance of Establishing Goals
Framework for Financial Reporting in March ● Establishing a goal is essential for financial
2018. reporting to evolve and improve its usefulness.
● It outlines the objective of financial reporting, ● The Conceptual Framework sets the concepts
qualitative characteristics of financial information, that guide estimates, judgements, and models in
and definitions of key elements like assets, financial reporting.
liabilities, equity, income, and expenses. ● Striving towards the Conceptual Framework's
2. Key Components of the Conceptual Framework vision is crucial for the improvement of financial
● Description of the reporting entity and its reporting.
boundaries.
● Criteria for recognizing assets and liabilities in Economic Resources and Claims
financial statements, as well as guidance on 1. Importance of Information on Economic Resources and
derecognition. Claims
● Various measurement bases and guidelines for ● Information about a reporting entity’s economic
their application. resources and claims helps users identify its
● Concepts and guidance on presentation and financial strengths and weaknesses.
disclosure of financial information. ● Users can assess the entity’s liquidity, solvency,
need for additional financing, and success in
Conceptual Framework for Financial Reporting obtaining financing.
1. Purpose of the Conceptual Framework ● It assists in evaluating management’s
● Assists the International Accounting Standards stewardship of the entity’s economic resources.
Board (Board) in developing consistent IFRS ● Details on priorities and payment requirements of
Standards. existing claims aid in predicting future cash flow
● Aids preparers in developing consistent distribution among claimants.
accounting policies in the absence of a Standard
or when a choice is allowed. Changes in Economic Resources and Claims
● Helps all parties understand and interpret the 1. Factors Influencing Changes
Standards. ● Changes in economic resources and claims stem
2. Relationship with Standards from the entity’s financial performance and
● The Conceptual Framework is not a Standard events like issuing debt or equity instruments.
and does not override any Standard. ● Users need to identify these changes to assess
● The Board may specify requirements that deviate future net cash inflows and management’s
from the Conceptual Framework to meet the stewardship.
objective of financial reporting.
● Any departure from the Conceptual Framework is Financial Performance and Accrual Accounting
explained in the Basis for Conclusions on that 1. Accrual Accounting Impact on Financial Performance
Standard. ● Accrual accounting shows the effects of
transactions on economic resources and claims
Objective and Usefulness of Financial Reporting when they occur, regardless of cash flow timing.
1. Objective of Financial Reporting ● It provides a better basis for evaluating past and
● To provide useful financial information about the future performance compared to focusing solely
reporting entity to investors, lenders, and on cash receipts and payments.
creditors.
● Assists in decisions related to buying, selling, or
holding equity and debt instruments.
● Helps in decisions regarding providing or settling
loans and influence management's actions.
 Module 2: CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

Qualitative Characteristics of Useful Financial ● Consideration of costs and benefits is essential in

Information financial reporting.
1. Types of Useful Information
● Financial reports offer data on economic Financial Statements
resources, claims against the entity, and effects 1. Objective of Financial Statements
of transactions and events. ● Financial statements aim to provide information
● Useful financial information must be relevant, about an entity's resources, claims, and changes
faithfully represent reality, and be comparable, in them.
verifiable, timely, and understandable. ● Information in financial statements should be
useful for assessing future cash flows and
Fundamental Qualitative Characteristics management's stewardship.
1. Relevance ● Financial statements include the statement of
● Relevant financial information can impact user financial position, statements of financial
decisions by having predictive or confirmatory performance, and other notes.
value. 2. Reporting Period
● Information should be capable of making a ● Financial statements cover a specific reporting
difference in decisions even if some users are period and detail assets, liabilities, equity,
already aware of it. income, and expenses.
● Predictive value and confirmatory value are key ● Comparative information from previous periods is
aspects of relevant financial information. provided to help users identify trends.
2. Faithful Representation ​ Information in financial statements is time-bound
● Financial reports must represent economic and specific to a reporting period.
phenomena accurately in words and numbers. 3. Going Concern Assumption
● Substance of economic phenomena must be ● Financial statements are typically prepared
faithfully represented, not just the legal form. assuming the entity will continue operating in the
● A faithful representation should be complete, foreseeable future.
neutral, and free from error. ● The going concern assumption implies no
3. Enhancing Qualitative Characteristics intention or need for liquidation or cessation of
● Comparability, verifiability, timeliness, and operations.
understandability enhance the usefulness of ● If there is a need for a different basis of
financial information. preparation, it should be clearly disclosed in the
● These characteristics help in determining the financial statements.
best way to represent a phenomenon if multiple
options are equally relevant and faithful.
● Enhancing characteristics ensure information is
comparable and understandable.

