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The Conceptual Framework

The frame works for financial reporting

These are basically two i.e. the Regulatory and the conceptual framework.
Conceptual Framework for financial Reporting
Meaning of the conceptual frame work
The Conceptual Framework is a theoretical map or definitive reference document that sets out the very
basic theory of accounting.
It can be seen as a statement of generally accepted accounting principles (GAAP) that form a frame of
reference for the evaluation of existing practices and the development of new ones.
As the purpose of financial reporting is to provide useful information as a basis for economic decision
making, a conceptual framework will form a theoretical basis for determining how transactions should
be measured and reported.
The framework sets out the concepts that underlie the preparation and presentation of financial
statements for external users.
It prescribes the nature, function, and limits of financial accounting and financial statements.
Conceptual framework was published by IASB to guide both the International and National standard
setters when setting standards, and to assist preparers and auditors when interpreting standards or
dealing with issues standards do not cover.
The History of the Frame work
April 1989
The Framework was approved by the IASC Board
July 1989
Framework was published
April 2001
Framework adopted by the IASB.
September 2010 The IFRS Framework approved by the IASB
Scope of the conceptual frame work. The conceptual framework includes guidance with regard to;
Users of financial statements
The objectives of financial statements (General purpose financial statements);
The underlying assumptions;
The qualitative characteristics that determine the usefulness of information in financial statements
The elements of financial statements;
Recognition of the elements of financial statements;
Why have a conceptual framework?
a) The framework enables accounting standards and GAAP to be developed in accordance with agreed
principles.
b) The framework helps prepares and auditors of accounts to deal with transactions which are not the
subject of an accounting standard.
c) Accounting standards based on principles are thought to be harder to circumvent.
d) The framework avoids fire fighting during development of accounting standards. Standards are
developed in a piecemeal way in response to specific problems or abuses.

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The Conceptual Framework

e) It makes it less likely that the standard setting process can be influenced by vested interests of large,
small, or any specific business sector.
f) Lack of the framework would mean that certain critical issues are not addressed. E.g. until recently,
there was no definitions of items like asset and liability in any accounting standard.
Purpose of the Framework
a) To help the IASB in its role of developing future accounting standards and in reviewing existing IFRS.
b) Help national standard-setting bodies in developing national standards.
c) Help those preparing financial statements to apply IFRS and also to deal with areas where there is no
relevant standard.
d) Help auditors when they are forming an opinion as to whether financial statements conform to IFRS.
e) To help users of financial statements to interpret information in financial statements which have been
prepared in accordance with IFRS.
f) To help IASB by providing a basis for reducing a number of alternative accounting treatments permitted
by IFRS.
Users of Financial Statements
a) Equity Investors (Existing and potential)
b) Employees (Existing, potential and past)
c) Lenders (Existing and potential including providers of short-loans)
d) Suppliers
e) Creditors
f) Customers
g) Debtors
h) Governments and their agencies e.g. Tax authorities
i) And the public at large
Objectives of Financial Statements
a) To provide information about the financial position, financial performance and changes in financial
position of an enterprise that is useful to a wider range of users in making economic decision.
b) Financial statements are also used to show the results of stewardship of management, or the
accountability of management for the resources entrusted to it
Underlying Assumptions
The Framework states that in order to meet their objectives and to be presented fairly, financial
statements must be prepared on the assumption that;
1. The entity is a going concern i.e. That the entity has neither the need nor the intention to liquidate or
curtail materially the scale of tits operations.
2. There is accrual basis of accounting, i.e. the effects of transactions and other events be recognized as
they occur and not as cash or its equivalent is received or paid.

Other Accounting Concepts / Principles Conventions (GAAP)

In drawing up accounting statements, a clear objective has to be that the accounts fairly reflect the true
substance of the business and the results of its operation.
The Accounting profession has developed the concept of a TRUE and FAIR VIEW.
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The Conceptual Framework

The true and fair view is applied in ensuring and assessing whether accounts do indeed portray
accurately the business activities.
To support the application of the true and fair view the Accounting profession has adopted certain
principles which help to ensure that accounting information is presented accurately and consistently.
GAAP = Generally Accepted Accounting Principles; these are basic ground rules which must be
followed when financial accounts are being prepared and presented. Below are some of the generally
recognized principles which underlie accounting and financial statements;
1. Historical cost concept
This requires transactions to be recorded at the price ruling at the time, and for assets to be valued at their
original cost.
Limitation
During inflation, historical cost will not reflect the value of the assets of the business. E.g if an asset was
bought at shs 1,000,000/= at the beginning of the year, and the annual inflation rate is 90%, its value at the
end of the year will be shs 1,900,000/=. The historical cost concept will required shs 1,000,000/= and not
shs 1,900,000 to be recorded
2. Monetary measurement concept;
According to this concept all transactions to be recorded must be quantified in monetary terms, since
money is a common denominator for all transactions.
Limitations

It assumes money has a stable value over time, yet actually money may lose value with time.

