Conceptual Framework and

Accounting Standards

PURPOSE AND STATUS

The main purpose of the Conceptual Framework is to guide the
International Accounting Standards Board (IASB) when it develops
International Financial Reporting Standards. It sets out the concepts that
underlie the preparation and presentation of financial statements for external
users.
Purpose
Preparers Assist them to develop consistent accounting policies when no IFRS Standard
applies to a particular transaction or other event, or when an IFRS Standard
allows a choice of accounting policy.

Auditors Assist them in forming on opinion whether financial statements comply with
IFRS.
Users of Assist them in interpreting the information contained in financial statements
Financial prepared in compliance with IFRS.
Statements
IASB Assist them 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.
Others Provide those who are interested in the work of the IASB with information
about its approach to the formulation of IFRSs.

While the Conceptual Framework is the foundation of IFRS Standards, it

is important to remember that it is not an IFRS Standard. Therefore, it does
not have the same authority as an IFRS Standard and does not override any
Standard.

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In those cases, where there is a conflict, the requirements of the specific IFRS
always prevail over the Conceptual Framework. The conceptual framework
will be revised from time to time on the basis of the Board’s experience of
working with it.

SCOPE
The Conceptual Framework deals specifically with:
1. The objective of general purpose financial reporting;
2. The qualitative characteristics of useful financial information;
3. The definition, recognition and measurement of the elements from
which financial statements are constructed; and
4. Concepts of capital and capital maintenance.

OBJECTIVE OF GENERAL-PURPOSE FINANCIAL REPORTING

Objective
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.
Usefulness
Primary users
These group of users are the primary users relies on general purpose
financial reports for much of the financial information they need.
Consequently, they are the primary users to whom general purpose financial
reports are directed.
Users Decisions Assessment Information needed
Investors Buying,  Prospects for  The entity’s economic
selling, or future net resources, claims
holding equity cash inflows against the entity,

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 Lenders, Providing or to the entity. changes in those
trade settling loans  Management’ resources and claims.
creditors and and other s stewardship  How efficiently and
other forms of of the entity’s effectively
creditors credit. economic management has
resources discharged its
responsibilities to use
the entity’s economic
resources

Other users
Users Information needed
Employees Interested in information about the stability and profitability of their
employer and its ability to pay remunerations and employee benefits.
Suppliers or Interested in information that enables them to determine whether
trade amounts owed to them will be repaid when due.
creditors
Government Requires information in order to regulate the activities of the entity,
agencies determine tax policies and as a basis for national income and other
statistics
Public Entities affect members of the public in many ways for example the
by contributing towards the local economy through the creation of
jobs. The public may therefore vest interest in the financial position
of an entity

Limitation
General purpose financial reports do not and cannot provide all of the
information that existing and potential investors, lenders and other creditors
need. Those users need to consider pertinent information from other sources,
for example, general economic conditions and expectations, political events
and political climate, and industry and company outlooks.

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 Information about a reporting entity’s economic resources, claims
against the entity and changes in resources and claims.
General purpose financial reports provide information about the financial
position, financial performance and change in the economic resources and
claims of a reporting entity. These types of information provide useful input
for decisions about providing resources to an entity.

Financial Position
This refers to information about the entity’s economic resources and the
claims against the reporting entity. It is useful in identifying the reporting
entity’s financial strengths and weaknesses which can help users to assess the
entity’s liquidity, solvency, and its financing needs. Information about
priorities and payment requirements of existing claims helps users to predict
how future cash flows will be distributed among those with a claim against the
reporting entity.

Financial Performance
Information about the performance of a reporting entity helps users to
understand the return that the entity has produced from its economic
resources which is an indication of how well management has discharged its
stewardship responsibilities.
Financial Performance Reflected by Accrual Accounting
Accrual accounting focuses on the effects of events and transactions when they occur and
not necessarily when cash is received or paid. Financial performance reflected by accrual
accounting is considered to provide a better basis for assessing the entity’s past and future
performance than information solely about cash receipt and payments.

Financial performance Reflected by Past Cash Flows

Information about entity’s cash flows during a period is also considered to be useful in the
assessment of the entity’s ability to generate future net cash inflows; it helps users to
understand an entity’s operations, evaluate its financing and investing activities, assess its
liquidity or solvency, and interpret other information about financial performance.

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 Changes in Economic Resources and Claims
A reporting entity’s economic resources and claims may also change for
reasons other than financial performance, such as issuing additional
ownership shares. Information about this type of change is necessary to give
users a complete understanding of why the reporting entity’s economic
resources and claims changed and the implications of those changes for its
future financial performance.

QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION

These apply to financial information provided in financial statements as well
as to financial information provided in other ways.

