CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING
Purpose of the Conceptual Framework
Prescribes the concepts for general purpose financial reporting:
a. assists the International Accounting Standards Board (IASB) in developing
Standards that are based on consistent concepts;
b. assists preparers in developing consistent accounting policies when no
Standard applies to a particular transaction or when Standard allows a choice
of accounting policy;
c. assist all parties in understanding and interpreting the Standards.
Conceptual Framework provides foundation for the development of Standards that:
a. promote transparency by enhancing the international comparability and
quality of financial information.
b. strengthen accountability by reducing the information gap between providers
of capital and the entity’s management.
c. Contribute to economic efficiency by helping investors to identify opportunities
and risks around the world, thus improving capital allocation.
Status of the Conceptual Framework
 Conceptual Framework is not a Standard.
 If there is a conflict between a Standard and the Conceptual Framework,
Standard will prevail.
Hierarchy of reporting standards:
1. PFRSs
2. Judgement
 Management shall consider the following:
a. Requirements in other PFRSs dealing with similar transactions
b. Conceptual Framework
 Management may consider the following:
a. Pronouncement issued by other standard-setting bodies
b. Other accounting literature and industry practices
Scope of the Conceptual Framework
Conceptual Framework is concerned with general purpose financial
reporting. Involves the preparation of general purpose financial statements.
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
Objective of Financial Reporting
To provide financial information about the reporting entity that is useful to
existing and potential investors, lender and other creditors in making decisions about
providing resources to the entity.
This objecting is the foundation of the Conceptual Framework.
Primary users of financial reporting
1. Existing and potential investors
2. Lenders and other creditors
These users cannot demand information directly from reporting entities and must
rely on general purpose financial reports for their financial information needs.
General purpose financial reporting caters to the common needs of the
primary users. Therefore, general purpose financial reporting do not and cannot
provide all the information needs of primary users.
General purpose financial reports do not directly show the value of a
reporting entity, however it provides information that helps users in estimating the
value of an entity.
Decisions about providing resources to the entity
a. buying, selling or holding investments;
b. providing or settling loan and other forms of credit;
c. exercising voting/similar rights that coul influence management’s actions
These decisions depend on the investor/lender/other creditor’s expected returns.
Expectations about returns depend on assessments of entity’s
i. prospects for future net cash inflows
ii. management stewardship
Information on Economic Resources, Claims, and Changes
General purpose financial reports provide information on an entity’s…
a. Financial position – information on economic resources (assets) and claims
against the reporting entity (liabilities and equity);
b. Changes in economic resources and claims – information on financial
performance (income and expenses) and other transactions and events that
lead to changes in financial position.
Economic resources and Claims
Information about the nature and amounts of an entity’s economic resources
(assets) and claims (liabilities and equity) can help users to identify the entity’s
financial strength and weaknesses and can help users in assessing the entity’s:
a. Liquidity and solvency;
b. Needs for additional financing and how successful it is likely to be in obtaining
that financing;
c. Management’s stewardship on the use of economic resources.
Liquidity – entity’s ability to pay short-term obligations
Solvency – entity’s ability to pay long-term obligations
Changes in economic resources and claims
Result from:
a. financial performance (income and expenses);
b. other events and transactions.
 Information on financial performance helps users assess the entity’s ability to
produce return from its economic resources.
 Return provides an indication on how well management has efficiently and
effectively used the entity’s resources.
 Information on the variability of the return helps users in assessing the
uncertainty of future cash flows.
 Information based on accrual accounting provides a better basis for assessing
an entity’s financial performance than based solely on cash receipts and
payments during the period.
 Information on past cash flows helps users assess the entity’s ability to generate
future cash flows.
Qualitative Characteristics of useful financial information
 Identify the types of information that are likely to be most useful to the primary
users.
 Apply to information in the financial statements as well as to financial information
provided in other ways.
