FINANCIAL ACCOUNTING AND REPORTING

TOPIC 2 - CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

Definition and Background

The Conceptual Framework is a summary of the terms and concepts that underlie the preparation and presentation of
financial statements.

The Conceptual Framework is concerned with general purpose financial statements, including consolidated financial
statements. Special purpose reports are outside the scope of the framework.

Underlying Theme
The underlying theme of the framework is decision usefulness or Usefulness of information in making economic decision.

Purpose
Basic Purpose: To serve as a guide in developing future PFRSs and as a guide in resolving accounting issues not directly
addressed by existing PFRS.

Specific Purpose
1. To Assist
a) In developing future PFRSS and reviewing existing PFRSs.
FRSC b) In promoting harmonization of regulations, accounting standards and procedures relating to
the presentation of FS.
Preparers of FS In applying PFRSs
Users of FS In interpreting the information in financial statements
Auditors In forming an opinion as to whether the financial statements conforms with PFRS
2. To provide information to those who are interested with the work of FRSC.

Authoritative Status of the Conceptual Framework

a) The Conceptual Framework is not a Philippine Financial Reporting Standard (PFRS) and hence does not define
standard for any particular measurement or disclosure issue. Thus, nothing in the Conceptual Framework overrides
any specific Philippine Financial Reporting Standard.
b) In case where there is a conflict, the requirements of the Philippine Financial Reporting Standards shall prevail
over the Conceptual Framework.
c) In the absence of a standard or an interpretation that specifically applies to a transaction, management shall consider
the applicability of the Conceptual Framework in developing and applying an accounting policy that results in
information that is relevant and reliable.

Underlying Assumptions
Accounting assumptions or accounting postulates are the basic notions or fundamental premises on which the accounting
process is based.
Stated Underlying Assumption?
List of Underlying Assumptions Under the Old Conceptual Under the New Conceptual
Framework Framework
Going Concern  
Accrual Principle  X
Accounting / Economic Entity Concept X X
Time Period Principle X X
Monetary Unit Principle X X

a) Going Concern
Going concern assumption means that the accounting entity is viewed as continuing in operation indefinitely in
the absence of evidence to the contrary. Going concern is the foundation of cost principle.

Examples of application of going concern principle:

 The current and non-current classification of assets and liabilities
 The accrual of income and expenses and prepayments and unearned income.
 Depreciation of PPE, amortization of intangible assets and etc.

b) Accrual Basis
Accrual principle addresses the recognition of income and expenses as against the cash basis principle. Under this
principle, income is recognized when earned rather than when received and expense is recognized when incurred
rather than when paid.

c) Accounting Entity Concept

Under this concept, the entity is viewed separately from its owners. Accordingly, the personal transactions of the
owners among themselves or with other entities are not recorded in the entity's accounting records.

d) Time Period Principle

According to the going concern principle, the operation of the business is viewed indefinitely. That was the foundation
of the time period principle. Under this principle, the life of the entity is divided into series of reporting periods.
An accounting period is usually 12 months and may either be a calendar year or a fiscal year.

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 e) Monetary Unit Principle
Under this principle, accounting information should be stated in a common measurement basis to be useful, which
is in the Philippines it is peso. Also, this concept assumes that the purchasing power of the peso is regarded as
constant.

SCOPE OF THE CONCEPTUAL FRAMEWORK

Chapter 1: Objective of the Financial Reporting (The Foundation of the CF)

Users of financial information is classified into primary and other users. Primary users include potential and existing investors,
lenders and other creditors.

Summary of users and their needs or concerns on the financial statements.

Users Concerns
a) Risk and return of investment
Investors
PRIMARY USERS b) Ability to pay dividends
Lenders Liquidity and solvency
Employees Stability and profitability
Customers Continuity
OTHER USERS
Government Regulatory
Public Various

Overall objective: 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".

Specific Objectives: (PAR)

a) To provide information useful in making decisions about providing resources to the entity.
b) To provide information useful in assessing the prospects of future net cash flows to the entity.
c) To provide information about entity resources, claims and changes in resources and claims.

Limitations:
a) General purpose financial reports do not and cannot provide all of the information that existing and potential investors,
lenders and other creditors need.
b) General purpose financial reports are not designed to show the value of an entity but they provide information to help
the primary users estimate the value of the entity.
c) General purpose financial reports are intended to provide common information to users and cannot accommodate
every request for information.
d) To a large extent, general purpose financial reports are based on estimate and judgment rather than exact depiction.

