Course Materials

STATUS AND PURPOSE OF THE CONCEPTUAL FRAMEWORK

The Conceptual Framework for Financial Reporting (Conceptual Framework) describes
the objective of, and the concepts for, general purpose financial reporting. The purpose of the
Conceptual Framework is to:
a) assist the International Accounting Standards Board (Board) to develop IFRS Standards
(Standards) that are based on consistent concepts;
b) assist preparers to develop consistent accounting policies when no Standard applies to
a particular transaction or other event, or when a Standard allows a choice of accounting
policy; and
c) assist all parties to understand and interpret the Standards.

The Conceptual Framework is not a Standard. Nothing in the Conceptual Framework

overrides any Standard or any requirement in a Standard. To meet the objective of general-
purpose financial reporting, the Board may sometimes specify requirements that depart from
aspects of the Conceptual Framework. If the Board does so, it will explain the departure in the
Basis for Conclusions on that Standard.

Objective, usefulness and limitations of general-purpose financial reporting

The Conceptual Framework is based on the objective of general-purpose financial reporting,
which aims to provide useful financial information to investors, lenders, and creditors for resource
allocation decisions, ensuring transparency and accountability. Those decisions involve decisions
about:
a) buying, selling or holding equity and debt instruments;
b) providing or settling loans and other forms of credit; or
c) exercising rights to vote on, or otherwise influence, management’s actions that affect the
use of the entity’s economic resources.

The decisions made by investors, lenders, and creditors depend on their expectations of
future net cash inflows and management’s stewardship of the entity’s economic resources. These
expectations are influenced by factors such as dividends, principal and interest payments, and
market price increases. To make accurate assessments, investors, lenders, and creditors require
information about the amount, timing, and uncertainty of future net cash inflows and
management’s stewardship of the entity’s economic resources. To make the assessments
described in paragraph 1.3, existing and potential investors, lenders and other creditors need
information about:
a) the economic resources of the entity, claims against the entity and changes in those
resources and claims; and
b) how efficiently and effectively the entity’s management and governing board have
discharged their responsibilities to use the entity’s economic resources.

Investors, lenders, and creditors rely on general purpose financial reports for financial information. The
Conceptual Framework aims to establish concepts that underlie these estimates, judgments, and models.
Although ideal financial reporting may not be achieved in the short term, establishing a goal is essential
for financial reporting to evolve and improve its usefulness.

Economic resources and claims

The reporting entity’s economic resources and claims can reveal its financial strengths and weaknesses,
liquidity, solvency, financing needs, management’s stewardship, and future cash flow distribution among
claimants. This information also aids in assessing management’s stewardship and predicting cash flow
distribution.

Changes in economic resources and claims

The reporting entity’s economic resources and claims are influenced by financial performance and
transactions like debt or equity instruments, requiring users to identify these changes for accurate
assessment.

Financial performance reflected by accrual accounting

Accrual accounting measures the impact of transactions on an entity’s economic resources and claims,
even if cash receipts and payments occur in different periods, providing a better basis for assessing
past and future performance.

QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION

This chapter discusses the usefulness of financial information for investors, lenders, and creditors. Financial
reports provide information about the reporting entity’s economic resources, claims, and the effects of
transactions. They also include explanatory material about management’s expectations and strategies. The
usefulness of financial information is enhanced by being comparable, verifiable, timely, and understandable.
 Fundamental qualitative characteristics

Relevance
Financial information can significantly influence user decisions, whether it’s predictive, confirmatory, or both,
even if not widely known or not utilized by some users.

Faithful representation
Financial reports accurately represent economic phenomena in words and numbers, but must faithfully
represent the substance of the phenomena. A perfect representation should be complete, neutral, and free
from error, but perfection is rare. The Board aims to maximize these qualities.

Enhancing qualitative characteristics

Qualitative characteristics like comparability, verifiability, timeliness, and understandability enhance the
usefulness of relevant and faithful information, helping determine the best way to depict a phenomenon.

Comparability
Users make decisions involving alternatives like investing or selling an investment. Comparability
helps users understand similarities and differences among items. It requires at least two items, unlike
other qualitative characteristics, which relate to a single item.

Verifiability
Verifiability ensures accurate representation of economic phenomena by allowing consensus among
knowledgeable observers, and quantified information can be verified for a range of possible amounts and
probabilities.