Fundamental Qualitative Characteristics

If financial information is to be useful, it must be both relevant and faithfully
represent what it purports to represent. The fundamental qualitative
characteristics are relevance and faithful representation.

Relevance (PCM)
Relevant financial information is capable of making a difference in the
decisions made by users. Financial information is capable of making a
difference in decisions if it has predictive value, confirmatory value or both.
Financial information has predictive value if it can be used as an input to
processes employed by users to predict future outcomes.
Financial information has confirmatory value if it provides feedback about
previous evaluations. The predictive value and confirmatory value of financial
information are interrelated.

Materiality
Information is material if omitting it or misstating it could influence decisions that users
make on the basis of financial information about a specific reporting entity. Materiality is
an entity-specific aspect of relevance based on the nature or magnitude, or both, of the
items to which the information relates in the context of an individual entity’s financial
report.

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 Faithful Representation (Free Co’Ne)
To be useful, financial information must not only represent relevant
phenomena, but it must also faithfully represent the phenomena that it
purports to represent. To be a perfectly faithful representation, a depiction
would have three characteristics. It would be complete, neutral and free from
error.

Complete
A complete depiction includes all information necessary for a user to understand the
phenomenon being depicted, including all necessary descriptions and explanations.

Neutral
A neutral depiction is without bias in the selection or presentation of financial
information. It is not slanted, weighted, emphasized, de-emphasized, or otherwise
manipulated to increase the probability that financial information will be received
favorably or unfavorably by users.

Free from Error

Free from error means there are no errors or omissions in the description of the
phenomenon, and the process used to produce the reported information has been
selected and applied with no errors in the process. Free from error does not mean
perfectly accurate in all respects.

A faithful representation is affected by the level of measurement uncertainty,

but measurement uncertainty does not prevent information from being useful.
However, in some cases, the most relevant information may have a high level
of measurement uncertainty and, therefore, may not faithfully represent the
underlying phenomenon, even with additional disclosures. In such cases, the
most useful information might be a different measure that is slightly less
relevant with a lower measurement uncertainty.

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Enhancing Qualitative Characteristics
Comparability, verifiability, timeliness and understandability are qualitative
characteristics that enhance the usefulness of information that is relevant and
faithfully represented. They should be maximized to the extent possible.
However, the enhancing qualitative characteristics, either individually or as a
group, cannot make information useful if that information is irrelevant or not
faithfully represented.

Comparability
Information about a reporting entity is more useful if it can be compared with
similar information about other entities and with similar information about
the same entity for another period or another date. Comparability is the
qualitative characteristic that enables users to identify and understand
similarities in, and differences among, items.

Consistency, although related to comparability, is not the same. Consistency

refers to the use of the same methods for the same items, either from period
to period within a reporting entity or in a single period across entities.

Although a single economic phenomenon can be faithfully represented in

multiple ways, permitting alternative accounting methods for the same
economic phenomenon diminishes comparability.

Verifiability
Verifiability means that different knowledgeable and independent observers
could reach consensus, although not necessarily complete agreement, that a
particular depiction is a faithful representation.
Verification can be direct or indirect. Direct verification means verifying an
amount or other representation through direct observation. Indirect
verification means checking the inputs to a model, formula or other technique
and recalculating the outputs using the same methodology.

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 Timeliness
Timeliness means having information available to decision-makers in time to
be capable of influencing their decisions. Generally, the older the information
is the less useful it is.

Understandability
Classifying, characterizing and presenting information clearly and concisely
makes it understandable.
Financial reports are prepared for users who have a reasonable knowledge of
business and economic activities and who review and analyze the information
diligently. They may, at times, seek the aid of an adviser. Excluding
information that is inherently complex and cannot be easy to understand from
financial reports might make the information in those financial reports easier
to understand. However, those reports would be incomplete and therefore
potentially misleading.

Applying the enhancing qualitative characteristics is an iterative process that does not
follow a prescribed order. Sometimes, one enhancing qualitative characteristic may have
to be diminished to maximize another qualitative characteristic.
For example, a temporary reduction in comparability because of prospectively applying a
new financial reporting standard may be worthwhile to improve relevance or faithful
representation in the longer term. Appropriate disclosures may partially compensate for
non-comparability.

Cost Constraint on Useful Financial Reporting

Cost is a pervasive constraint on the information that can be provided by
financial reporting. Reporting financial information imposes costs, and it is
important that those costs are justified by the benefits of reporting that
information. There are several types of costs and benefits to consider.
Users of financial information also incur costs of analyzing and interpreting
the information provided. If needed information is not provided, users incur
additional costs to obtain that information elsewhere or to estimate it.

