Conceptual Framework for Financial Reporting Purpose • assist the International Financial Reporting Standards Council (FRSC) developing Standards that are based on consistent concepts 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 assist all parties in understanding and interpreting the Standards. • • Status • Conceptual Framework (CF) is not Philippine Financial Reporting Standards (PFRS) PFRS will prevail Absence of a Standard, management shall consider CF in making decisions • • • • • • • • The objective of financial reporting Qualitative characteristics of useful financial information Financial statements and the reporting entity The elements of financial statements Recognition and derecognition Measurement Presentation and disclosure Concepts of capital and capital maintenance Objective • • (a) Completeness- necessary for users to understand the phenomenon being depicted is provided (b) Neutrality- selected or presented without bias (c) Free from error- no errors in the description and in the process by which the information is selected and applied. II. Enhancing- enhance the usefulness of information (1) Comparability- 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- available to users in time to be able to influence their decisions. Scope • • (2) Faithful representation- the information provides a true, correct and complete depiction of what it purports to represent. (4) Understandability- users are expected to have: a. the entity’s ability to generate future net cash inflows; and b. management’s stewardship over economic resources. Financial statements and the Reporting entity Reporting period • The objective of general-purpose financial reporting (GPFR) is to provide financial information about the reporting entity that is useful to primary users in making decisions about providing resources to the entity. forms the foundation Going concern • Primary Users • • those who cannot demand information directly from reporting entities. o (a) Existing and potential investors o (b) Lenders and other creditors. Only the common needs of primary users are met by the financial statements. Qualitative Characteristics • 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. 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. 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. I. Fundamental- that makes information useful to users. (1) Relevance- if it can affect the decisions of users (a) Predictive value- – the information can be used in making predictions (b) Feedback value- the information can be used in confirming past predictions ➢ Materiality – entity-specific aspect of relevance 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.” ➢ If the other party performs first, the entity’s combined right and obligation changes to a liability. 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. Liability is “a present obligation of the entity to transfer an economic resource as a result of past events.” 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. • “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 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.” Recognition & Derecognition The recognition process • Recognition criteria • 2. as a consequence, the entity will or may have to transfer an economic resource that it would not otherwise have had to transfer. b. recognizing it would provide useful information, i.e., relevant and faithfully represented information. Relevance • • • An executory contract “is a contract that is equally unperformed – neither party has fulfilled any of its obligations, or both parties have partially fulfilled their obligations to an equal extent.” (CF 4.56) An executory contract establishes a combined right and obligation to exchange economic resources. The contract ceases to be executory when one party performs its obligation. ➢ If the entity performs first, the entity’s combined right and obligation changes to an asset. The recognition of an item may not provide relevant information if, for example: a. it is uncertain whether an asset or liability exists; or Executory contracts • An item is recognized if: a. it meets the definition of an asset, liability, equity, income or expense; and 3. Present obligation as a result of past events – A present obligation exists as a result of past events if: 1. the entity has already obtained economic benefits or taken an action; and Recognition is the process of including in the statement of financial position or the statement(s) of financial performance an item that meets the definition of one of the financial statement elements (i.e., asset, liability, equity, income or expense). This involves recording the item in words and in monetary amount and including that amount in the totals of either of those statements. b. an asset or liability exists, but the probability of an inflow or outflow of economic benefits is low. (Conceptual Framework 5.12) However, the presence of one or both of the foregoing does not automatically lead to the nonrecognition of an item. Other factors should also be considered. Faithful representation • The level of measurement uncertainty and other factors can affect an item’s faithful representation, but not necessarily its relevance. Measurement uncertainty • • Measurement uncertainty exists if the asset or liability needs to be estimated. A high level of measurement uncertainty does not necessarily lead to the non-recognition of an asset or liability if the estimate provides relevant information and is clearly and accurately described and explained. However, measurement uncertainty can lead to the non-recognition of an asset or a liability if making an estimate is exceptionally difficult or exceptionally subjective. Derecognition • Derecognition is the removal of a previously recognized asset or liability from the entity’s statement of financial position. • Derecognition occurs when the item ceases to meet the definition of an asset or liability. Unit of account is “the right or the group of rights, the obligation or the group of obligations, or the group of rights and obligations, to which recognition criteria and measurement concepts are applied.” Measurement bases 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.” Entry values vs. Exit values • Current cost • a. Fair value b. Value in use and fulfilment value c. Current cost 3. The historical cost of: a. an asset is the consideration paid to acquire the asset plus transaction costs. b. a liability is the consideration received to incur the liability minus transaction costs. 