Financial Accounting and Reporting III

ACC5

The Conceptual Framework

for Financial Reporting
Financial Accounting and Reporting III
Conceptual Framework
General Definition
General accepted theoretical framework for a field
of study

Specific
Basis for the development of new accounting
standards and evaluation of existing ones
Sets out agreed concepts that underlie financial
reporting

 The frameworks is not an IFRS (PFRS)

 When there is a conflict between IFRS (PFRS)
and the Frameworks, the IFRS (PFRS) prevails
 Although theoretical in nature, the frameworks
has a clear practical value
Purpose of the Conceptual Framework
(LO1.A)

Stakeholder Purpose
IASB -Development of IFRS
-Review of existing IFRS
-Harmonisation of standards
-Enhances consistency across
standards and the Board
FRSC -Developing national standards
FS -Application of IFRS
Preparers -Topics not dealt by IFRS
Auditors -Expressing audit opinion
Users -Interpreting the financial information
General -Work of IASB
Public -Standards formulation process
Conceptual Frameworks - Overview
Overview
Objective of Provide useful information
Financial (Other aspects of the Conceptual
Reporting Framework flow logically from the
objective)
Qualitative Fundamental:
Characteristics Relevance and Faithful Representation
Enhancing:
Verifiability, Comparability,
Understandability, Timeliness
Elements of FS Financial Position: Asset, Liabilities and
Equity
Financial Performance: Income and
Expenses
Other concepts Capital and capital maintenance
Conceptual Frameworks - Overview
Recognition and Measurement
Primary FS
Concepts
Users
Resources and SFP
Useful Claims
Information
Changes

Financial SCI
Fundamental QC Performance
Enhancing QC
Cost Constraint
Past Cash Flows SCF

Capital and Capital Changes Not SCE

Maintenance Affecting
Performance
Objectives of Financial Reporting
(LOI.B)

• General purpose versus specific purpose

financial statements
• Objective of general purpose financial
reporting:
Useful • Existing and
information Making
potential decisions
investors* (i.e., capital
Reporting •Lenders* provision)
entity •Creditors*
* Collectively called capital providers
Users of Financial Information
Users Decisions Information
Existing and Buy, sell, hold Returns such us
Potential investments dividends, market
Investors price increases and
principal and interest
payments
Existing and Providing or Principal and interest
potential settling the loan repayments
lenders and and extending
creditors credit lines

Users‟ return expectation depends on the entity‟s

future net cash inflows based on resources and claims
of the entity and how they are effectively and
efficiently managed.
Financial Information – Caveats

General purpose financial statements are:

a) NOT meant to cater to all the needs of users,
focus is in the need of maximum no. of users
b) NOT designed to show the value of a reporting
entity, users must estimate it themselves
c) NOT based on exact depictions but on
estimates, judgments and models
d) NOT primarily directed to regulators, but may
find them useful still
Qualitative Characteristics (LOI.C)

• Financial information is useful if (a) it is

relevant and (b) it faithfully represents what it
purports to represent (fundamental qualities)
• Usefulness of financial information is enhanced
by its verifiability, completeness,
understandability and timeliness
• Financial information cannot be useful if it is
not relevant and not faithfully represented,
even though it is verifiable, complete,
understanble and timely.
• Fundamental qualities = sine qua non;
Enhancing qualities = less critical but highly
desirable; must be maximised as necessary
Fundamental Characteristics*
Relevance
• making a difference in users‟ decision
• predictive value
• confirmatory value
• materiality (entity specific)

Faithful Representation
• present what it purports to present
• completeness (words and numbers)
• neutrality (not biased)
• free from error (ideally)

*adapted from the presentation “Conceptual Framework for Financial Reporting: Joint World
Bank and IFRS Foundation „train the trainers‟ workshop”
Enhancing Characteristics*
Comparability
• like things look alike; different things look
different
• Intercompany and intracompany

Verifiability
• knowledgeable and independent observers
could reach consensus, but not necessarily
complete agreement, that a depiction is a
faithful representation
*adapted from the presentation “Conceptual Framework for Financial Reporting: Joint World
Bank and IFRS Foundation „train the trainers‟ workshop”
Enhancing Characteristics*
Timeliness
• having information available to decision-makers in
time to be capable of influencing their decisions