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 ELEMENTS OF FINANCIAL STATEMENTS
Underlying Assumption of the Conceptual Framework
Going Concern
The financial statements are normally prepared on the assumption that an
entity is a going concern and will continue in operation for the foreseeable
future. Hence, it is assumed that the entity has neither the intention nor the
need to liquidate or curtail materially the scale of its operations; if such an
intention or need exists, the financial statements may have to be prepared on
a different basis and, if so, the basis used is disclosed.

The elements of financial statements

Financial statements portray the financial effects of transactions and other
events by grouping them into broad classes:
 Financial Position - the elements directly related to the measurement of
financial position are assets, liabilities and equity.
 Financial performance - the elements directly related to the
measurement of profit are income and expenses.

Asset
An asset is defined as a present economic resource (1) controlled by the
entity(2) as a result of past events and from which future economic benefits
are expected to flow to the entity(3)
1. Present economic resource
A right, or an economic resource, is not a physical object, such as an item of
property, plant and equipment, but a set of rights over the object –the right to use,
sell, or pledge the object, as well as other undefined rights.
2. Control
Control both encompasses a power and benefits elements. An entity must have the
present ability to direct how a resource is used and be able to obtain the economic
benefits from that resource in order to control it.
3. Potential to produce future economic benefits The future economic benefit
embodied in an asset is the potential to contribute, directly or indirectly, to the
flow of cash and cash equivalents to the entity.

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Liabilities
A liability is defined as a present obligation of the entity1 to transfer an
economic resource2 as a result of past events3.

1. Present obligation
This is an essential characteristic of a liability. An obligation is a duty or
responsibility to act or perform in certain way. Obligations are established by
contract, legislation or similar means. Obligations may also arise, however, from an
entity’s customary practices, published policies or specific statements if the entity
has no practical ability to act in a manner inconsistent with those practices, polices
or statements. These are sometimes referred to as a “constructive obligation.”
Example: Coming from customer – 1 year warranty = Liability.
Purchase xxx
AP xxx
AP xxx
Cash xxx (economic resource.)
2. Obligation to transfer an economic resource.
The settlement of a present obligation usually involves the entity giving up
resources embodying economic benefits in order to satisfy the claim of the other
party Settlement may be by payment of cash, transfer of other assets, provision of
services, replacement of that obligation with another obligation or conversion of
the obligation to equity.

3. Present obligation as a result of past events. (PAS 37)

Liabilities result from past transactions or other past events. Thus, for example, the
acquisition of goods and the use of services give rise to trade payables (unless paid
for in advance or on delivery) and the receipt of a bank loan results in an obligation
to repay the loan.

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Equity
Equity is the residual interest in the assets of the entity after deducting all
its liabilities. In other words, they are claims against the entity that do not
meet the definition of liability.

Income (PAS 1)
Income is increases in economic benefits during the accounting period in
the form of inflows or enhancements of assets or decreases of liabilities that
result in increases in equity, other than those relating to contributions from
equity participants. It encompasses both revenue and gains.
Revenue arises in the course of the ordinary activities of an entity. Gains
represent increases in economic benefits and as such are no different in
nature from revenue.

Expense (PAS 1)
Expenses are decreases in economic benefits during the accounting
period in the form of outflows or depletions of assets or incurrences of
liabilities that result in decreases in equity, other than those relating to
distributions to equity participants. It encompasses losses as well as those
expenses that arise in the course of the ordinary activities of the entity.
Expenses that arise in the course of the ordinary activities of the entity.
Losses represent other items that meet the definition of expenses and may, or
may not, arise in the course of the ordinary activities of the entity. Losses
include, for example, those resulting from disasters such as fire and flood, as
well as those arising on the disposal of non-current assets.

Recognition of the Elements of Financial Statements

Recognition is the process of incorporating in the statement of financial
position or statement of financial performance an item that meets the
definition of an asset, a liability, equity, income or expenses.
An item that meets the definition of an element should be recognized if:

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 a. it is probable that any future economic benefit associated with the item
will flow to or from the entity; and
b. the item has a cost or value that can be measured with reliability

The probability of Future Economic Benefit

The concept of probability is used in the recognition criteria to refer to
the degree of uncertainty that the future economic benefits associated with
the item will flow to or from the entity.
Assessments of the degree of uncertainty attaching to the flow of future
economic benefits are made on the basis of the evidence available when the
financial statements are prepared.

Reliability of Measurement
The recognition of an item has a cost or value that can be measured with
reliability. In many cases, cost or value must be estimated; the use of
reasonable estimates is an essential part of the preparation of financial
statements and does not undermine their reliability. When, however, a
reasonable estimate cannot be made the item is not recognized but would be
disclosed in the notes, explanatory material or supplementary schedules.

NOTE:
Most of the events we record is based on reasonable ESTIMATE amounts.
Example: Dep Exp and allowance for BD.

