Chapter 4: Conceptual
framework
Learning objectives
• Generally accepted accounting practice
• The objective of financial reporting
• The going concern assumption
• Qualitative characteristics of useful financial information
• Elements of the financial statements
• Recognition criteria for the elements
• Derecognition of assets and liabilities
• Measurement bases
• The accrual concept
Generally accepted accounting practice
The objective of financial reporting
• According to the “Conceptual Framework for Financial Reporting”, the
objective of financial reporting is to provide financial information
about the business that is useful to existing and potential investors,
lenders and other creditors when they make decisions about
providing resources to a business.
Who are the primary users of financial
statements?
• Existing and potential investors
• Lenders
• Creditors
Who else would be interested in the financial
statements?
• Customers
• South African Revenue Services (SARS)
• Employees
The going concern assumption
• So what does the going concern assumption mean? This means that
the business intends to continue to trade in the foreseeable future at
a similar or on a larger scale of operations.
• If the statements have not been prepared on the going concern basis,
this fact must be stated in the financial reports, and an explanation of
the basis that was used must be included.
Qualitative characteristics of useful financial
information
Fundamental qualitative characteristics
• Relevance
• Faithful representation
Enhancing qualitative characteristics
• Comparability
• Timeliness
• Verifiability
• Understandability
Fundamental qualitative characteristics
• Relevance: that financial information is relevant if it is capable of
making a difference to the decisions made by users.
• Faithful representation: A faithful representation of information
records the actual outcome of actual transactions and events. (free
from error and bias and complete)
Enhancing qualitative characteristics
• Comparability- to meet the users needs ,the financial information should
be given comparable information in order to identify trends over time.
• Timeliness- Users of financial statements need the financial statements to
be published as soon as possible after the end of the financial year.
• Verifiability- It is possible to verify information directly, for example, by
watching the bookkeeper counting cash or performing an inventory count.
• Understandability- to achieve the aim of reporting, the financial
statements should be understandable to the average user who has a
reasonable knowledge of business and willingness to study the information
with necessary diligence
Elements of the financial statements
(a) Assets –Present economic resource controlled by the entity as a result of
past event
(b) Liabilities –a present obligation of the entity to transfer an economic
resource as a result of past events.
(c) Equity –Is the residual interest in the assets of the entity after deducting
all its liability.
(d) Income –An increase Equity that results from an increase in assets ,or
decrease in liabilities ,other than from contributions from the owner
(e) Expenses –An expense is a decrease in assets or increase in liability as a
result of decrease in equity ,other than the transaction with the owner .
Recognition criteria for the elements
• Recognising an asset, liability, income or expense means that the item
appears in the financial reports of a business.
• An asset, liability, income or expense can be recognised on the
financial statements if it meets the definition and recognition criteria
of the element.
If the definition has not been met, there cannot be an asset or
liability.
If the definition has been met, we must determine if we can
recognise the asset or liability on the statement of financial position.
Recognition criteria for the elements cont.
• Assets, liabilities, income, expenses or changes in equity will be
recognised if such recognition provides users of the financial
statements with relevant information and a faithful representation
of the underlying transaction.
• Relevance is influenced by uncertainties, i.e. it may be uncertain
whether an asset or liability actually exists
• Faithful representation can be affected by the level of measurement
uncertainty.
Derecognition of assets and liabilities
• Derecognition is defined as the removal of all or part of a previously
recognised asset or liability from a business statement of financial position.
• Derecognition of an asset normally happens when the business loses
control of all or part of the recognised asset.
• Derecognition of a liability happens when the business no longer has a
present obligation for all or part of the recognised liability.
The conceptual framework states that derecognition should aim to
faithfully represent both:
• any assets and liabilities retained after the transaction that lead to
derecognition, and
• the change in the assets and liabilities as a result of that transaction.
Measurement basis
• Elements can be recognised on the financial statements once the
definition and recognition criteria have been met.
• In deciding on the amount at which to recognise the asset, liability,
equity, income and expenses, we will need to understand how the
elements are measured.
• The conceptual framework offers two categories of measurement
bases that can provide information that is useful.
historical cost measurement and
 current value measurement.
Historic cost measurement
• According to the historical cost measurement basis, an asset is
valued at the cost paid to purchase (or create) the asset. Transaction
costs such as import duties or legal fees are considered part of the
historical cost of an item.
• According to the historical cost measurement basis, a liability is the
value of the consideration received, i.e. the value of the liability
would be the cost of the inventory taken on credit (the amount of the
obligation required to settle the liability).
• The historical cost of an asset is reduced if the asset (or part of the
asset) has been consumed (referred to as depreciation for noncurrent assets) or has been damaged (referred to as impairment).
Current value measurement
• These bases provide information updated to reflect conditions at the
measurement date.
 Fair value- Meaning the price or amount you would received when you
sold the asset today or paid to transfer the liability. Also referred to as a
market value
 Value in use (assets) and fulfillment value (liabilities)- Present of future
cash flows generated from using the asset and disposing of the asset less
the cost of disposal
Current cost- Current cost refers to the amount that would be paid to
acquire an equivalent asset or the amount that would be received to take
on an equivalent liability.
Deciding which measurement base to use when
initially recognizing an asset value
• In deciding whether an asset or a liability should be measured using
historical cost or current value, the decision should be based on
which measure would provide useful information. In other words,
which measurement would provide the most relevant information
that is a faithful representation of the transaction?
Class example
The following transactions occurred on 1 January X1:
(a) Took delivery of a vehicle and paid R100 000 by cheque.
(b) Took delivery of inventory. The business will pay R40 000 on 31
March X1. The payment period is less than one year.
(c) Took delivery of equipment. The business will pay R1 000 000 on 1
January X2. The payment period is more than one year. Assume a fair
interest rate of 12%.
Solution
(a)
(b)
Solution
• Given that a fair interest rate is 12%, the present value of the cash to
be paid on 1 January X2 is calculated as follows:
• R1 000 000 = 112% (cost of asset = 100% plus interest @ 12% for one
year)
• How much is 100%?
• R1 000 000 × 100/112
• = R892 857, which is the portion of the payment relating to the assets
acquisition.
Solution to (c)
Subsequent measurement
• The framework recommends using the same measurement basis for initial
recognition and subsequent measurement. This is so that change in the
value of the asset/liability is not due to a change measurement basis.
• If the asset had initially been recognised at historical cost, the carrying
amount at any subsequent measurement date would be the unconsumed
or uncollected historical cost that is considered to be recoverable.
• If the asset had initially been recognised at fair value, the carrying amount
at any subsequent measurement date would be the price that would be
received to sell the asset at that point in time. Remember that if a portion
of the asset has been sold or consumed, this will decrease the carrying
amount shown at that date.
The accrual concept
• The accrual basis requires the effects of transactions to be reported in
the financial period in which they occur, i.e. when assets/liabilities
change, not necessarily in the period in which cash is received or
paid.
Any questions
End ………..