ACC 203 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS
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Module 1
Conceptual Framework and Presentation of Financial Statements
Week 2 - 3
Introduction
This module tackles the new Conceptual Framework for Financial Reporting and PAS 1
for the Financial Statements Presentation. This discusses the concepts that underlies the
preparation and presentation of financial statements. The Conceptual Framework sets
the concepts and objectives of the general purpose financial reporting. PAS 1 Presentation of Financial Statements discusses the specific accounting standards that
are provided by the IASB in presenting the financial statements.
Learning Objectives
After studying this module, students should be able to:
1. Understand the purpose and content of the Conceptual Framework for Financial
Reporting.
2. Acquire the knowledge and concepts about the Philippine Accounting Standards
(PAS) 1 - Presentation of Financial Statements.
Discussion:
The Conceptual Framework for Financial Reporting
The Conceptual Framework for Financial Reporting is a basic document that sets
objectives and the concepts for general purpose financial reporting. Its predecessor,
Framework for the preparation and presentation of the financial statements was issued
back in 1989. Then in 2010, IASB published the new document, Conceptual Framework
for Financial Reporting.
Content of Conceptual Framework for Financial Reporting
1. The Objective of General Purpose 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
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8. Concepts of capital and capital maintenance.
Is the Framework equivalent to the Standard?
Let me please make one point clear: Framework is NOT a Standard itself. Thus if you
wish to decide on the financial reporting of certain transaction, you need to look into the
appropriate standard – IFRS or IAS. Sometimes, it may even happen that the rules in that
IFRS or IAS standard will be contrary to what the Framework says. In this case, you need
to apply the standard, not the Framework.
When should you apply the Framework? In most cases, when there are no specific rules
for your transaction and you need to develop your accounting policy, then you would look
to the Framework as you cannot depart from its basic principles and definitions.
The objective of general purpose financial reporting
The main objective of general purpose financial reports is to provide the financial
information about the reporting entity that is useful to existing and potential:
● Investors,
● Lenders, and
● Other creditors
to help them make various decisions (e.g. about trading with debt or equity instruments
of a reporting entity).
The objective is NOT about the financial statements itself, instead, this describes more
general purpose reports that should contain the following information about the reporting
entity:
● Economic resources and claims (this refers to the financial position);
● The changes in economic resources and claims resulting from the entity's financial
performance and from other events.
This puts an emphasis on accrual accounting to reflect the financial performance of an
entity. It means that the events should be reflected in the reports in the periods when the
effects of transactions occur, regardless of the related cash flows.
However, the information about past cash flows is very important to assess
management’s ability to generate future cash flows.
Qualitative characteristics of useful financial information
The Framework describes 2 types of characteristics for financial information to be useful:
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1. Fundamental, and
2. Enhancing.
Fundamental qualitative characteristics
● Relevance: capable of making a difference in the users’ decisions. The financial
information is relevant when it has predictive value, confirmatory value, or both.
Materiality is closely related to relevance.
● Faithful representation: The information is faithfully represented when it is
complete, neutral and free from error.
Enhancing qualitative characteristics
● Comparability: Information should be comparable between different entities or time
periods;
● Verifiability: Independent and knowledgeable observers are able to verify the
information;
● Timeliness: Information is available in time to influence the decisions of users;
● Understandability: Information shall be classified, presented clearly and concisely.
Financial Statements and the Reporting Entity
Financial Statements
The financial statements should provide the useful information about the reporting entity:
1. In the statement of financial position, by recognizing
○ Assets,
○ Liabilities,
○ Equity
2. In the statements of financial performance, by recognizing
○ Income, and
○ Expenses
3. In other statements, by presenting and disclosing information about
○ recognized and unrecognized assets, liabilities, equity, income and
expenses, their nature and associated risks;
○ Cash flows;
○ Contributions from and distributions to equity holders, and
○ Methods, assumptions, judgements used, and their changes.
Financial statements are always prepared for a specified period of time, or the reporting
period. Normally, the financial statements are prepared on the going concern assumption.
It means that an entity will continue to operate for the foreseeable future (usually 12
months after the reporting date).
Reporting Entity
Although the term “reporting entity” has been used throughout IFRS for some time, the
Framework introduced it and “made it official” only in 2018. Reporting entity is an entity
who must or chooses to prepare the financial statements. It can be:
● A single entity – for example, one company;
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● A portion of an entity – for example, a division of one company;
● More than one entity – for example, a parent and its subsidiaries reporting as a
group.
As a result, we have a few types of financial statements:
● Consolidated: a parent and subsidiaries report as a single reporting entity;
● Unconsolidated: e.g. a parent alone provides reports, or
● Combined: e.g. reporting entity comprises two or more entities not linked by
parent-subsidiary relationship.