4. Historical cost is updated over time to depict the following: a. Depreciation, amortization, or impairment of assets b. a liability is “the consideration that would be received for an equivalent liability at the measurement date minus the transaction costs that would be incurred at that date.” Considerations when selecting a measurement basis • b. The qualitative characteristics, the costconstraint, and other factors (e.g., a particular measurement basis may be more verifiable or more costly to apply than the other measurement bases). Measurement of Equity • Total equity is not measured directly. It is simply equal to difference between the total assets and total liabilities. • Because different measurement bases are used for different assets and liabilities, total equity cannot be expected to be equal to the entity’s market value nor the amount that can be raised from either selling or liquidating the entity. • Equity is generally positive, although some of its components can be negative. In some cases, even total equity can be negative such as when total liabilities exceed total assets. 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.” • 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.” (Conceptual Framework 6.17) When selecting a measurement basis, it is important to consider the following: a. The nature of information provided by a particular measurement basis (e.g., measuring an asset at historical cost may lead to the subsequent recognition of depreciation or impairment, while measuring that asset at fair value would lead to the subsequent recognition of gain or loss from changes in fair value). b. Collections or payments that extinguish part or all of the asset or liability c. Unwinding of discount or premium when the asset or liability is measured at amortized cost The current cost of: a. an asset is “the cost of an equivalent asset at the measurement date, comprising the consideration that would be paid at the measurement date plus the transaction costs that would be incurred at that date.” 1. Historical cost 2. Current value Current cost and historical cost are entry values (i.e., they reflect prices in acquiring an asset or incurring a liability), whereas fair value, value in use and fulfilment value are exit values (i.e., they reflect prices in selling or using an asset or transferring or fulfilling a liability). Presentation and Disclosure • Information is communicated through presentation and disclosure in the financial statements. • Effective communication makes information more useful. Effective communication requires: • a. focusing on presentation and disclosure objectives and principles rather than on rules. b. classifying information by grouping similar items and separating dissimilar items. c. aggregating information in a manner that it is not obscured either by excessive detail or by excessive summarization. Presentation and disclosure objectives and principles • The objectives are specified in the Standards. • The principles include: a. the use of entity-specific information is more useful that standardized descriptions, and b. duplication of information is usually unnecessary. Classification • Classifying means combining similar items and separating dissimilar items. • Offsetting of assets and liabilities is generally not appropriate. Classification of income and expenses • Income and expenses are classified as recognized either in: General purpose financial statements are those intended to serve users who do not have the authority to demand financial reports tailored for their own needs. General purpose financial statements cater to most of the common needs of a wide range of external users. General purpose financial statements are the subject matter of the Conceptual Framework and the PFRSs. Complete set of financial statements 1. Statement of financial position 2. Statement of profit or loss and other comprehensive income 3. Statement of changes in equity 4. Statement of cash flows 5. Notes (5a) comparative information in respect of the preceding period; and 6. Additional statement of financial position (required only when certain instances occur) General features 1. Fair Presentation and Compliance with PFRSs - The application of PFRSs, with additional disclosure when necessary, is presumed to result in financial statements that achieve a fair presentation. 2. Going concern - An entity is not a going concern if, as of the financial reporting date or prior to the date of authorization of the financial statements for issue, management either: a. Intends to liquidate the entity or to cease trading, or a. profit or loss; or b. Has no realistic alternative but to do so. b. other comprehensive income. • Aggregation is “the adding together of assets, liabilities, equity, income or expenses that have shared characteristics and are included in the same classification.” The assessment of going concern is at least 12 months. 3. Accrual Basis of Accounting - An entity shall prepare its financial statements, except for cash flow information, using the accrual basis of accounting. Concepts of Capital and Capital Maintenance • • Financial concept of capital – capital is regarded as the invested money or invested purchasing power. Capital is synonymous with equity, net assets, and net worth. Physical concept of capital – capital is regarded as the entity’s productive capacity, e.g., units of output per day. 4. Materiality & Aggregation - Each material class of similar items must be presented separately in the financial statements. 5. Offsetting - Assets and liabilities, and income and expenses, shall not be offset unless required or permitted by a PFRS. • PAS 1 Presentation of Financial Statements Objective of PAS 1 PAS 1 prescribes the basis for presentation of general purpose financial statements to improve comparability both with the entity's financial statements of previous periods (intra-comparability) and with the financial statements of other entities (inter-comparability). General purpose financial statements Measuring assets net of valuation allowances, for example, obsolescence allowances on inventories, allowances for doubtful accounts on receivables, and accumulated depreciation on property, plant, and equipment are not offsetting. 