Chapter 2: Qualitative Characteristics of Useful Information

Definition: Qualitative characteristics are the qualities or attributes that make financial accounting information useful to the
users.

Under the Conceptual Framework for Financial Reporting, qualitative characteristics are classified into fundamental qualitative
characteristics and enhancing qualitative characteristics.

Fundamental Qualitative Characteristics – are the qualities that make the information useful to the users in making economic
decisions. These characteristics address the content or substance of information. The fundamental qualitative
characteristics are relevance and faithful representation.

Relevance means the capacity of information to make a difference in a decision made by users. Relevant information
has the following ingredients:
a) Predictive Value - the information can help users increase the likelihood of correctly predicting or forecasting
outcome of events.
b) Confirmatory Value the information enables users confirm or correct earlier expectations.

TAKE NOTE:
a) Predictive and confirmatory values are INTERRELATED, meaning, often, information has both predictive and
confirmatory values.
b) Materiality is NOT an ingredient of relevance but rather a specific aspect of relevance. Meaning, all material items
are relevant but not all relevant items are material.
c) What is materiality?
It is the omission or misstatement of information causing to influence the decision of the users. Accordingly, the
framework and PFRSs do not specify a uniform quantitative threshold for materiality, thus, materiality is purely based
on judgment. In the exercise of judgment in determining materiality, the following factors may be considered:
a. Relative size of the item in relation to the total of the group to which the item belongs;
b. Nature of the item.

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Faithful Representation means that the information provides a true, correct and complete depiction of the economic
phenomena that it purports to represent. To be a perfectly faithful representation, a depiction should have three ingredients,
namely:
a) Completeness – all information necessary for users to understand the phenomena depicted is provided, whether in
words or in numbers.
b) Neutrality – means that the financial statements should not be prepared so as to favor one party to the detriment of
another party. A neutral depiction is "without bias" in the selection or presentation of financial information.
c) Free from error – in this context, free from error does not mean perfectly accurate in all respects. 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.

TAKE NOTE:
1. Substance over form and conservatism are NOT INGREDIENTS of faithful representation and are specific aspect
only.
2. If there is a conflict between substance and form, the ECONOMIC SUBSTANCE OF THE TRANSACTION SHALL
PREVAIL OVER THE LEGAL FORM. Examples of situation where substance over form is applied: (a) accounting
for non-interest bearing notes receivable/payable; (b) finance lease accounting.
3. The Conceptual Framework DID NOT include conservatism or prudence as an aspect of faithful representation
because to do so would be inconsistent with neutrality. Under conservatism, when alternatives exist, the alternative
which has the least effect on equity shall be chosen

Enhancing Qualitative Characteristics – are the qualities of information that enhances its usefulness. These characteristics
address the form or presentation of information. The enhancing qualitative characteristics are verifiability, comparability,
understandability and timeliness. (VCUT)

Verifiability means that different knowledgeable and independent observers could reach consensus, although not
necessarily complete agreement, that a particular depiction is a faithful representation.

Information is comparable if it helps users identify similarities and differences between different sets of information
that are provided by:

a) Single entity but different periods (intra - comparability); or

b) Different entities in a single period (inter - comparability).

Although related, consistency and comparability are not the same. Comparability is the goal while consistency is the
means of achieving the goal.

Understandability requires that financial information must be comprehensible or intelligible if it is to be useful but
complex matters cannot be eliminated. Because of this, the framework requires the users to have a reasonable
knowledge of business and economic activities and must review and analyze the information diligently.

Timeliness means having information available to decision makers in time to influence their decisions. In other
words, timeliness requires that financial information must be available or communicated early enough when a
decision is to be made. Relevant information may lose its relevance if there is undue delay in its reporting.

The Cost Constraint

Cost is a pervasive constraint on the information that can be provided by financial reporting. In other words, the cost constraint
is a consideration of the cost incurred in generating financial information against the benefit to be obtained from having the
information. The benefit derived from the information should exceed the cost incurred in obtaining the information.

Chapter 3: The Financial Statements and The Reporting Entity and Scope of Financial Statements
The objective of general purpose financial statements is to provide financial information about the reporting entity's assets,
liabilities, equity, income and expenses that is useful in assessing:
a) The entity's prospects for future net cash inflows and
b) Management's stewardship over economic resources.

That information is provided in the:

1. Statement of Financial Position (for recognized assets, liabilities and equity)
2. Statement(s) of Financial Performance (for income and expenses)
3. Other Statements and Notes

Reporting Period of Financial Statements

Financial statements are prepared for a specified period of time or the reporting period. Financial statements also
provide comparative information for at least ONE PRECEDING REPORTING PERIOD.