It limits recognition of transactions to those that can be quantified and leaves out qualitative factors
that can have a direct impact on the business e.g workforce skill, morale, market leadership, brand
recognition, quality of management etc.
3. Business Entity Concept
This convention seeks to ensure that private transactions and matters relating to the owners of a business
are segregated from transactions that relate to the business.
Limitation
The main limitation of the concept is that the owner and the business are actually inseparable. For
instance if a sole trader sells and dwells on the same premises, then rent and utilities paid will be difficult to
apportion between the owner and the business especially if there are no clear apportionment bases.
4. Realization concept
This concept demands the recognition of income as earned only when a sale has been made and the
goods have been accepted by the customers or services have been offered and enjoyed by customers
rather than just when cash actually changes hands. For example, a company that makes a sale to a
customer can recognize that sale when the transaction is legal at the point of contract. The actual payment
due from the customer may not rise until several weeks (or months) later if the customer has been
granted some credit terms.
5. Consistency, i.e. Items should be treated in the same way year on year. This will enable valid
comparisons to be made. However, if circumstances change then a business is allowed to change policies
to give a fairer representation of the financial statements.
6. Materiality. The threshold quality that is demanded of all information given in the financial statements,
i.e. information that is material should be given in the financial statements. Information that is not material
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The Conceptual Framework

need not be given. Information is material if its omission or misstatement might reasonably be expected to
influence the economic decisions of users. Whether or not information is material will depend on the size
and nature of the item and the size of the business.
7. Prudence / conservatism
This concept requires the accountants not to anticipate revenues and profits until realized but should
provide for all possible losses. E.g. provision for bad debts. In addition, the concept tends to undervalue
assets i.e. if there are two or more methods of valuing an asset, an accountant should choose the one that
leads to a lower value.
8. Matching
This concept requires accurate matching of expenses against incomes by writing off only those costs or
expenses that were incurred in generating specific income for the period ended e.g.

If income of shs 50,000,000/= was earned during a particular financial period, and rent of shs
1,800,000 had been paid for one and half years, not the whole shs 1,800,000 should be written off
or subtracted from the income shs 50,000,000/= it is shs 1,200,000 and not shs 1,800,000. The
difference is recorded as prepaid rent.

Likewise if electricity expenses paid was shs 500,000/= but some electricity equivalent to
200,000/= was used but not paid, that amount should as well be matched against the income i.e
the amount of electricity expense to be subtracted from income of shs 50,000,000/= should be shs
700,000/= (i.e 500,000/= + 200,000/=. The unpaid shs 200,000/= should be recorded as an
accrual.
9. Substance over form
This states that transactions and other events should be recorded in accordance with financial and
economic reality other than its legal form. E.g in a hire purchase, the buyer takes possession and use of the
asset but does not become the legal owner until the last installment has been paid. Though he is not the
legal owner, he has to recognize this transaction in his books.
10. Duality concept (dual aspect)
This requires a transaction to be recorded twice (dual recording) e.g. it recognizes that a transaction
involves the giving and receiving effect when somebody gives something another must receive it. This
provides a basis for the double entry system.
11. Periodicity and disclosure concept
This requires a company to prepare and disclose financial statements at the end of every accounting or
financial year. This enables comparability, timely performance measurement and tax computations.
Qualitative Characteristics of Financial Statements
Qualitative characteristics are the attributes that make the information provided in financial statements
useful to users.
If and when these principal qualitative characteristics together with accounting standards are applied
and followed ,financial statements will convey what is generally understood as a true and fair view or
representing fairly such information.

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The Conceptual Framework

Financial information is useful when it is relevant and represents faithfully what it purports to
represent. The usefulness of financial information is enhanced if it is comparable, verifiable, timely
and understandable.

The two fundamental qualitative characteristics;Relevance and

Faithful representation.
There are 4 Enhancing qualitative characteristics;Comparability
Verifiability
Timely and
Understandability.
Relevance
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;a) Predictive value, Confirmatory value, or both.
The predictive and confirmatory roles of information are interrelated.
Information has predictive and confirmatory value if it is used to predict future position and
performance.
And if it can be used to confirm the accuracy or inaccuracy of past predictions.
b) Materiality
Information is material if omitting it or misstating it could influence the decisions that users make on the
basis of financial information about a specific reporting entity
Faithful representation.
Faithful representation requires three characteristics;a) The information must be complete,
b) The information must be neutral and
c) The information must be 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