Classifies into the following:
1. Fundamental qualitative characteristics – make information useful to users.
a. Relevance (capable of influencing decisions)
b. Faithful representation
2. Enhancing qualitative characteristics – enhance the usefulness of information.
a. Comparability
b. Verifiability
c. Timeliness
d. Understandability
Fundamental qualitative characteristics
Relevance
Information is relevant if it can make a difference in the decisions of users.
a. Predictive value – help users in making predictions about future outcomes.
b. Confirmatory value – help users in confirming their previous predictions.
Both are interrelated.
 Materiality - “Information is material if omitting, misstating or obscuring
it could reasonably be expected to influence decisions that the primary
users make.”
Conceptual Framework states that materiality is an ‘entity-specific’ aspect of
relevance (materiality depends on the facts and circumstances surrounding a
specific entity.
Materiality is a matter of judgement. The guidance consists of a 4-step
process called the “materiality process.”
Step 1 – Identify information that has the potential to be material.
Step 2 – Assess whether the information identifies is, in fact, material.
 Quantitative factors – size of the impact of the item.
- requirements of IFRS
 Qualitative factors – characteristics of the item or its context.
- entity-specific and external
- knowledge about primary users’ common information
needs
Step 3 – Organize the information within the draft financial statements in a way that
communicates the information clearly and concisely to primary users.
Step 4 – Review the drafts financial statements to determine whether all material
information has been identified and materiality considered from a wide perspective
and in aggregate, on the basis of the complete set of financial statements.
Faithful Representation
Information provides a true, correct and complete depiction of the economic
phenomena that it purports to represent.
a. Completeness – all information (in words and numbers) necessary for users to
understand the phenomenon being depicted is provided.
b. Neutrality – information is selected or presented without bias and not
manipulated to increase the probability that users will receive it favorably or
unfavorably. (supported by prudence)
c. Free from error – this does not mean that the information is perfectly accurate
in all aspects. It means there are no errors in the description and in the process
by which the information is selected and applied.
Enhancing qualitative characteristics
Comparability
Information is comparable if it helps users identify similarities and differences
between different sets of information that are provided by:
a) a single entity but in different periods (intra-comparability);
b) different entities in a single period (inter-comparability).
Verifiability
Information is verifiable if different users could reach a general agreement as
to what the information purports to represent.
Direct verification – direct observation (counting of cash)
Indirect verification – checking the inputs to a model or formula and recalculating
the outputs using the same methodology (checking the debits and credits in the cash
ledger and recalculating the ending balance).
Timeliness
Information is timely if it is available to users in time to be able to influence
their decisions.
Understandability
Information is understandable if it is presented in aa clear and concise
manner.
Accordingly, financial reports are intended for users:
a. who have reasonable knowledge of business activities;
b. who are willing to analyze the information diligently.
Applying the qualitative characteristics
Fundamental qualitative characteristics
- essential to the usefulness of information; meaning, information must be
both relevant and faithfully represented for it to be useful.
Enhancing qualitative characteristics
- only enhance the usefulness of information that is both relevant and faithfully
represented but cannot make information that is irrelevant or erroneous to
be useful.
- should be maximized to the extent possible.
The Cost Constraint
Cost is a pervasive constraint on the entity’s ability to provide useful financial
information. Costs must not outweigh the benefits.
Financial Statements and 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 prospects for future net cash inflows;
b. management’s stewardship over economic resources.



That information provided in the:
a. Statement of Financial Position (assets, liabilities and equity)
b. Statement of Financial Performance (income and expenses)
c. Other statements and notes (additional information that are relevant)
Reporting period
Financial statements are prepared for a specified period of time.
Comparative information – provide at least one preceding reporting period.
Forward-looking information – include information about events after the end of the
reporting period if it is necessary to meet the objective of financial statements.
Perspective adopted financial statements – prepared from the perspective of the
reporting entity.
If a reporting entity comprises both the parent and its subsidiaries, its
financial statements are referred to as consolidated financial statements.
