THE CONCEPTUAL

FRAMEWORK FOR
FINANCIAL
REPORTING - PART I

Slides created by Zaid Zghoul ©

based on Contemporar y Issues in
Accounting book by Rankin
 CONCEPTUAL FRAMEWORKS

A conceptual framework is a group of ideas or

principles used to plan or decide something. It
can be seen as a set of guiding principles —
that is, those ideas or concepts that influence
and direct decisions being made in a
particular area.
 QUESTIONS THAT NEED TO BE
CONSIDERED WHEN PREPARING
FINANCIAL STATEMENTS SUCH AS:

 What is the purpose of financial statements?

 Who are they prepared for?
 What are the assumptions to be made when
preparing financial statements?
 What type of information should be included ?
 What are the elements that make up financial
statements?
 When should the elements of financial
statements be included?
 CONCEPTUAL FRAMEWORK THEORY

 The Conceptual Framework is a normative

theory.
 It prescribes the basic principles that are to be
followed in preparing financial statements.
 So an accounting conceptual framework
can be described as ….
“a coherent system of concepts, which are guidelines
to the accounting standards used for financial
reporting”.
 DIFFERENCE BET WEEN THE CONCEPTUAL
FRAMEWORK AND THE ACCOUNTING
STANDARDS
 Principles in the Conceptual Framework are general
concepts designed to provide guidance.

 and apply to a wide range of decisions relating to the

preparation of financial reports .

 Accounting standards provide specific requirements

for a particular area of financial reporting.
 DIFFERENCE BET WEEN THE CONCEPTUAL
FRAMEWORK AND THE ACCOUNTING
STANDARDS
 For example:

 The Conceptual Framework defines what an asset is and

when it should be included in the financial statements .

 The accounting standard on inventory (e.g. AASB 102/IAS 2

Inventories) outlines the definition of what is considered
inventory and what costs are included and also requires these
assets to be measured at the lower of cost and net realizable
value.
 REPORTING FOCUS

 The Conceptual Framework states that it is

concerned with general purpose financial
reports.

 These can be defined as financial reports intended

to meet the needs of users who are not in a position
to require an entity to prepare reports tailored to
their particular information needs.
 REPORTING FOCUS

 The Conceptual Framework does not need to be

applied in the preparation of special purpose
financial reports
 which are reports prepared to meet the needs of
particular users.
 These normally contain specialized information
designed for users who have the power to ask for the
information they need.
 Some significant lenders
 Taxation authorities
 Management
 ENTIT Y FOCUS

 While financial statements relate to a particular entity, there

is no definition of a reporting entity in the Conceptual
Framework.

 Paragraph 8 of the Framework stated : The Framework applies

to the financial statements of all
 commercial,
 industrial
 and business reporting entities,

whether in the public or the private sectors.

 REPORTING ENTIT Y

 Proposed definition of the reporting entity:

 A reporting entity is a circumscribed area of economic

activities whose financial information has the potential to be
useful to existing and potential equity investors, lenders, and
other creditors who cannot directly obtain the information
they need in making decisions about providing resources to
the entity and in assessing whether the management and the
governing board of that entity have made ef ficient and
ef fective use of the resources provided.
 REPORTING ENTIT Y

 Notes on the definition

 Rather than considering the legal form, a reporting entity is

identified from a bounded set of economic events and
transactions with a link to a group of users reliant on general
purpose financial reports .

 The Conceptual Framework is not aimed at financial reports

prepared by not-for-profit entities.

 The Conceptual Framework does not set out which entities

must actually prepare financial reports.
 THE OBJECTIVE OF FINANCIAL
REPORTING

Stewardship
Decision
or
usefulness
accountability Vs
 STEWARDSHIP OR ACCOUNTABILIT Y

Stewardship or accountability focuses on

the duty of the managers of an entity.
They are entrusted with the resources of
the entity. Stewardship (or accountability)
requires the managers to provide a report
to the providers of the resources to
explain how well they have managed
them.
 DECISION USEFULNESS

 The Conceptual Framework does not include

Accountability as a separate objective giving primacy to
decision usefulness.

According to the Conceptual Framework

 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.
 Those decisions involve buying, selling or holding equity
and debt instruments, and providing or settling loans and
other forms of credit.
 USERS

 Itis important to consider who the users are and

what information they need, given that the purpose
of financial statements is to provide them with
useful information.

 The Conceptual Framework identifies a limited range

of primary users of financial statements. They
include:

 existing and potential investors

 lenders
 other creditors.
 USERS’ INFORMATION NEEDS

the Conceptual Framework acknowledges that

not all users’ information needs can be met by
general purpose financial statements.

aim is to provide information where users’

needs overlap or are shared — that is, to meet
the information needs that are common to
these user groups and meet the needs of the
maximum number of these primary users
(paragraph OB8).
 USERS’ INFORMATION NEEDS

The information in financial reports is limited

mainly to financial information.