Enhancing Qualitative Characteristics

1. Comparability
● Comparability enables users to identify
similarities and differences among items.
● Information is more useful when it can be
compared with similar data from other entities or
periods.
● Comparability requires at least two items for a
meaningful comparison.
2. Verifiability
● Verifiability ensures that information accurately
represents economic phenomena.
● Different independent observers should be able
to reach consensus on the accuracy of the
depiction.
● Quantified information can be verified through
ranges and related probabilities. Elements of Financial Statements
3. Timeliness 1. Asset
● Timeliness means having information available ● An asset is a present economic resource
when it can influence decisions. controlled by the entity as a result of past events.
● Older information is generally less useful, but ● An economic resource is a right that has the
some data may remain timely for trend analysis. potential to produce economic benefits.
● Having information available in a timely manner ● Three aspects of asset definitions: right, potential
is crucial for decision-making. to produce economic benefits, and control.
4. Understandability 2. Liability
● Clear and concise presentation enhances ● A liability is a present obligation of the entity to
understandability of financial information. transfer an economic resource as a result of past
● Information should be prepared for users with events.
reasonable knowledge of business activities. ● For a liability to exist, three criteria must all be
● Even well-informed users may need assistance in satisfied: the entity has an obligation, the
understanding complex economic phenomena. obligation is to transfer an economic resource,
and the obligation is a present obligation that
Cost Constraint on Useful Financial Reporting exists as a result of past events.
1. Cost vs. Benefit 3. Equity
● Cost is a significant constraint on the extent of ● Equity is the residual interest in the assets of the
financial information provided. entity after deducting all its liabilities.
● Reporting financial data incurs costs that should
be justified by the benefits.
 Module 2: CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

● Equity claims are claims on the residual interest ● Derecognition is the removal of a recognized
in the assets of the entity after deducting all its asset or liability when it no longer meets the
liabilities. definition.
● Claims against the entity that do not meet the ● For assets, derecognition occurs when the entity
definition of a liability. loses control of the asset.
4. Income and Expenses ● For liabilities, derecognition occurs when the
● Income is increases in assets, or decreases in entity no longer has a present obligation.
liabilities, that result in increases in equity, other
than those relating to contributions from holders Measurement Bases
of equity claims. 1. Historical Cost
● Expenses are decreases in assets, or increases ● Historical cost measures assets, liabilities,
in liabilities, that result in decreases in equity, income, and expenses based on past transaction
other than those relating to distributions to prices.
holders of equity claims. ● It does not reflect changes in values unless
● Income and expenses are elements of financial related to asset impairment or liability
statements related to an entity’s financial onerousness.
performance. 2. Current Value
● Current value measures assets, liabilities,
Recognition Process income, and expenses based on updated
1. Recognition Definition conditions at the measurement date.
● Recognition is the process of capturing an item ● Reflects changes in estimates of cash flows and
that meets the definition of elements of financial other factors since the previous measurement
statements. date.
● Involves depicting the item in a statement with a 3. Measurement of Equity
monetary amount and including it in totals. ● Total equity is the difference between total
2. Statement of Financial Position recognized assets and total recognized liabilities.
● Depicts recognized assets, liabilities, equity,
income, and expenses in structured summaries. Presentation and Disclosure
● Designed to make financial information 1. Communication Tools
comparable and understandable. ● Financial statements communicate information
3. Recognition Links about assets, liabilities, equity, income, and
● In the statement of financial position, total assets expenses.
minus total liabilities equal total equity. ● Effective communication enhances relevance,
● Recognized changes in equity during the understandability, and comparability of
reporting period comprise income minus information.
expenses recognized in the statements of 2. Classification
financial performance, plus contributions from ● Assets, liabilities, equity, income, and expenses
holders of equity claims, minus distributions to are classified based on shared characteristics for
holders of equity claims. presentation and disclosure.
4. Examples of Recognition ● Classification may involve separating
● Recognition of income occurs simultaneously components with different characteristics to
with the initial recognition of an asset or an enhance financial information.
increase in the carrying amount of an asset. 3. Offsetting
● Recognition of expenses occurs simultaneously ● Offsetting combines separate assets and
with the initial recognition of a liability or an liabilities into a single net amount in the
increase in the carrying amount of a liability. statement of financial position.
● Generally not appropriate as it groups dissimilar
items together.