Reporting Entity
Reporting entity is an entity who must or chooses to prepare the financial statements and is NOT necessarily a legal entity.

As a result, we have a few types of financial statements:

a) Consolidated - a parent and subsidiaries report as a single reporting entity.
b) Unconsolidated or Individual - a parent alone provides reports.
c) Combined reporting entity comprises - two or more entities not linked by parent- subsidiary relationship

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Chapter 4: Elements of Financial Statements
The elements of financial statements refer to the quantitative information shown in the statement of financial position and
statement of comprehensive income, namely: Assets, Liabilities, Equity, Income and Expense. These elements are classified
into:
Elements directly related to Entity’s
Financial Position Financial Performance
Asset Income
Liability Expense
Equity

Assets – a present economic resource controlled by the entity as a result of a past event. An economic resource is a right that
has the potential to produce economic benefits. The essential characteristics of an asset are:
a) The asset is controlled by the entity.
b) The asset is the result of a past transaction or event.
c) The asset provides future economic benefits.
d) The cost of the asset can be measured reliably.

NOTE: Tangibility and ownership are not essential characteristics of assets. Also, the presence or absence of expenditure is
not necessary in determining the existence of assets.

Liability – is a present obligation of an entity arising from past transaction or event, the settlement of which is expected to result
in an outflow from the entity of resources embodying economic benefits. The essential characteristics of a liability are:
a) The liability is the present obligation of a particular entity.
b) The liability arises from past transaction or event.
c) The settlement of the liability requires an outflow of resources embodying economic benefits.

NOTE: Identification of payee and certainty of timing of settlement and amount of liability are not essential characteristics of
liabilities.

Equity – is the residual interest in the assets of the entity after deducting all of its liabilities. Also known as “Net Assets”

Income – is the increase in economic benefit during the accounting period in the form of an inflow or increase of asset or
decrease of liability that results in increase in equity, other than contribution from equity participants. Simply stated, income is
an inflow of future economic benefit that increases equity, other than contribution by owners.

NOTE: Income encompasses both revenue and gains

Revenue Gain
Arises from/ Ordinary course of business Incidental or peripheral operations
Presentation in the FS At gross amount At net income (net of direct cost)

Comprehensive income is classified into two: Profit or Loss (P/L) or Other Comprehensive Income (OCI).
General rule is an income is part of profit or loss unless it will be classified as OCI which are as follows:
1. Unrealized gain or loss on financial asset measured at fair value through other comprehensive income
2. Gain or loss from translating the financial statements of a foreign operation
3. Revaluation surplus during the year
4. Unrealized gain or loss from derivative contracts designated as cash flow hedge
5. Remeasurements of defined benefit plan including actuarial gain or loss on defined benefit obligation

Expense – is the decrease in economic benefit during the accounting period in the form of outflow or decrease in asset and
increase in liability that results in decrease in equity, other than distribution to equity participants.

Chapter 5: Recognition and Derecognition

Recognition is a term which means the process of reporting an asset, liability, income or expense on the face of the financial
statements of an entity

Recognition criteria:
a) It meets the definition of an asset, liability, equity or expense and
b) Recognizing it would provide useful information

The recognition of an item may not provide useful information if:

a) It is uncertain whether an asset or liability exists
b) An asset or liability exists but the probability of an inflow or outflow of economic benefits is low.

NOTE:
a) The recognition criteria above apply to assets, liabilities, income and expense. There is no Equity Recognition
Principle / Criteria because it is a residual interest.
b) The expense recognition principle is the application of the matching principle. Accordingly, the matching principle
requires that those costs and expenses incurred in earning a revenue should be reported in the same period.

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 c) Expenses are incurred in conformity with the three applications of the matching principle, namely:
a. Cause and effect association - the cause and effect association principle means that "the expense is
recognized when the revenue is already recognized" on the basis of a presumed direct association of the
expense with specific revenue. This is actually the "strict matching concept". Examples: Cost of sales, warranty
expense, sales commissions.
b. Systematic and rational allocation - Under the systematic and rational allocation principle, some costs are
expensed by simply allocating them over the periods benefited. Example: Depreciation of PPE,
amortization of intangible assets and depletion of wasting assets.
c. Immediate recognition - Under immediate recognition principle, the cost incurred is expensed outright
because of uncertainty of future economic benefits or difficulty of reliably associating certain costs with
future revenue. Examples: officers' salaries and most administrative expenses, losses. casualty

Derecognition is the OPPOSITE of recognition. It is the removal of a previously recognized asset or liability from the entity's
statement of financial position.

