the purpose of the Conceptual Framework is to:

 assist the International Accounting Standards Board to develop IFRS Standards that are based on
consistent concepts;
 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
 assist all parties to understand and interpret the Standards.

The conceptual framework identifies fundamental and enhancing qualitative characteristics of

useful information.

The fundamental characteristics are

Relevance. means that information is “capable of making a difference in the decisions made by users”
The definition is further refined to state that information is capable of influencing decisions if it has
predictive value, confirmatory value, or both.

Predictive value means that the information can be used to assist in the process of making
predictions about future events, such as potential investment returns, credit defaults, and other
decisions that financial-statement users need to make.

Confirmatory value means that the information provides some feedback about previous
decisions that were made. Quite often, the same information may be useful for prediction and feedback
purposes, but in different time periods.

The framework also mentions the concept of materiality. A piece of information is considered
material if its omission would affect a user’s decision. Materiality is a concept used frequently by both
internal accountants and auditors in determining the need to make adjustments for errors identified.
Clearly, an item that is not deemed to be material is not relevant, as it would not affect a user’s decision.

Faithful representation. means that the financial information presented represents the true economic
substance or state of the item being reported. This does not mean, however, that the representation
must be 100 percent accurate, as perfection is rarely attainable. The CPA Handbook indicates that for
information to faithfully represent an economic phenomenon, it must be complete, neutral, and free
from error.

The enhancing characteristics are

comparability, is the quality that allows readers to compare either results from one entity with another
entity or results from the same entity from one year with another year. This quality is important because
readers such as investors are interested in making decisions whether to purchase one company’s shares
over another’s or to simply divest a share already held. One key component of the comparability quality
is consistency. Consistency refers to the use of the same method to account for the same items, either
within the same entity from one period to the next or across different entities for the same accounting
period. Consistency in application of accounting principles can lead to comparability, but comparability
is a broader concept than consistency. Also, comparability must not be confused with uniformity. Items
that are fundamentally different in nature should be accounted for differently.

verifiability, quality suggests that two or more independent and knowledgeable ob- servers could come
to the same conclusion about the reported amount of a particular financial-statement item. This does
not mean that the observers have to be in complete agreement with each other. In the case of an
estimated amount on the financial statements, such as an allowance for doubtful accounts, it is possible
that two auditors may agree that the amount should fall within a certain range, but each may have
different opinion of which end of the range is more probable. If they agree on the range, however, we
can still say the amount is verifiable. Verification may be performed by either directly observing the
item, such as examining a purchase invoice issued by a vendor, or indirectly verifying the inputs and
calculations of a model to determine the output, such as reviewing the assumptions and recalculating
the amount of an allowance for doubtful accounts by using data from an aged trial balance of accounts
receivable.

timeliness, is one of the simplest but most important concepts in accounting. Generally, information
needs to be current to be useful. Investors and other users need to know the economic condition of the
business at the present moment, not at some previous period. However, past information can still be
useful for tracking trends and may be especially useful for evaluating management stewardship.

understandability. is the one characteristic that the accounting profession has often been accused of
disregarding. It is generally assumed that readers of financial statements should have a reasonable
understanding of business issues and basic accounting terminology. However, many business
transactions are inherently complex, and the accountant faces a challenge in crafting the disclosures in
such a way that they completely and concisely describe the economic nature of the item while still being
comprehensible. Financial disclosures should be reviewed by non-specialist, knowledgeable readers to
ensure the accountant has achieved the quality of understandability.

going concern. This means that the company is expected to continue operating into the
foreseeable future and that there will be no need to liquidate significant portions of the
business or otherwise materially scale back operations. This assumption is important, because a
company that is not a going concern would likely need to apply a different method of
accounting in order not to be misleading. If a company needed to liquidate equipment at a
substantial discount due to bankruptcy or other financial distress, it would not be appropriate
to carry those assets at depreciated cost. In situations of financial distress, the accountant
needs to carefully consider the going-concern assumption in determining the correct
accounting treatment.

Elements of financial Statements

An asset is the first financial-statement element that needs to be considered. In the simplest sense, an
asset is something that a business owns. The CPA Canada Handbook defines an asset as “a present
economic resource controlled by the entity as a result of past events”

The most obvious benefit is the future inflow of cash. This can be seen very clearly with an item
such as inventory held by a retail store, as the store expects to sell the items in a short period of time to
generate cash. This is also considered an economic benefit. The use of the term “right” in the definition
also suggests other types of relationships, such as the right to use a patented process or the right to
receive a favourable amount under a derivative contract.

A liability is defined as “a present obligation of the entity to transfer an economic resource as a result of
past events”

If a retailer of mobile telephones agrees to replace one broken screen per customer, then the
expected cost of these replacements should be reported as a liability, even if the damage resulted from
the customer’s neglect and there is no legal obligation to pay. This type of liability is referred to as a
constructive obligation.

Equity is the owners’ residual interest in the business, representing the remaining amount of assets
available after all liabilities have been settled.

The usual categories of equity include share capital, which can include common and preferred
shares, retained earnings, and accumulated other comprehensive income (IFRS only). The purpose of all
these subcategories of equity is to give readers enough information to understand how and when the
owners may be able to receive a distribution of their interests.

Income is defined as “increases in assets, or decreases in liabilities, that result in in- creases in equity,
other than those relating to contributions from holders of equity claims.”

This represents the balance sheet approach used in the conceptual framework, which considers
any measure of performance, such as profit, to simply be a representation of the change in balance
sheet amounts. This perspective is quite different from some historical views adopted previously in
various jurisdictions, which viewed the primary purpose of accounting to be the measurement of profit
(an income-statement approach).

Income can include both revenues and gains. Revenues arise in the course of the normal
activities of the business; gains arise from either the disposal of noncurrent assets (realized gains) or the
revaluation of noncurrent assets (unrealized gains).

Expenses are defined as “decreases in assets, or increases in liabilities, that result in decreases in equity,
other than those relating to distributions to holders of equity claims.”

The Conceptual Framework also notes that once recognition is affirmed, the appropriate measurement
base needs to be considered. The following measurement bases are identified in the conceptual
framework:

Historical cost is perhaps the most well-entrenched concept in accounting. This simply means that items
are recorded at the actual amount of cash paid or received at the time of the original transaction. This
concept has persisted in accounting thought for so long because of its relative reliability and verifiability.

The current value concept results in elements being reported at amounts that reflect current conditions
at the measurement date. This measurement base tries to achieve greater relevance by using current
information, but it may not always be possible to represent this information faithfully when active
markets for the item do not exist. It may be very difficult to find the current cost of a unique or
specialized asset that was purpose built for a company.

Fair value is the price that would be received to sell an asset, or paid to transfer a liability, in an orderly
transaction between market participants at the measurement date (CPA Canada, 2019, 6.12). This
amount can be easily determined when active markets exist. However, if there is no active market for
the item in question, the fair value may still be estimated using a discounted cash flow technique.
Obviously, the more assumptions required in deriving the fair value, the more measurement uncertainty
will exist.

Value in use is also a discounted cash flow technique. It differs from fair value in that it uses entity
specific assumptions, rather than market assumptions. In other words, the entity projects future cash
flows based on the specific way it uses the asset in question, rather than cash flows based on market
assumptions about the use of the asset. In many cases, fair value and value in use may result in the
same valuation, but this is not necessarily true in all cases.
Current cost is the cost to acquire an equivalent asset at the measurement date. This cost will include
any transaction costs to acquire the asset, and will take into consideration the age and condition of the
asset, along with other factors. Current cost represents an entry value, while fair value and value in use
represent exit values.