Elements of the financial statements
This extensively deals with the definitions of individual elements of the financial
statements. There are five basic elements:
1. Asset = a present economic resource controlled by the entity as a result of past
events;
2. Liability = a present obligation of the entity to transfer an economic resource as a
result of past events;
3. Equity = the residual interest in the assets of the entity after deducting all its
liabilities;
4. Income = increases in assets or decreases in liabilities resulting in increases in
equity, other than contributions from equity holders;
5. Expenses = decreases in assets or increases in liabilities resulting in decreases in
equity, other than distributions to equity holders;
The Framework then discusses each aspect of these definitions and provides wide
guidance on how to decide what element you are dealing with.
Recognition and derecognition
Recognition Simply speaking, recognition means including an element of financial
statements in the financial statements. In other words, if you decide on recognition, you
decide on whether to show this item in the financial statements. Recognition process links
the elements in the financial statements according to the following formula: Please let me
stress here that not all items that meet the definition of one of the elements listed above
are recognized in the financial statements.
The Framework requires recognizing the elements only when the recognition provides
useful information – relevant with faithful representation. Then, the Framework discusses
the relevance, faithful representation, cost constraints and other aspects in a detail.
Derecognition. it means removal of an asset or liability from the statement of financial
position and normally it happens when the item no longer meets the definition of an asset
or a liability. Again, the Framework discusses the derecognition in a greater detail.
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Measurement
Measurement means in what amount to recognize asset, liability, piece of equity, income
or expense in your financial statements. Thus, you need to select the measurement basis,
or the method of quantifying monetary amounts for elements in the financial statements.
The Framework discusses two basic measurement basis:
1. Historical cost – this measurement is based on the transaction price at the time of
recognition of the element;
2. Current value – it measures the element updated to reflect the conditions at the
measurement date. Here, several methods are included:
○ Fair value;
○ Value in use;
○ Current cost.
Each of these measurement bases is discussed in a greater detail. The Framework then
gives guidance on how to select the appropriate measurement basis and what factors to
consider (especially relevance and faithful representation). What I personally find really
useful is the guidance on measurement of equity. The issue here is that the equity is
defined as “residual after deducting liabilities from assets” and therefore total carrying
amount of equity is not measured directly. Instead, it is measured exactly by the formula:
● Total carrying amount of all assets, less
● Total carrying amount of all liabilities.
The Framework points out that it can be appropriate to measure some components of
equity directly (e.g. share capital), but it is not possible to measure total equity directly.
Presentation and disclosure
The main aim of presentation and disclosures is to provide an effective communication
tool in the financial statements.
Effective communication of information in the financial statements requires:
● Focus on objectives and principles of presentation and disclosure, not on the
rules;
● Group similar items and separate dissimilar items;
● Aggregate information, but do not provide unnecessary detail or the opposite –
excessive aggregation to obscure the information.
The Framework discusses classification of assets, liabilities, equity, income and
expenses in greater detail with describing offsetting, aggregation, distinguishing between
profit or loss and other comprehensive income and other related areas.
Concepts of capital and capital maintenance
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The Framework explains two concepts of capital:
1. Financial capital – this is synonymous with the net assets or equity of the entity.
Under the financial maintenance concept, the profit is earned only when the
amount of net assets at the end of the period is greater than the amount of net
assets in the beginning, after excluding contributions from and distributions to
equity holders.
The financial capital maintenance can be measured either in
a. Nominal monetary units, or
b. Units of constant purchasing power.
2. Physical capital – this is the productive capacity of the entity based on, for
example, units of output per day.
Here the profit is earned if physical productive capacity increases during the
period, after excluding the movements with equity holders.
The main difference between these concepts is how the entity treats the effects of
changes in prices in assets and liabilities.
PAS 1: Presentation of Financial Statements
Statement of Financial Position
1. Statement of Profit or Loss and Other Comprehensive Income
2. Statement of Changes in Equity
3. Statement of Cash Flow
4. Notes to the Financial Statement
Terms to Remember:
1. Financial Statements are written records that convey the business activities and
the financial performance of a company.
2. General Purpose Financial Statements are those intended to meet the needs of
users who are not in a position to require an entity to prepare reports tailored to
their particular information needs.
3. Objective of Financial Statements is to provide information about the financial
position, financial performance and cash flows of an entity that is useful to a wide
range of users in making economic decisions.
4. Frequency of Reporting states that financial statements shall be presented at least
annually.
5. Judgement is used to determine the best method of presenting information.
6. Statement of Financial Position is a formal statement showing the three elements
comprising financial position, namely assets, liabilities and equity. It is used to
evaluate such factors as liquidity, solvency and the need of the entity for additional
financing.