(viewed as a single reporting entity)
If a reporting entity is the parent alone, its financial statements are referred to
as unconsolidated financial statements.
If a reporting entity comprises two or more entities that are not all linked by a
parent-subsidiary relationship, its financial statements are referred to as
combined financial statements.
(Financial statements of each subsidiary alone are referred to as individual financial
statements.)
The Elements of Financial Statements
Financial position
1. Assets
2. Liabilities
3. Equity
Financial performance
4. Income
5. Expenses
Asset
Going concern assumption
Financial statements are normally prepared on the assumption that the entity
is a going concern. If not, the entity’s financial statements are prepared on another
basis.
“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.”
Three aspects:
1. Right
2. Potential to produce economic benefits
3. Control
The reporting entity
 One that is required to prepare financial statements.
 Not necessarily a legal entity.
 It can be a single entity or a combination of two or more entities.
 Sometimes an entity controls another entity.
 The controlling entity is called the parent, while the controlled entity is called
the subsidiary.
Liability
“A present economic obligation of the entity to transfer economic resources as
a result of past events.”
Three aspects:
1. Obligation
2. Transfer of an economic resource
3. Present obligation as a result of past events
Obligation
“A duty or responsibility that an entity has no practical ability to avoid.”
a. Legal obligation – results from a contract, legislation, or operation of law;
b. Constructive obligation – results from an entity’s actions (past practice/published
policies) that create a valid expectation on others that the entity will and
discharge certain responsibilities.
Ex: Warranty
Executory contracts
“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.”
The contract ceases to be executory when one party performs its obligation.
Equity
“The residual interest in the assets of the entity after deducting all its
liabilities.”
Income
“Increases in assets, or decreases in liabilities, that result in increases in
equity, other than those relating to contributions from holders of equity claims.”
Expenses
“Decreases in assets, or increases in liabilities, that result in decreases in
equity, other than those relating to distribution to holders of equity claims.”
Recognition and Derecognition
Recognition is the process of including in the financial statements an item that meets
the definition of the financial statement elements (assets, liabilities, equity, income or
expenses).
“The amount of which an asset, a liability, or equity is recognized in the
statement of financial position is referred to its ‘carrying amount’.
Statement of financial position at beginning of reporting period
Assets – Liabilities = Equity
+
Statement of financial performance
Income – Expenses
+
Contributions from holders of equity claims – Distributions to holders of equity of
claims
=
Statement of financial position at end of reporting period
Assets – Liabilities = Equity
Sometimes the recognition of income results in the simultaneous recognition
of a related expense. It is called “matching costs and income” (matching
concept).
Recognition criteria
a. It meets the definition of an asset, liability, equity, income, or expense; and
b. Recognizing it would provide useful information
Both the criteria above must be met before an item is recognized.
Relevance
The recognition of an item may not provide relevant information if:
a. it is uncertain whether an asset or liability exists; or
b. an asset or liability exists, but the probability of an inflow or outflow of
economic benefits is low.
Faithful representation
The recognition of an item is appropriate if it provides both relevant and
faithfully represented information.
Derecognition
Derecognition is the opposite of recognition. It is the removal of previously
recognized asset or liability from the entity’s statement f financial position. It occurs
when the item no longer meets the definition of an asset or liability.
On derecognition, the entity:
a. derecognizes the assets or liabilities that have expired or have been
consumed, collected, fulfilled, or transferred, and recognizes any resulting
income and expenses.
b. continues to recognize any assets or liabilities retained after the
derecognition; the retained component becomes a unit of account separate
from the transferred component.
Unit of account
“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.”
Transfers
Derecognition is not appropriate if the entity obtains substantial control over
the transferred asset.
If there is only a partial transfer, the entity derecognizes only that transferred
component and continues to recognize the retained component.
Measurement
Recognition requires quantifying an item in monetary terms, thus
necessitating the selection of an appropriate measurement basis.
