CONCEPTUAL FRAMEWORK

Lecture Aid

1
Purpose of the Conceptual Framework

• The Conceptual Framework prescribes the concepts for general

purpose financial reporting. Its purpose is to:
a. assist the International Accounting Standards Board (IASB) in
developing Standards that are based on consistent concepts;
b. assist preparers in developing consistent accounting policies
when no Standard applies to a particular transaction or when a
Standard allows a choice of accounting policy; and
c. assist all parties in understanding and interpreting the
Standards.

2
Status of the Conceptual Framework
• The Conceptual Framework is not a PFRS. When there is a
conflict between the Conceptual Framework and a PFRS, the
PFRS will prevail.
• In the absence of a standard, management shall consider the
Conceptual Framework in making its judgment in developing
and applying an accounting policy that results in useful
information.

3
Scope of the Conceptual Framework
The Conceptual Framework is concerned with general purpose
financial reporting. General purpose financial reporting involves the
preparation of general purpose financial statements. The Conceptual
Framework provides the concepts regarding the following:
1. The objective of financial reporting
2. Qualitative characteristics of useful financial information
3. Financial statements and the reporting entity
4. The elements of financial statements
5. Recognition and derecognition
6. Measurement
7. Presentation and disclosure
8. Concepts of capital and capital maintenance

4
Objective of general purpose financial reporting
• The objective of general purpose financial reporting
is to provide financial information about the reporting entity
that is useful to primary users in making decisions about
providing resources to the entity.
• The objective of general purpose financial reporting forms
the foundation of the Conceptual Framework.

5
Primary Users

• Primary users – are those who cannot demand information

directly from reporting entities. The primary users are:
(a) Existing and potential investors
(b) Lenders and other creditors.

• Only the common needs of primary users are met by the financial
statements.

6
Qualitative Characteristics
I. Fundamental qualitative characteristics
(1) Relevance
(a) Predictive value
(b) Feedback value
➢ Materiality – entity-specific aspect of relevance
(2) Faithful representation
(a) Completeness
(b) Neutrality (free from bias)
(c) Free from error

II. Enhancing qualitative characteristics

(1) Comparability
(2) Verifiability
(3) Timeliness
(4) Understandability
7
Fundamental vs. Enhancing

• The fundamental qualitative characteristics are the

characteristics that make information useful to users.
• The enhancing qualitative characteristics are the
characteristics that enhance the usefulness of information

8
Relevance

• Information is relevant if it can affect the decisions of users.

• Relevant information has the following:
a. Predictive value – the information can be used in making predictions
b. Confirmatory value – the information can be used in confirming
past predictions

➢ Materiality – is an ‘entity-specific’ aspect of relevance.

9
Faithful Representation

• Faithful representation means the information provides a true,

correct and complete depiction of what it purports to represent.
• Faithfully represented information has the following:
a. Completeness – all information necessary for users to
understand the phenomenon being depicted is provided.
b. Neutrality – information is selected or presented without bias.
c. Free from error – there are no errors in the description and in
the process by which the information is selected and applied.

10
Enhancing Qualitative Characteristics

1. Comparability – the information helps users in identifying

similarities and differences between different sets of information.
2. Verifiability – different users could reach consensus as to what
the information purports to represent.
3. Timeliness – the information is available to users in time to be
able to influence their decisions.
4. Understandability – users are expected to have:
a. reasonable knowledge of business activities; and
b. willingness to analyze the information diligently.

11
Financial statements and the Reporting entity

Objective 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 ability to generate future net cash inflows; and
b. management’s stewardship over economic resources.

12
Financial statements and the Reporting entity

Reporting entity
• A reporting entity is one that is required, or chooses, to prepare
financial statements, and is not necessarily a legal entity. It can be a
single entity or a group or combination of two or more entities.

