FAR.

02 Conceptual Framework for Financial Reporting

TOPIC OUTLINE
1. Basic Concepts
2. Purpose of Conceptual Framework
3. Authoritative Status
4. Underlying Assumption
5. Scope of Conceptual Framework
a. Chapter 1: Objective of Financial Reporting
b. Chapter 2: Qualitative Characteristics of Useful Information
c. Chapter 3: The Financial Statements and the Reporting Entity
d. Chapter 4: Elements of Financial Statements
e. Chapter 5: Recognition and Derecognition
f. Chapter 6: Measurement
g. Chapter 7: Presentation and Disclosure
h. Chapter 8: Concepts of Capital and Capital Maintenance

BASIC CONCEPTS
The Conceptual Framework is a summary of the terms and concepts that underlie the preparation and presentation
of financial statements.
 All the contents are general terms and concepts that is used in preparation and presentation of financial
statements.
The conceptual framework is concerned with general purpose financial statements, including consolidated
financial statements.
 Exclusion of scope – Special Purpose Financial Statements
 CF is commonly known as the mother standard same as the Philippine Constitution. In case there’s a
conflict between Conceptual Framework and PFRS, PFRS will prevail.
The underlying theme of the framework is decision usefulness or usefulness of information in making economic
decision.

PURPOSE OF CONCEPTUAL FRAMEWORK

Basic Purpose: To serve as a guide in developing future PFRS and as a guide in resolving accounting issues not
directly addressed by existing PFRS.
 Hierarchy: Specific Standard, Related Standard, Conceptual Framework, Other GAAP, Accounting Literature
Specific Purposes:
 To assist FRSC
o Standard setting body in the Philippines. Conceptual framework assist FRSC
 In developing future PFRSs and reviewing existing PFRSs
 In promoting harmonization of regulations, accounting standards and procedures relating to
the presentation of Financial Statements
 To assist FS Preparers
o Conceptual framework assist them in applying PFRSs.
 To assist FS Users
o Conceptual framework assist them in interpreting the information in Financial Statement.
 To assist Auditors
o Auditors examine financial statement and to opine of the fairness of those FS. Conceptual framework
assist auditors in forming an opinion as to whether the FS conforms with PFRS.
 To provide information to those who are interested with the work of FRSC.

AUTHORITATIVE STATUS
The Conceptual Framework is not a Philippine Financial Reporting Standard (PFRS) and hence does not define
standard for any particular measurement or disclosure issue.
In case where there is a conflict, the requirements of the Philippine Financial Reporting Standards shall prevail over
the Conceptual Framework.
o Nothing on the Conceptual Framework can override any specific provision of any specific PFRS
FAR.02 Conceptual Framework for Financial Reporting

o PFRSs contains specific concepts. They are the specific standard addressing all the specific needs of a
transaction.
In the absence of a standard or an interpretation that specifically applies to a transaction, management shall consider
the applicability of the Conceptual Framework in developing and applying an accounting policy that results in
information that is relevant and reliable.

UNDERLYING ASSUMPTIONS
Underlying assumptions or accounting postulates are the basic notions or fundamental premises on which the
accounting process is based.
o Going Concern (Continuity Assumption)
Going Concern assumption means that the accounting entity is viewed as continuing in operation
indefinitely in the absence of evidence to the contrary.
Going Concern is the foundation of cost principle
Examples of application of going concern principle:
 The current and non-current classification of assets and liabilities.
 The accrual of income and expenses and prepayments and unearned income.
 Depreciation of PPE, amortization of intangible assets, depletion of wasting assets and
etc.
o Only assumption recognized in the framework
o Accrual Principle
Accrual principle addresses the recognition of income and expenses against the cash basis principle. Under
this principle, income is recognized when earned rather than when received and expense is recognized
when incurred rather than when paid.
o Accounting Entity Concept
Under this concept, the entity is viewed separately from its owners. Accordingly, the personal
transactions of the owners among themselves or with other entities are not recorded in the entity’s
accounting records.
o Business is a separate entity and individual from its owner. Businesses are the artificial person
while we are considered as natural person. Businesses can’t operate on its own.
o Time Period Principle
Under this principle, the life of the entity is divided into series of reporting periods. An accounting
period is usually 12 months and may either be a calendar year or a fiscal year.
o This principle supports going concern assumption, it views that the business will continue
indefinitely. Here, we need to report in certain time period. Even though the business has
indefinite operation, we have to report into series of reporting period.
 Reporting Period – 12 months
 Calendar year reporting – every December 31 (less than 12 months)
 Fiscal year – always 12 months
o Monetary Unit Principle
Under this principle, accounting information should be stated in a common measurement basis to be
useful, which is in the Philippines it is Peso.