Classification of Equity
1. Purpose of Classification
● Equity claims may be classified separately based
on different characteristics to provide useful
information.
2. Importance of Classification
● Enhances the usefulness of financial information
by grouping equity claims with similar
characteristics together.

Classification of Income and Expenses

1. Application of Classification
● Applied to income and expenses related to
selected assets or liabilities.
● Components with different characteristics are
Recognition and Derecognition identified and classified separately for clarity.
1. Recognition Criteria 2. Example of Classification
● Only items meeting the definition of an asset, ● For instance, changes in asset value may include
liability, equity, income, or expenses are value changes and interest accrual, which can be
recognized in financial statements. classified separately for better financial insight.
● Not recognizing an item meeting the definition of
an element can make financial statements Profit or Loss vs. Other Comprehensive Income
incomplete. 1. Classification of Income and Expenses
● Recognition of assets or liabilities is based on ● Income and expenses are categorised either in
providing useful information to users of financial the statement of profit or loss or in other
statements. comprehensive income.
2. Derecognition
 Module 2: CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

2. Primary Source of Financial Performance ● Only the part of asset price increase exceeding
● The statement of profit or loss serves as the main general price level increase is regarded as profit.
source of an entity's financial performance for the
reporting period.
● It provides a summarised view of the entity's
financial performance, including total profit or
loss.
3. Analysis of Financial Performance
● Understanding an entity's financial performance
requires analysing all recognized income and
expenses, including those in other
comprehensive income.
● Users of financial statements often use the profit
or loss total as a starting point for analysis or as a
key indicator of financial performance.
4. Aggregation
● Aggregation summarizes assets, liabilities,
equity, income, or expenses with shared
characteristics in the same classification.
● Balancing aggregation is crucial to avoid
obscuring relevant information.

Financial vs. Physical Concepts of Capital

1. Financial Concept of Capital
● Involves capital synonymous with net assets or
equity of the entity.
● Can be measured in nominal monetary units or
constant purchasing power.
2. Physical Concept of Capital
● Considers capital as the productive capacity of
the entity.
● Measured based on factors like units of output
per day.

Concepts of Capital Maintenance and Profit

Determination
1. Financial Capital Maintenance
● Profit is earned if net assets at the end exceed
those at the beginning, excluding owner
distributions/contributions.
● Can be measured in nominal monetary units or
constant purchasing power.
● Profit is the residual amount after deducting
expenses from income.
2. Physical Capital Maintenance
● Profit is earned if the physical productive capacity
at the end exceeds that at the beginning,
excluding owner transactions.
● Requires adoption of the current cost basis of
measurement.
● All price changes are considered as changes in
the measurement of physical productive capacity.
3. Linkage between Capital Maintenance and Profit
● Capital maintenance defines the capital an entity
seeks to maintain.
● Profit is the residual amount after deducting
expenses from income.
● Inflows exceeding capital maintenance needs are
considered profit.

Basis of Measurement under Financial Capital

Maintenance
1. Nominal Monetary Units
● Profit is the increase in nominal money capital
over the period.
● Holding gains are considered profits but may not
be recognized until assets are disposed of.
2. Constant Purchasing Power Units
● Profit represents the increase in invested
purchasing power over the period.