13
Elements of Financial Statements

14
Asset

• Asset is “a present economic resource controlled by the

entity as a result of past events. An economic resource is
a right that has the potential to produce economic
benefits.” (Conceptual Framework 4.3 & 4.4)

15
Three aspects in the definition of an asset
1. Right – asset refers to a right, and not necessarily to a physical
object, e.g., the right to use, sell, lease or transfer a building.
2. Potential to produce economic benefits – the right has a
potential to produce economic benefits for the entity that are
beyond the benefits available to all others. Such potential need
not be certain or even likely – what is important is that the right
already exists and that, in at least one circumstance, it would
produce economic benefits for the entity.
3. Control – means the entity has the exclusive right over the
benefits of an asset and the ability to prevent others from
accessing those benefits.

16
Liability

• Liability is “a present obligation of the entity to transfer

an economic resource as a result of past events.” (Conceptual
Framework 4.26)

17
Three aspects in the definition of a liability
1. Obligation – An obligation is “a duty or responsibility that an
entity has no practical ability to avoid.” (CF 4.29) An obligation can be
either legal obligation or constructive obligation.
2. Transfer of an economic resource – the obligation has
the potential to require the transfer of an economic resource
to another party. Such potential need not be certain or even
likely – what is important is that the obligation already exists
and that, in at least one circumstance, it would require the
transfer of an economic resource.

18
Three aspects …… liability (continuation)
3. Present obligation as a result of past events – A present
obligation exists as a result of past events if:
a. the entity has already obtained economic benefits or taken an
action; and
b. as a consequence, the entity will or may have to transfer an
economic resource that it would not otherwise have had to
transfer.
(Conceptual Framework 4.43)

19
Equity

• “Equity is the residual interest in the assets of the entity after

deducting all its liabilities.” (Conceptual Framework 4.63)
• Equity equals Assets minus Liabilities

20
Income and Expenses

• Income
Income is “increases in assets, or decreases in liabilities, that result in
increases in equity, other than those relating to contributions from
holders of equity claims.” (Conceptual Framework 4.68)

• Expenses
Expenses are “decreases in assets, or increases in liabilities, that result
in decreases in equity, other than those relating to distributions to
holders of equity claims.” (Conceptual Framework 4.69)

21
Accounting Assumptions
1. Going Concern
Financial statements are normally prepared on the assumption that the
reporting entity is a going concern, meaning the entity has neither
the intention nor the need to end its operations in the foreseeable
future.

2. Reporting period/Periodicity
Financial statements are prepared for a specific period of time (i.e., the
reporting period) and include comparative information for at least
one preceding reporting period.

22
Accounting Assumptions
3. Business Entity Concept/Economic Entity
This concept assumes that a business enterprise is separate and distinct
from its owner or investor.

4. Measurement in Terms of Money

All business transactions are measured and recorded using only one
unit of measurement. The concept is based on the assumption that the
value of money will remain constant. Money Measurement also known
as measurability concept means that only transactions and events that
are capable of being measured in terms of money are recorded in the
books of accounts.

23
Accounting Principles

1. Cost Principle
Assets, liabilities, revenues and expenses should be based on cost. Cost
now may vary from yesterday and changing the amount will make our
asset value unreliable.

2. Accrual
Assets, liabilities, revenues and expenses should be recognized based
on the period they relate or based on the occurrence of transaction
event rather than based on cash received or paid.

24
Accounting Principles

3. Realization Principle
The concept that revenue can only be recognized once the underlying
goods or services associated with the revenue have been delivered or
rendered, respectively.

4. Matching Principle
Dictates that companies report expenses at the same time as
the revenues they are related to. Revenues and expenses are matched
on the income statement for a period of time (e.g., a year, quarter, or
month).

25
Accounting Principles

5. Full disclosure
This principle states that companies should disclose all information
that is relevant to their financial statements. This includes information
about their assets, liabilities, revenues, and expenses.

26
 END
Conceptual Framework & Acctg. Standards (by: Zeus Vernon B. Millan) 27