Also, this concept assumes that the purchasing power of the peso is regarded as constant.
o Stability of monetary unit – supports cost principle, measure the asset as is and disregarding the
changes in purchasing power (i.e., inflation or deflation)
o Identifiability – identified measurement basis

SCOPE OF THE CONCEPTUAL FRAMEWORK

CHAPTER 1: OBJECTIVE OF FINANCIAL REPORTING
Foundation of Conceptual Framework

USERS OF FINANCIAL REPORTING

Users of financial information is classified into primary and other users
PRIMARY USERS OTHER USERS
FAR.02 Conceptual Framework for Financial Reporting

Investors Employees
Lenders and Other Creditors Customers
*Primarily addressed as the users of the Financial Government
Statement Public
Primary users – they are the one provides resources for the entity, explained by the accounting equation.
Other users – not necessarily provides resources for the entity

Concerns:
1. Investors – risk and return of investment.
Ability to pay dividends.
The higher the risk, the higher the return.
2. Lenders and Other Creditors – Liquidity and Solvency
Ability to pay its obligation as well as the interest.
Liquidity – the company is able to pay its short term and currently maturing obligation.
Solvency – ability to pay all of its obligation whether long term or short term.
3. Employees – Stability and profitability
Stability – if the company is unstable there is a possibility that they will not get their
compensation.
Profitability – they can request for salary increase.
4. Customers – Continuity
Entity is the supplier; concern is the long-term relationship.
5. Government – Regulatory
If the entity is following the laws and regulation, as well as the tax codes when it comes to paying
taxes.
6. Public – Various
Residual concern, concerns that are not mentioned above.

OBJECTIVE OF FINANCIAL REPORTING

OVERALL OBJECTIVE: To provide financial information about the reporting entity that is useful to existing and
potential investors, lenders and other creditors in making decisions about providing resources to the entity.
SPECIFIC OBJECTIVE: (PAR)
o To provide information useful in making decisions about providing resources to the entity.
o To provide information useful in assessing the prospects of future net cash flows to the entity.
o To provide information about entity resources, claims and changes in resources and claims.
LIMITATIONS OF FINANCIAL REPORTING
o General purpose financial reports do not and cannot provide all of the information that existing and
potential investors, lenders and other creditors need.
o GPFS only provides the general or common needs of your users. If you want to address the
specific or special needs of the users then you will be needing the Special Purpose Financial
Reports (MAS).
o General Purpose financial reports are not designed to show the value of an entity but the provide
information to help the primary users estimate the value of the entity.
o GPFS cannot provide the exact and true value of an entity but can provide estimations for its
value.
o To a large extent, general purpose financial reports are based on estimate and judgment rather than exact
depiction.

CHAPTER 2: QUALITATIVE CHARACTERISTICS

Qualitative characteristics are the qualities or attributes that make financial accounting information useful to the
users.
 What type of information should the financial reports contains?

Under the conceptual framework for financial reporting, qualitative characteristics are classified into fundamental
qualitative characteristics and enhancing qualitative characteristics.
FAR.02 Conceptual Framework for Financial Reporting

FUNDAMENTAL QUALITATIVE CHARACTERISTICS

 These are the qualities that make the information useful to the users in making economic decisions.
 These characteristics address the content or substance of information.
 The fundamental qualitative characteristics are relevance and faithful representation.
o Relevance – means the capacity of information to make a difference in a decision made by users.
Relevant information has the following ingredients:
 Predictive Value – the information can help users increase the likelihood of correctly
predicting or forecasting outcome of events.
 Confirmatory Value – the information enables users confirm or correct earlier
expectations.
 Should contain both predictive and confirmatory value.
MATERIALITY
 It is the omission or misstatement of information causing to influence the decision of the
users.
 It is not an ingredient of relevance but rather a specific aspect of relevance.
 All material items are relevant but not all relevant items are material.
 In the exercise of judgement in determining materiality, the following factors may be
considered:
 Relative Size of the item in relation to the total of the group to which the item
belongs.
o Materiality is not based on absolute size but rather the relative size.
o Relating that item in connection to others.
 Nature of the item
o Regardless of the size, if the nature of the item is material, then it is
considered material.
o Faithful Representation – same as reliability. Faithful representation means that the information
provides a true, correct and complete depiction of the economic phenomena that it purports to
represent.
 What exactly happened, you provided it truly, completely and correctly.
 If an item is faithfully represented, it is considered reliable.
 To be perfectly faithful representation, a depiction should have three ingredients, namely:
 Completeness
 Neutrality
 Free from error
NOTE: Substance over form and conservatism are not ingredients of faithful representation and
are specific aspect only.