Understandability
• classifying, characterizing and presenting
information clearly and concisely makes it
understandable
• complex phenomenon might not be
understandable but omission will make the
information incomplete
• users = reasonable knowledge of business and
economic activities; review and analyse the
information with diligence.
*adapted from the presentation “Conceptual Framework for Financial Reporting: Joint World
Bank and IFRS Foundation „train the trainers‟ workshop”
Pervasive Constraint
• Financial reporting has costs that must be
justified by benefits
• Benefits: more efficient functioning of capital
markets and lower cost of capital for the
economy
• Costs: collecting, processing, verifying and
disseminating financial information and the
costs of analysing and interpreting the
information provided
• Assessing cost-benefit constraints involves
both qualitative and quantitative assessments
• The board assesses cost-benefit constraints in
relation to financial reporting in general, and
not entity specific.
Elements of Financial Statements
Financial Position

Assets Resources controlled, from past events with future

economic benefit
Present obligation, from past events with outflow
Liabilities
of resources

Equity Residual definition; assets minus liabilities

Financial Performance

Income
Increase in economic benefits from:
-Inflow / enhancement of assets
- Decrease in liabilities
-Increase in equity, other than
capital contribution
Expenses
Decrease in economic benefits from:
-Outflow / depletion of assets
-Incurrence of liabilities
-Decrease in equity, other than
distributions
Elements of Financial Statements
• Definitions of the elements identify their essential
features, but do not attempt to specify recognition
criteria
• Substance and economic reality over legal form

Assets
• Sources of future economic benefits:
• Used in production
• Exchanged for other assets
• Used to settle a liability
• Distributed to owners
• Physical form is not essential
• Legal ownership is not essential
• Close association between expenditures and
generating assets, but not absolute
Elements of Financial Statements
Liabilities
• Legally enforceable or normal business
practice
• Present obligation versus future
commitment
• Settlement may be in the form of:
• Payment of cash
• Transfer of other assets
• Provision of services
• Replacement with another obligation
• Conversion to equity
• Some can only be measured with a
substantial degree of estimation
Elements of Financial Statements
Equity
• May have sub-classifications
• Contributions
• Retained earnings
• Reserves
• Appropriations
• Amount of equity shown in the balance sheet is
dependent on the measurement of assets and
liabilities
Income
• Includes both revenue and income
• Revenue: sales, fees, interest, dividends, royalties
and rent. Arises in ordinary course of business
• Gains: May or may not arise in ordinary course of
business. Often presented net of any related
expense.
Elements of Financial Statements
Expenses
• Includes both expenses and losses
• Expense – Normal Course; Losses may or may
not arise from the ordinary course of business
• Losses are often presented net of any related
income

Capital Maintenance Adjustments

• Meets definition of expenses and income, but
not presented in income statement
Elements of Financial Statements
Recognition: process of incorporating the
elements to the financial statements
• Recognition criteria (accrual basis):
• Probable that any future economic
benefit
• Usually means, “more likely than
not”; varies across standards
• Measurable
• Estimates, judgments, models
rather than exact depiction
• Recognition of income and expenses
occurs simultaneously with the increase
or decrease in asset or liability
Elements of Financial Statements
Measurement: process of determining
monetary amounts of elements
Estimates
Financial Statements Judgments
are based on..
Models
Rather than exact depiction

Conceptual
Frameworks
Establishes Underlying
Concepts
Measurement Bases
Historical Cost
Assets Liabilities
Cash or cash equivalent paid or FV Proceeds received or amount to be
of consideration given paid

Current Cost
Assets Liabilities
Cash or cash equivalent that would Cash or cash equivalent required to
have been paid if similar asset is settle the obligation (undiscounted)
acquired currently currently

Realizable (Settlement) Value

Assets Liabilities
Cash or cash equivalent to be Cash and cash equivalent expected
received if sold in an orderly to be paid to satisfy the obligation
disposal (undiscounted)
Measurement Bases (cont‟d)

Present Value
Assets Liabilities
Discounted net cash inflow Discounted net cash outflow
expected from the asset expected from the asset

-Most common basis is historical cost

-Historical cost is usually combined with other bases
Concepts of Capital, Capital Maintenance and
Profit
Financial Concept Physical Concept
Definition Net assets Productive capacity
Example Total shareholders‟ equity of Generation capacity of a
a retail company power plant
Maintenance Profit is NA End less NA Profit is PC End less, PC
Beg, less contributions, add Beg, less contributions,
back distributions add back distributions
Price Δs Nominal: Part of equity, not profit or
Considered in profit or loss loss

Purchasing Power:
Considered in profit or loss,
after taking away effect of
changes in general price
indices

Selection of measurement bases and concept of capital depends on the

accounting model used in the preparation of the financials statements.