Asset
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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.
Classification of assets
Current Assets
1. Cash and cash equivalents
2. Financial assets at fair value such as trading securities and other investment in
quoted equity instruments
3. Trade and other receivables
4. Inventories
5. Prepaid expense
Non-Current Assets
1. Property, plant and equipment
2. Long-term investments
3. Intangible assets
4. Deferred tax assets
5. Other non-current assets
Liabilities
- are present obligations of the entity to transfer an economic resource as a result
of past events. An obligation is a duty of responsibility that the entity has no
practical ability to avoid.
Classification of liabilities
Current Liabilities
1. Trade and other payables
2. Current provisions
3. Short-term borrowing
4. Current portion of long-term debt
5. Current tax liability
Non-current Liabilities
1. Non-current portion of long-term debt
2. Finance lease liability
3. Deferred tax liability
4. Long-term obligations to company officers
5. Long-term deferred revenue
Currently maturing long-term debt
The original term was for a period longer than twelve months.
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An agreement to refinance or to reschedule payment on a long-term basis is completed
after the reporting period and before the financial statement are authorized for issue.
Discretion to refinance
- Or roll over an obligation for at least twelve months after the reporting period under
an existing loan facility, the obligation is classified as noncurrent.
Covenants
- is often attached to borrowing agreements which represent undertakings by the
borrower.
- Actual restriction on the borrower.
Effect of breach of covenant
IAS 1, paragraph 74: The liability is classified as current even if the lender has agreed,
after the reporting period and before the statements are authorized for issue, not to
demand payment as a consequence of the breach.
Equity
is the residual interest in the assets of the enterprise after deducting all its liabilities.
IAS 1, paragraph 7: The holders of instruments classified as equity are simply known as
owner. Shareholders’ equity is the residual interest of owners in the assets of a
corporation measured by the excess of assets over liabilities.
The Statement of Profit or Loss and Other Comprehensive Income
Profit or Loss
1. Revenue
2. Finance cost
3. Share of profits and losses of associates and joint ventures accounted for using
the equity method
4. A single amount for the total of discontinued operation
5. Tax expense
Other Comprehensive Income
1. Unrealized gain/loss on equity investment measured at fair value through OCI
2. Unrealized gain/loss on debt investment measure at fair value through OCI
3. Gain/Loss from translation of the financial statements of a foreign operation
4. Revaluation surplus during the year
5. Unrealized gain/loss from derivative contracts designated as cash flow hedge
6. “Remeasurements” of defined benefit plan, including actuarial gain/loss
7. Change in fair value attributable to credit risk of a financial liability designated at
fair value through profit/loss
Statement of Changes in Equity
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Comprehensive income for the period
1. The effects of changes in accounting policies and corrections of error
2. A reconciliation between carrying amount at the beginning and end of the period
Notes to the Financial Statement
Present information about the basis on which the financial statements were prepared and
which specific accounting policies were chosen and applied to significant transaction
1. Disclose any information which is required by IFRSs
2. Show any additional information that is relevant to understanding which is not
shown elsewhere in the financial statement
Assessments
Answer the following requirements:
1. Describe the Conceptual Framework for Financial Reporting
2. Enumerate the Objectives of a general purpose financial reporting?
3. Identify the Qualitative characteristics of a useful financial statement,
4. Find the relationship between financial statements and reporting entity
5. Enumerate the elements of financial statements.
6. Explain the concept of recognition, derecognition and measurement
7. Explain the presentation of financial
8. Explain the concept of capital and capital maintenance.
9. Enumerate the complete set of financial statements.
10. Define the elements of financial statements.
11. Explain the classification of assets and liabilities/
12. Identify the content of statement of comprehensive income
13. Explain the importance of notes to financial statements.
References
APA style
Source:
Peralta, Jose F., Valix, Christian Aris M., Valix, Conrado T. (2017), Financial
Accounting Volume Two. Manila, Philippines. GIC Enterprises & Co.,Inc.
Asuncion, Darrell Joe O. CPA,MBA, Escala, Raymund Francis A. CPA, MBA, Ngina,
Mark Alyson B. CPA, MBA (2018), Applied Auditing Book 2 of 2. Aurora Hill,
Baguio City. Real Excellence Publishing and Nation’s Foremost CPA Review Inc.
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Silvia.M.,2019.https://www.ifrsbox.com/ifrs-conceptual-framework2018/#:~:text=The%20Conceptual%20Framework%20for%20the,was%20issued%20ba
ck%20in%201989.
IFRS Community (2018). Retrieved From:
https://ifrscommunity.com/knowledge-base/ifrs-16-recognition-and-measurement-of-l
eases/#link-subsequent-measurement-of-the-lease-liability
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