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The Conceptual Framework

Enhancing qualitative characteristics

a) Comparability
Users must be able to compare an entity's financial statements:
Through time to identify trends
With other entities' statements, to evaluate their relative financial position, performance and changes in
financial position.
The consistency of treatment is therefore important across like items over time, within the entity and across
all entities
b) Verifiability
This gives assurance to users that information is a faithful representation. Verification can be direct or
indirect.
c) Timeliness.
If there is undue delay in the reporting of information it may not be capable of influencing the decisions
of decision-makers.
Generally, information becomes less useful as it ages.
d) Understandability
Users must be able to understand financial statements.
They are assumed to have some knowledge of business and economic activities and to be able to
study the information properly.
Complex matters should not be left out of financial statements simply due the difficulty of understanding
them.
Note:
The Cost constraint.
The benefits derived from information should exceed the cost of providing it.
The costs will ultimately be borne by the users of financial information.
Elements of Financial Statements
Elements of financial statements include;
Assets
Liabilities
Equity
Income
Expenses
1. Assets
Assets are resources controlled by the enterprise as a result of past events and from which future
economic benefits are expected to flow to the enterprise.
Controlled by the enterprise:
Control is ability to obtain the economic benefits from an assets through
sale
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The Conceptual Framework

use and
To restrict the access of others.
Ownership
Usually synonymous with control.
An entity may however own plant and equipment but lease it to another party under a finance lease
arrangement
Ownership must carry the rewards and risks of ownership
Tangibility is not an essential Characteristic
Legal right of ownership is not essential
The past event
The event must be past before an asset can arise. Example, land arises from a purchase, trade
receivables arise from making a sale.
Managements future intentions do not create assets.
Depending on the terms of contract, the past event occur at the point of accepting the order or on
delivery
Future economic benefits:
These are evidenced by the prospective receipt of cash.
This could be cash itself, a debt receivable or any item, which may be sold.
E.g. a delivery van may not be sold (on going-concern basis) but the revenue realized from goods sold
being transported by use of the van is the economic benefit from the use of the van.
A machine will make goods that will be sold to create cash.
2. Liability
An entity's present obligation arising from past events, the settlement of which will result in an outflow of
economic benefits from the entity.
Obligations;
Arises from a past event known as an obligating event. E.g. signing of a contract
These may be legal or constructive.
A constructive obligation is an obligation which is as result of expected practice rather than required by
law or a legal contract.
An entity creates a valid expectation that it will discharge responsibilities that it is not legally obliged to.
This is usually as a result of past behaviors, or by commitments given in a published statement. E.g. a
company voluntarily shows that it incurs environmental costs.
Transfer of economic benefits;
This could be a transfer of cash, or other property, the provision of services, or the refraining from activities
which would otherwise be profitable.
Past event; e.g. a tax liability arises from profits earned in the past.
3. Equity interest
This is the residual amount after deducting all liabilities of the entity from all of the entitys assets.

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The Conceptual Framework

This is always analyzed in financial statements to distinguish interest arising from owners contributions
from that resulting from other events.
The latter is split into different reserves which may have different applications or legal status. Share
capital and revaluation reserves are normally non-distributable.

4. Income
This is an increase in economic benefits during the accounting period inform of inflows or
enhancements of assets or decreases in liabilities.
Income is also is an increase in equity from transactions not relating to contributions by equity
participants. This means that contributions from owners are not income.
5. Expenses
Represents decreases in economic benefits during the accounting period in form of outflows or
depletion of assets (prepayments depleted) or incurrence of liabilities (a credit purchase).
A decrease in equity resulting from transactions other than those relating to distributions to equity
participants. This means that distributions to owners are not expenses.
Recognition of Assets, Liabilities, Income and expenses
Recognition; Means the description of an element in words and by monetary amount in the financial
statements.
Many items or events may comply with the definition of an element.
However, they should only be included in the financial statements if they meet the recognition criteria.
If an item does not meet the recognition criteria, it may need to be disclosed in the notes to the financial
statements, but it must not be included in the statements themselves.
General recognition criteria
An item should be recognized in the financial statements if;
It meets one of the definitions of an element
It is probable that any future economic benefit associated with the item will flow to or from the entity.
The item can be measured as a monetary amount (cost or value) with sufficient reliability.
Normally the monetary amount will come straight from the sale or purchase invoice
However, reasonable, reliable and prudent estimates can be recognized, for example, a property
revaluation or a warranty provision.
The recognition process. Recognition is triggered where a past event indicates that there has been a
measurable change in the assets or liabilities of the entity.
The stages of recognition; the recognition of assets and liabilities falls into three stages;
Initial recognition (the purchase of a non current asset)
Subsequent remeasurement (E.g. revaluation of the above asset)
Derecognition (sale or destruction of the Asset)
The effects of uncertainty; The more evidence there is for an item, the more reliable its recognition and
measurement will be.
Recognition of Assets

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An asset should be recognized in the statement of financial position (the balance sheet) when and only
when:
It is probable that the future economic benefits embodied in the asset will flow to the enterprise
The asset has a cost or other value that can be measured reliably
There is sufficient evidence of its existence.