This is normally in the form of the Financial

Statements and associated notes.

 The Conceptual Framework explicitly states

that these reports are not designed to show
the value of a reporting entity.
 UNDERLYING ASSUMPTION

 The going concern assumption

 It states that ‘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.

 The going concern assumption has a direct impact on

both the recognition and measurement of items in
the financial statements.
 GOING CONCERN

 If the entity is not expected to continue in business, then

the economic benefits in particular items, such as
prepaid insurance, would no longer be expected to be
received, so they could not be recognized as assets.

 The reported values of assets would also need to be

reconsidered.

 For example, if the business is to close, inventory may

not realize its ‘normal’ selling price. Where the
assumption that the entity is a going concern is
inappropriate, this basis should not be used and this
would need to be disclosed.
 QUALITATIVE CHARACTERISTICS OF
USEFUL INFORMATION
 To be useful for decision making information must have both
of the two fundamental characteristics .

 The enhancing characteristics are not essential, but can

improve the usefulness of the information and also assist in
making choices between information that has the
fundamental characteristics.
 FUNDAMENTAL QUALITATIVE
CHARACTERISTICS

The two fundamental qualitative

characteristics are:

 relevance

 faithful representation.
 RELEVANCE

 The relevance characteristic aims to ensure that only financial

information that could make a dif ference in decisions is
included.

 This fundamental qualitative characteristic outlines why the

financial information is needed. It is linked directly to the
purpose of financial reports — that is, to provide information
useful to users in making decisions.

 Clearly, if the information cannot be used either to help make

predictions or to provide feedback, it is not useful to users,

 often the first ‘test’ applied to financial information

 MATERIALIT Y

Entity specific
Related to the size/amount
Nature of the item regardless of the size
 FAITHFUL REPRESENTATION

 The purpose of faithful representation is to make sure that

users can ‘trust’ the financial information that is provided in
financial reports
 In Conceptual Framework it replaces reliability as a
qualitative characteristic.
 Faithful representation requires making sure that what is
shown in the financial reports corresponds to the actual
events and transactions that are being represented.
 Accounting standards often require us to consider the
substance over form — that is, requiring items to be
accounted for and presented in accordance with their
substance and economic reality and not merely their legal
form.
 COMPONENTS OF FAITHFUL
REPRESENTATION
 Complete depiction: Users require all relevant information
about an event or phenomena to be included in the financial
reports, if these are to be useful for decision making.

 Neutrality: For information to be neutral, it must be free from

bias
 Freedom from error Clearly if there are errors in the
information it is not a faithful representation. This does not
imply however that the information is ‘exact’. Many estimates
are used in accounting and in hindsight many of these will be
found to be incorrect or inaccurate. Providing these estimates
are identified as such, and made on a reasonable basis, these
would still meet the requirement for faithful representation
 (paragraph QC14). This component of faithful representation
aims to ensure that there is no attempt to promote any
particular view and that the financial reports provide an
impartial description of the events and transactions
(paragraph QC15).
 Disclaimer
• Disclaimer:- Slides that have this theme were
created by Matthew Tilling ©2012 John Wiley
& Sons Australia Ltd
 Enhancing
Qualitative Characteristics
• Comparability
– Achieved with consistent measurement and
presentation of items over time and between
entities

• Verifiability
– Information can be supported or confirmed so
that users are confident in relying on it
 Enhancing
Qualitative Characteristics
• Timeliness
– Users need information on a timely basis

• Understandability
– Financial reports are prepared for users who
• Have reasonable knowledge of business and economic
activities, and
• will conduct a diligent review and analysis of the
information
Determining the Relative Importance
of Qualitative Characteristics
• Ideally information will have all characteristics
• In reality there are often trade-offs
– Timeliness versus faithful representation
– Relevance versus verifiability
– Relevance versus understandability

• Cost Constraint on Financial Information

– Cost versus benefit
 The Elements Of
Financial Statements
• Assets
A resource controlled by the entity as a result of
past events and from which future economic
benefits are expected to flow to the entity.
• Liabilities
A present obligation of the entity arising from past
events, the settlement of which is expected to
result in an outflow from the entity of resources
embodying economic benefits.
 The Elements Of
Financial Statements
• Equity
The residual interest in the assets of the entity after
deducting all its liabilities.
• Income
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.
• Expenses
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.
 Recognition Criteria
• Recognition is the process of incorporating an
item in the balance sheet or income
statement . . . It involves depiction of the item
in words and by a monetary amount and the
inclusion of that amount in the balance sheet
or income statement totals.
• Two tests for recognition
– Probability
– Measurability
 Probability
• An element should be recognised if
(a) it is probable that any future economic
benefit associated with the item will flow to or
from the entity
• Probability criteria is met if ‘the event if more
likely than not to occur’.
 Reliable Measurement
• An element should be recognised if
(b) the item has a cost or value that can be
measured with reliability.

• Estimation is acceptable
• Either a cost or a value