6. Frequency of reporting – An entity shall present a complete set of financial statements (including comparative information) at least annually. • When an entity changes the end of its reporting period and presents financial statements for a period longer or shorter than one year, an entity shall disclose the following: 1. it expects to realize the asset or intends to sell or consume it, in its normal operating cycle; 1. The period covered by the financial statements, 2. it holds the asset primarily for the purpose of trading; 2. The reason for using a longer or shorter period, and 3. it expects to realize the asset within twelve months after the reporting period; or 3. The fact that amounts presented in the financial statements are not entirely comparable. 4. the asset is cash or a cash equivalent unless the asset is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting period. 7. Comparative Information An entity shall present comparative information in respect of the preceding period for all amounts reported in the current period’s financial statements, unless other standards permit or require otherwise. Current Liabilities • 8. Consistency of presentation - An entity shall retain the presentation and classification of items in the financial statements from one period to the next unless: 1. it expects to settle the liability in its normal operating cycle; 2. it holds the liability primarily for the purpose of trading; a. it is apparent that another presentation or classification would be more appropriate following a significant change in the nature of the entity’s operations or a review of its financial statements; or 3. the liability is due to be settled within twelve months after the reporting period; or 4. the entity does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period. b. a PFRS requires a change in presentation. Additional Statement of financial position • An additional statement of financial position is presented as at the beginning of the preceding period when an entity: 1. Applies an accounting policy retrospectively, or Currently maturing long-term liabilities • General rule: Currently maturing long term liabilities are presented as current liabilities. • Exceptions: 1. Refinancing agreement is fully completed on or before the balance sheet date – non-current liability 2. Makes a retrospective restatement of items in its financial statements, or 2. Refinancing agreement after the balance sheet date but before the financial statements are authorized for issue – noncurrent liability if the entity expects, and has the discretion, to refinance it on a longterm basis under an existing loan facility. 3. reclassifies items in its financial statements. ..and the effect of the event to the statement of financial position as at the beginning of the preceding period is material. Statement of financial position • A statement of financial position may be presented as either 1. Classified – showing distinctions between current and noncurrent assets and liabilities, or Breach of loan agreement • General rule: A liability that is payable on demand is a current liability. • Exception: It is presented as non-current liability if the lender provides the entity, on or before the balance sheet date, a grace period ending at least 12 months after the balance sheet date to rectify a breach of loan covenant. 2. Unclassified (based on liquidity) – showing no distinction between current and noncurrent items Current Assets • An entity shall classify an asset as current when: An entity shall classify a liability as current when: Presentation of Deferred taxes • Deferred tax liabilities (assets) are presented as noncurrent items in a classified statement of financial position, irrespective of their expected dates of reversal. Minimum line items in the statement of financial position a. Property, plant and equipment; b. Investment property; c. Intangible assets; d. Financial assets (excluding amounts shown under (e), (h) and (i)); e. Investments accounted for using the equity method; f. Biological assets; g. Inventories; presenting profit or loss and other comprehensive income or in the notes. Other comprehensive income for the period a. Changes in revaluation surplus b. Unrealized gains and losses on investments in FVOCI securities c. Remeasurements of the net defined benefit liability (asset) d. Gains and losses arising from translating the financial statements of a foreign operation e. Effective portion of gains and losses on hedging instruments in a cash flow hedge • h. Trade and other receivables; i. Cash and cash equivalents; j. Assets (or disposal groups) classified as held for sale in accordance with PFRS 5; OCI may be presented either (a) net of tax or (b) gross of tax. Reclassification adjustments are amounts reclassified to profit or loss in the current period that were recognized in other comprehensive income in the current or k. Trade and other payables; l. Provisions; m. Financial liabilities (excluding amounts shown under (k) and (l)); n. Liabilities and assets for current tax, as defined in PAS 12 Income Taxes; o. Deferred tax liabilities and deferred tax assets, as defined in PAS 12; p. Liabilities included in disposal groups classified as held for sale in accordance with PFRS 5; q. Non-controlling interests, presented within equity; and r. Total comprehensive income • PAS 1 does not prescribe the order or format in which an entity presents items. Total comprehensive income comprises all components of 1. Profit or loss; and Issued capital and reserves attributable to owners of the parent Order/ Format of Presentation • previous periods. 2. Other comprehensive income. Presentation of Expenses 1. Nature of expense method 2. Function of expense method Statement of profit or loss and other comprehensive income • • An entity shall present all items of income and expense recognized in a period: If an entity classifies expenses by function, it shall disclose additional information on the nature of expense Disclosure of dividends 1. in a single statement of profit or loss and other comprehensive income; or 2. in two statements: (1) a statement displaying the profit or loss section only (separate ‘statement of profit or loss’ or ‘income statement’) and (2) a second statement beginning with profit or loss and displaying components of other comprehensive income. Extraordinary items • PAS 1 prohibits the presentation of any items of income or expense as extraordinary items in the statement(s) • Dividends declared by an entity are disclosed either in the (a) notes or (b) statement of changes in equity. Order of presentation of disclosures in the Notes 1. Statement of compliance with PFRSs; 2. Summary of significant accounting policies applied; 3. Supporting information for items presented in the other financial statements; and 4. Other disclosures.