Measurement bases
1. Historical cost
2. Current value
a. Fair value
b. Value in use and fulfillment value
c. Current cost
Historical cost
Asset – The consideration paid to acquire the asset plus transaction costs,
Liability – The consideration received to incur the liability minus transaction costs.
Current value
Measures reflect changes in values at the measurement date.
Fair value
“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.”
Accordingly, it is not an entity-specific measurement, and not adjusted for
transaction costs.
Value in use and fulfillment value
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.”
Fulfillment 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.”
These two reflect entity-specific measurement rather than assumption by
market participants. They do not include transaction costs in acquiring an asset or
incurring a liability, but include transaction costs expected to be incurred on the
ultimate disposal of the asset or fulfillment of the liability.
Current cost
Asset:
“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.”
Liability:
“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.”
Current cost and historical costs are entry values, whereas fir value, value in use
and fulfillment value are exit values.
Considerations when selecting a measurement basis
a. the nature of information provided by a particular measurement basis; and
b. the qualitative characteristics, the cost constraint, and other factors.
Relevance
The relevance of information is affected by:
a. the characteristics of the asset or liability; and
b. how the asset or liability contributes to future cash flows.
Faithful representation
The level of measurement uncertainty may affect the faithful representation of
information.
“Measurement uncertainty is different from both outcome uncertainty and existence
uncertainty.:
a. outcome uncertainty arises when there is uncertainty about the amount or
timing of any inflow or outflow of economic benefits that will result from an
asset or liability.
b. existence uncertainty arises when it is uncertain whether asset or liability
exists.”
Presentation and disclosure as communication tools
Information about assets, liabilities, equity, income and expenses is
communicated through presentation and disclosure in the financial statements.
Effective communication requires:
a. Focusing on presentation and disclosure objectives and principles rather than
rules.
b. Classifying information by grouping similar items and separating dissimilar
items.
c. Aggregating information in a manner that is not obscured either by excessive
detail or by excessive summarization.
Presentation and disclosure objectives and principles
- are specified in the Standards. Strive for a balance between:
a. giving entities the flexibility to provide relevant and faithfully represented
information; and
b. requiring information that has both intra-comparability and inter-comparability.
Enhancing qualitative characteristics and the Cost constraint
Comparability
Consistently using same measurement bases for same items, either from
period to period within a single entity (intra-comparability) or within a single period
across different entities (inter-comparability), makes the financial statements more
comparable.
Understandability
Generally, the more different measurement bases are used, the more
complex the resulting information become, and hence less understandable.
Verifiability
Using measurement bases that result in measures that can be independently
corroborated either directly or indirectly enhances verifiability.
Central estimates
a. Statistical mean – the average
b. Statistical median – the middle value
c. Statistical mode – the most frequent value
Classification
The sorting of assets, liabilities, equity, income, or expenses with similar
nature, function, and measurement basis for presentation and disclosure purposes.
Offsetting
Occurs when an asset and a liability with separate units of account are
combined and only the net amount is presented in the statement of financial position.
However, it is not generally appropriate.
Aggregation
The adding together of assets, liabilities, equity, income or expenses that
have shared characteristics and are included in the same classification.
It summarizes a large volume of detail, thus making information more useful.
Concepts of Capital and Capital Maintenance
The Conceptual Framework mentions two concepts of capital, namely:
a. Financial concept of capital – capital is regarded as the invested money or
invested purchasing power. Capital is synonymous with equity, net assets, or
net worth.
b. Physical concept of capital – capital is regarded as the entity’s productive
capacity, e.g., units of output per day.
The concepts of capital give rise to the following concepts of capital maintenance:
a. Financial capital maintenance – profits is earned if the net assets at the end
of the period exceeds the net assets at the beginning of the period, after
excluding any distributions to, and contribution from, owners during the
period.
b. Physical capital maintenance – profit is earned only if the entity’s productive
capacity at the end of the period exceed the productive capacity at the
beginning of the period, after excluding any distributions to, and contributions
from, owners during the period.