Timeliness

Timeliness refers to timely information for decision-makers, with older information being less useful. Some
information may remain timely beyond reporting periods for trend identification.
 Understandability
Financial reports are designed for users with business knowledge and diligent analysis, but may require
adviser assistance for complex economic phenomena.

The cost constraint on useful financial reporting

Cost is a significant constraint on financial reporting, and it’s crucial to justify these costs by considering
the benefits of reporting the information.

Financial statements
Financial statements provide essential information about an entity’s economic resources,
claims, and changes, helping users assess future net cash inflows and management’s
stewardship of its resources, meeting the definitions of financial statements elements. That
information is provided:
a) in the statement of financial position, by recognizing assets, liabilities and equity;
b) in the statement(s) of financial performance, by recognizing income and
expenses; and
c) in other statements and notes, by presenting and disclosing information about:
i. recognized assets, liabilities, equity, income and expenses, including information
about their nature and about the risks arising from those recognized assets and
liabilities;
ii. assets and liabilities that have not been recognized, including information about
their nature and about the risks arising from them;
iii. cash flows;
iv. contributions from holders of equity claims and distributions to them; and
v. the methods, assumptions and judgements used in estimating the amounts
presented or disclosed, and changes in those methods, assumptions and
judgements.

Reporting period
Financial statements are prepared for a specified period of time (reporting period) and
provide information about:
a) assets and liabilities—including unrecognized assets and liabilities—and equity that
existed at the end of the reporting period, or during the reporting period; and
b) income and expenses for the reporting period.
To help users of financial statements to identify and assess changes and trends, financial
statements also provide comparative information for at least one preceding reporting period.

Going concern assumption

Financial statements assume the reporting entity will continue operating, without liquidation or ceasing
trading. If a need exists, the basis used may need to be adjusted, as described in the financial statements.
 THE ELEMENTS OF FINANCIAL STATEMENTS

An asset is 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. This section
discusses three aspects of those definitions:
a) right;
b) potential to produce economic benefits; and
c) control.

A liability is a present obligation of the entity to transfer an economic resource as a result

of past events. For a liability to exist, three criteria must all be satisfied:
a) the entity has an obligation;
b) the obligation is to transfer an economic resource; and
c) the obligation is a present obligation that exists as a result of past events.

Equity claims are claims against an entity’s residual interest in assets after deducting liabilities, which do
not meet the definition of a liability and can be established through contract, legislation, or similar means.
Through:
a) shares of various types, issued by the entity; and
b) some obligations of the entity to issue another equity claim.
 Income is increases in assets, or decreases in liabilities, that result in increases in equity,
other than those relating to contributions from holders of equity claims.

Expenses are decreases in assets, or increases in liabilities, that result in decreases in

equity, other than those relating to distributions to holders of equity claims.

Financial statements include income and expenses, which are crucial for users to understand an
entity’s financial position and performance, as they are based on changes in assets and
liabilities.

THE RECOGNITION PROCESS

Recognition is the process of capturing an item in a financial statement, such as an asset,
liability, equity, income, or expense, in a statement of financial position or performance. This is
done by depicting the item in words and monetary terms, and including it in totals. The carrying
amount of an asset, liability, or equity is crucial in ensuring financial information is comparable
and understandable. Recognition links the elements; the statement of financial position and the
statement(s) of financial performance as follows (see Diagram 5.1):
a) in the statement of financial position at the beginning and end of the reporting period,
total assets minus total liabilities equal total equity; and
b) recognized changes in equity during the reporting period comprise:
i. income minus expenses recognized in the statement(s) of financial
performance; plus
ii. contributions from holders of equity claims, minus distributions to holders of
equity claims.

Statements are linked because the recognition of one item necessitates the recognition or
derecognition of another item or changes in its carrying amount. For example:
a) the recognition of income occurs at the same time as:
i. the initial recognition of an asset, or an increase in the carrying amount of an
asset; or
ii. the derecognition of a liability, or a decrease in the carrying amount of a liability.

b) the recognition of expenses occurs at the same time as:

i. the initial recognition of a liability, or an increase in the carrying amount of a
liability; or
ii. the derecognition of an asset, or a decrease in the carrying amount of an asset.
 How recognition links the elements of financial statements

Recognition criteria
The statement of financial position and statement(s) of financial performance recognize only items that meet
the definition of assets, liabilities, or equity. Not all items are recognized, making the statements less complete
and potentially excluding useful information. Recognizing some items may not provide useful information, as it
only provides useful information to users of financial statements.