Derecognition occurs when the item no longer meet the definition of an asset or liability, such as when the entity control of all
or part of the asset or no longer has a present obligation for all or part of the liability.

On derecognition, the entity:

a) Derecognizes the assets or liabilities that have expired or have been consumed, collected, fulfilled or transferred and
recognized any resulting income and expenses.
b) Continues to recognize any assets or liabilities retained after the derecognition.

NOTE: Derecognition is NOT appropriate if the entity retains substantial control of a transferred asset.

Chapter 6: Measurement
Measurement is the process of determining the monetary amounts at which the elements of the financial statements are to
be recognized and carried in the statement of financial position and income statement. The Framework acknowledges that a
variety of measurement bases are used today to different degrees and in varying combinations in financial statements including:

Historical cost - This measurement is based on the transaction price at the time of recognition of the element. The
historical cost of an asset is the consideration paid to acquire the asset plus transaction costs. The historical cost of a liability
is the consideration received to incur the liability minus transaction costs.

Current value - It measures the element updated to reflect the conditions at the measurement date. Current value
measurement bases include the following:
1. 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. Fair value is not an entity specific measurement.
2. Value in use is the present value of the cash flows or other economic benefits, that an entity expects to derive from
the use of an asset and from its ultimate disposal. Fulfilment value is the present value of the cash or other economic
resources that an entity expects to be obliged to transfer as it fulfils a liability.

NOTE: Value in use and fulfilment value DO NOT include transaction costs in acquiring an asset or incurring the
liability but include transactions costs expected to be incurred on the ultimate disposal of the asset or fulfilment of
the liability.

3. Current cost of an asset is the cost of an equivalent asset at the measurement date, comprising the consideration
that

NOTE: Current cost and historical cost are ENTRY VALUES while value in use, fulfilment value and fair value are
EXIT VALUES. The framework points out that it can be appropriate to measure some components of equity directly
but it is not possible to measure total equity directly.

Chapter 7: Presentation and Disclosure

Information about assets, liabilities, equity, income and expenses is communicated through presentation and disclosure in the
financial statements. Effective communication makes information more useful. Effective communication requires:
1. Focusing on presentation and disclosure objectives and principles rather than on rules.
2. Classifying information by grouping similar items and separating dissimilar items.
3. Aggregating information in a manner that it is not obscured either by excessive detail or by excessive summarization.

NOTE:

Classification refers to the sorting of assets liabilities, equity, income or expenses with similar nature, function and
measurement basis for presentation and disclosure purposes.

Aggregation is the adding together of assets, liabilities, equity, income or expenses that have shared characteristics
and are included in the same classification.

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Chapter 8: Concepts of Capital and Capital Maintenance

Financial Capital Physical Capital

Concept of Capital Invested money or invested purchasing power Productive capacity of the entity
Adopted by most entities?  X
Measurement Historical Cost Current Cost

The "capital maintenance approach" or net assets approach means that net income occurs only after the capital used from
the beginning of the period is maintained.

Under the financial capital concept, net income occurs "when the financial or nominal amount of the net assets at the end
of the year exceeds the financial or nominal amount of the net assets at the beginning of the period, after excluding
distributions to and contributions by owners during the period."

Under the physical capital concept, net income occurs "when the physical productive capital of the entity at the end of the
year exceeds the physical productive capital at the beginning of the period, also after excluding distributions to and
contributions from owners during the period."

Most of the problem solving questions regarding capital maintenance approach is based on financial capital. With such, the
template below might be of help in answering.

Net changes in equity XXX

Less: Additional Investment by Owners (XXX)
Add: Withdrawals and distributions to owners XXX
Comprehensive Income XXX
Less: Other comprehensive income (XXX)
Add: Other comprehensive loss XXX
Profit or Loss / Net Income XXX

Reminders in using the template:

a) Please be mindful of the requirement of the problem. Profit or loss is different from comprehensive income.
b) The computation of net changes in equity depends on the given information. If the given information is already the beginning
and ending balance of equity then it is easy to solve. But if the given information are the changes on the assets and liabilities
then you have to evaluate each line item's impact on equity. In evaluating the impact on the equity remember that:
1. Asset is directly related to equity while
2. Liability is inversely related to equity.

Summary of Effects on Equity

Item Effect
Asset
Increase +
Decrease -
Contra – Asset
Increase -
Decrease +
Liability
Increase -
Decrease +
Contra – Liability
Increase +
Decrease -