Recognition of Liabilities
A liability should be recognized in the statement of financial position (the balance sheet) when and only
when:
It is probable that the future economic benefits (resources) will be required to flow out of the entity for
settlement of a present obligation.
And that the amount of the obligation can be measured reliably.
There is sufficient evidence of its existence.
Recognition of income
Income is recognized in the SOCI when;
An increase in future economic benefits arises from an increase in an asset (or a reduction in a
liability), and
The increase can be measured reliably.
Recognition of expenses
Expenses are recognized in the SOCI when;
A decrease in future economic benefits arises from a decrease in an asset or an increase in a liability.
Can be measured reliably.
Financial position approach to recognition
It can be seen that;
Income is an increase in an asset or decrease in a liability.
Expense is an increase in a liability or decrease in an asset.
Income and expenses are recognized on the basis of changes in assets and liabilities. This is the
SOFP approach to recognition.
The concept of Capital maintenance

The capital maintenance concept states that a profit should not be recognized unless a business has at
least maintained the amount of its net assets during an accounting period. Stated differently, this
means that profit is essentially the increase in net assets during a period.

It provides linkages between the concepts of capital and the concepts of profit because it provides the
point of reference by which profit is measured.

It is a prerequisite for distinguishing between an entitys return on capital and its return of capital.

Its only inflows of assets in excess of amounts needed to maintain capital that may be regarded as
profit and therefore as a return on capital.

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The Conceptual Framework

Hence, profit is the residual amount that remains after expenses (including capital maintenance
adjustments, where appropriate) have been deducted from income. If expenses exceed income, the
residual amount is a loss.

Selection of an appropriate concept of capital.

The selection of an appropriate concept of capital by an entity should be based on the needs of users
of its financial statements.

Thus, a financial concept of capital should be adopted if the users of financial statements are primarily
concerned with the maintenance of nominal invested capital or purchasing power of invested capital.

If however, the main concern of users is with the operating capability of an entity, a physical concept of
capital should be used.

There are two main dimensions of capital maintenance.

1. Physical capital maintenance (PCM). This at times known as operating capital maintenance (OCM)
2. Financial capital maintenance (FCM)
Physical capital maintenance (PCM).
The concept measures the operating capability of an entity and therefore, capital is regarded as the
productive capacity of an entity based on, for example, units of output per day.
Financial capital maintenance.
This is adopted by most entities when preparing financial statements. Under this concept, capital is
synonymous with the net assets or equity of the entity.
The concept of Capital maintenance and profit determination
The concept chosen shows the goal to be attained in determining profit, even though there may be some
measurement difficulties in making the concept operational.
Financial capital maintenance.

Profit is earned only if the financial or money amount of the net assets at the end of a period exceeds
the financial or money amount 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.

Physical capital maintenance.

Here a profit is earned only if the physical productive capacity or operating capability of the business or
resources/ funds needed to achieve that capacity at the end of the period exceeds the physical
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The Conceptual Framework

productive capacity at the beginning of the period after excluding any distributions to, and contributions
from owners during the period.

This concept requires adoption of the current cost basis of measurement.

Difference between the two concepts

The principle difference between the two concepts is the treatment of the effects of changes in the
prices of assets and liabilities of the entity.
In general terms, an entity has maintained its capital if it has as much capital at the end of the period as
it had at the beginning of the period.
Any amount over and above that required to maintain the capital at the beginning of the period is
profit.
Under Financial capital maintenance, where capital is defined in terms of nominal monetary units,
profit represents the increase in nominal money capital over the period.
Thus, increases in the prices of assets held over the period, conventionally referred to as holding gains,
are conceptually, profits.
They may not be recognized as such, however, until the assets are disposed off in an exchange
transaction.
When the concept of financial capital maintenance, is defined in terms of constant purchasing
power units, profit represents the increase in invested purchasing power over the period.
Thus, only that part of the increase in prices of assets that exceeds the increase in the general level of
prices is regarded as profit.
The rest of the increase is treated as capital maintenance adjustment and hence part of equity.
Under the concept of physical capital maintenance, when capital is defined in terms of the physical
productive capacity, profit represents the increase in that capital over the period.
All price changes affecting the assets and liabilities of the entity are viewed as changes in the
measurement of the physical productive capacity of the entity.
Hence, they are treated as capital maintenance adjustments that are part of equity and not as profit.

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