When to recognized?
Elements Probability of future economic benefits Reliability Measurement

Asset When it is probable that the future economic has a cost or value that can be
benefits will flow to the entity measured reliably.
Liability when it is probable that an outflow of resources the amount at which the
embodying economic benefits will result from settlement will take place can be
the settlement of a present obligation measured reliably
Income when an increase in future economic benefits can be measured reliably.
related to an increase in an asset or a decrease of

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 a liability has arisen
Expenses When a decrease in future economic benefits can be measured reliably.
related to a decrease in an asset or an increase of
a liability

Different Recognition Bases for Expenses

Basis Detail

Direct association Referred to as the matching of costs with revenues that involves the
between cost incurred simultaneous or combined recognition of revenues and expenses that
and income earned result directly and jointly from the same transactions or other events.
(Matching Principle)
Example: sales and Expense
Cash
Sales
COGS
M.I
Systematic and Expenses are recognized when economic benefits are expected to arise
rational allocation over several accounting periods and the association with income can only
be broadly or indirectly determined with the use of asset.
Immediate An expense is recognized immediately in the income statement when an
recognition expenditure produces no future economic benefits or when, and to the
extent that, future economic benefits do not qualify, or cease to qualify,
for recognition in the balance sheet as an asset.

Derecognition of the Elements of Financial Statements

Derecognition occurs when the item no longer meets the definition of an asset
or liability. An asset is derecognized when the entity loses control of all or part
of the recognized asset. A liability is derecognized when the entity no longer
has a present obligation for all or part of the recognized liability.

Measurement of the Elements of Financial Statements

Measurement is the process of determining the monetary amounts at which
the elements of the financial statements are to be recognized and carried in
the statement of financial position or statement of financial performance. This
involves the selection of the particular basis of measurement. (Measurement
Principle)

Different Measurement Bases for Assets and Liabilities

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 Bases Assets Liabilities
Historical Cost amount of cash or cash amount of proceeds received
(Original costs when equivalents paid or the fair value in exchange for the
purchased and acquired) of the consideration given to obligation, or in some
acquire them at the time of their circumstances, at the
acquisition amounts of cash or cash
equivalents expected to be
paid to satisfy the liability in
the normal course of
business.
Current cost amount of cash or cash undiscounted amount of cash
equivalents that would have to be or cash equivalents that
paid if the same or an equivalent would be required to settle
asset was acquired currently the obligation currently
Realizable amount of cash or cash undiscounted amounts of
(Settlement) equivalents that could currently cash or cash equivalents
be obtained by selling the asset in expected to be paid to satisfy
Value
an orderly disposal the liabilities in the normal
course of business
Present Value present discounted value of the present discounted value of
future net cash inflows that the the future net cash outflows
item is expected to generate in that are expected to be
the normal course of business required to settle the
liabilities in the normal
course of business
Concept of Time Value of Money

Presentation and Disclosure

Information about assets, liabilities, equity, income and expenses is
communicated through presentation and disclosures in financial statements.
Effective communication of financial statements makes that information
more relevant and contributes to a faithful representation of an entity’s assets,
liabilities, equity, income and expenses. It also enhances the understandability
and comparability of information in financial statements.

CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE

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Concepts of Capital
Financial Concept
Under a financial concept, capital is synonymous with the net assets or equity
of the entity. Financial concept of capital should be adopted if the users of
financial statements are primarily concerned with the maintenance of
nominal invested capital or the purchasing power of invested capital.

Physical Concept
Under a physical concept, capital is regarded as the productive capacity of the
entity based on, for example, units of output per day. Physical concept of
capital should be adopted if the users of financial statements are primarily
concerned with the operating capability of the entity.

Concepts of Capital Maintenance and Determination of Profit

The concept of capital maintenance is concerned with how an entity defines
the capital that it seeks to maintain. It provides the linkage between the
concepts of capital and the concepts of profit because it provides the point of
reference by which profit is measured.

Financial Capital Maintenance

Profit is earned only if the financial amount of the net assets at the end of the
period exceeds the financial amount of net assets at the beginning of the
period, after excluding any distributions to, and contributions from, owners
during the period. Financial capital maintenance can be measured in either
nominal monetary units or units of constant purchasing power.
The financial capital maintenance concept, however, does not require the use
of a particular basis of measurement. Selection of the basis under this concept
is dependent on the type of financial capital that the entity is seeking to
maintain.

Physical Capital Maintenance

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Profit is earned only if the physical productive capacity (or operating
capability) of the entity (or the resources or funds needed to achieve that
capacity) 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. It requires the adoption of the
current cost basis of measurement.

References:

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  International Financial Reporting Standards (IFRS) ® Issued by the
International Accounting Standards Board, 2021.
 Millan (2021), Conceptual Framework and Accounting Standards.
 National University – Module.

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