Derecognition
Derecognition is the removal of all or part of a recognized asset or liability from an entity’s
statement of financial position. Derecognition normally occurs when that item no longer meets the
definition of an asset or of a liability:
a) for an asset, derecognition normally occurs when the entity loses control of all or part
of the recognized asset; and
b) for a liability, derecognition normally occurs when the entity no longer has a present
obligation for all or part of the recognized liability.
 MEASUREMENT BASES
Financial statements quantify elements using a measurement basis, which is a feature like historical cost,
fair value, or fulfilment value, to measure the asset or liability’s income and expenses.

Historical cost
Historical cost measures provide monetary data on assets, liabilities, income, and expenses, excluding
changes in values due to asset or liability impairment.

Current value
Current value measures provide monetary information about assets, liabilities, income,
and expenses, updated to reflect conditions at the measurement date. They reflect changes in
estimates of cash flows and other factors, unlike historical cost. Current value measurement
bases include:
a) fair value;
b) value in use and fulfilment value for liabilities; and
c) current cost

Measurement of equity
The total carrying amount of equity (total equity) is not measured directly. It equals the
total of the carrying amounts of all recognized assets less the total of the carrying amounts of all
recognized liabilities.

Presentation and disclosure as communication tools

Effective financial statement communication enhances the relevance and accuracy of an entity’s assets,
liabilities, equity, income, and expenses. It also improves understandability and comparability. Cost
constraints financial reporting decisions, so it’s crucial to weigh the benefits to users against the costs of
providing and using information.

Classification

Classification is the systematic arrangement of assets, liabilities, equity, income, or expenses based on
shared characteristics, including their nature, function, and measurement within a business.
 Classification of assets and liabilities
Classification applies to the chosen unit of account for an asset or liability. Sometimes, it’s necessary to
separate components with different characteristics, such as current and non-current components, to
enhance the usefulness of financial information.

Offsetting
Offsetting occurs when an entity recognizes and measures both an asset and liability as
separate units of account, but groups them into a single net amount in the statement of financial
position. Offsetting classifies dissimilar items together and therefore is generally not appropriate.

Classification of equity
To provide useful information, it may be necessary to classify equity claims separately if
those equity claims have different characteristics

Classification of income and expenses

Classification is applied to:
a) income and expenses resulting from the unit of account selected for an asset or liability;
or
b) Classifying income and expenses separately can improve the usefulness of financial
information by identifying different characteristics and enhancing the understanding of
asset value changes and interest accrual.

Profit or loss and other comprehensive income

Income and expenses are classified and included either:
a) in the statement of profit or loss; or
b) outside the statement of profit or loss, in other comprehensive income.

The statement of profit or loss provides a summary of an entity's financial performance for the reporting
period. It is often used as a starting point or main indicator. However, understanding an entity's
performance requires analyzing all income and expenses, including comprehensive income.

Aggregation

Aggregation involves adding shared assets, liabilities, equity, income, or expenses to summarize large
volumes of detail, but it can conceal some information, requiring a balance to avoid insignificant detail or
excessive aggregation.
 CONCEPTS OF CAPITAL
Most entities use a financial concept of capital in financial statements, referring to net assets or
equity, or a physical concept like operating capability, which refers to an entity’s productive
capacity.

Concepts of capital maintenance and the determination of profit

The concepts of capital in paragraph 8.1 give rise to the following concepts of
capital maintenance:
a) Financial capital maintenance. Profit is earned when net assets at the end of a
period exceed initial net assets, excluding owner contributions. Financial capital
maintenance is measured in nominal monetary units or constant purchasing power.
b) Physical capital maintenance. Profit is earned when an entity’s physical
productive capacity exceeds its initial capacity, excluding owner contributions and
distributions.

Capital maintenance is the process of defining an entity’s capital and

determining its return on capital. It links capital and profit concepts,
distinguishing between return on capital and return of capital. Profit is the
residual amount remaining after expenses are deducted from income. The
concept requires the current cost basis of measurement, while financial capital
maintenance does not. In financial capital maintenance, profit represents the
increase in nominal money capital over time, while in physical capital
maintenance, it represents the increase in physical productive capacity. Price
changes affecting assets and liabilities are treated as capital maintenance
adjustments, not as profit.