ENHANCING QUALITATIVE CHARACTERISTICS

 These are the qualities or characteristics that enhances its usefulness.
 It supports fundamental qualitative characteristics.
 These characteristics address the form or presentation of information.
 The enhancing qualitative characteristics are verifiability, comparability, understandability, and timeliness
(V-CUT).
o Verifiability means that different knowledgeable and independent observers could reach
consensus, although not necessarily complete agreement, that a particular depiction is a faithful
representation.
 There’s an independent observer that can support your document.
o Information is comparable if it helps users identify similarities and differences between
different sets of information that are provided by:
 A single entity but different periods (intra-comparability); or
 Different entities in a single period (inter-comparability).
 Financial accounting focuses on intra-comparability.
Although related, consistency and comparability are not the same.
FAR.02 Conceptual Framework for Financial Reporting

 Comparability is the goal while the consistency is the means of achieving the goal.
Consistency is ingredients for comparability.
 Consistency and regular reporting period must be present for you to be able to compare
different sets of information.
o Understandability requires that financial information must be comprehensible or intelligible if it
is to be useful.
NOTE: Complex matters cannot be eliminated.
o Timeliness means having information available to decision makers in time to influence their
decisions.
In other words, timeliness requires that financial information must be available or communicated
early enough when a decision is to be made.

COST CONSTRAINT
o Cost is a pervasive constraint on the information that can be provided by financial reporting.
o The benefit derived from the information should exceed the cost incurred in obtaining the
information.

CHAPTER 3: THE FINANCIAL STATEMENTS AND THE REPORTING ENTITY

THE FINANCIAL STATEMENTS
Financial statements are the reports containing useful information to be reported to the user.
The objective of general-purpose financial statements is to provide financial information about the reporting entity’s
assets, liabilities, equity, income and expenses contained in the following:
o Statement of Financial Position (for recognized assets, liabilities and equity)
o Statement(s) of Financial Performance (for income and expenses)
o Other Statements and Notes
Financial statements are prepared for a specified period of time or the reporting period. Financial statements also
provide comparative information for at least ONE PRECEDING REPORTING PERIOD.
THE REPORTING ENTITY
Reporting entity is an entity who must or chooses to prepare the financial statements and is NOT necessarily a legal
entity.
As a result, we have a few types of financial statements:
o Consolidated – a parent and subsidiaries report as a single reporting entity.
FAR.02 Conceptual Framework for Financial Reporting

o Unconsolidated or Individual – a parent alone provides reports.

o Combined – reporting entity comprises two or more entities not linked by parent- subsidiary relationship.

CHAPTER 4: ELLEMENTS OF FINANCIAL STATEMENTS

The elements of financial statements refer to the quantitative information shown in the statement of financial
position and statement of comprehensive income, namely:
o Financial Position (Balance Sheet)
o Assets
o Liability
o Equity
o Financial Performance (Income Statement)
o Income
o Expenses

ASSETS
A present economic resource controlled by the entity as a result of a past event. An economic resource is a right that
has the potential to produce economic benefits.
o A present economic resource controlled by the entity as a result of a past event that brings economic benefit
to the entity.
 Asset is controlled by the entity
 Control – power to govern economic benefits and restricting others to enjoy the same
benefits.
 The asset is the result of a past transaction or event
 An asset cannot arise from a future-events, it should be from past transaction.
 The asset provides future economic benefits.
NOTE: Tangibility and ownership are not essential characteristics of assets. Also, the presence or absence
of expenditure is not necessary in determining the existence of assets. There is such a thing called donation,
thus there’s a donated asset.

LIABILITY
A present obligation of an entity arising from past transaction or event, the settlement of which is expected to result
in an outflow from the entity of resources embodying economic benefits.
The essential characteristics of a liability are:
 The liability is the present obligation of a particular entity
o Present obligation is different from future settlement.
 The liability arises from past transaction or event
o There is no such thing that there’s a liability arises from future event.
 The settlement of the liability requires an outflow of resources embodying economic benefits.
NOTE: Identification of payee and certainty of timing of settlement and amount of liability (provision or
estimated liabilities) are not essential characteristics of liabilities. It is important to acknowledge that you have
present obligation.

EQUITY
The residual interest in the assets of the entity after deducting all of its liabilities.
 Also known as net assets

INCOME
The increase in economic benefit during the accounting period in the form of an outflow or increase of asset or
decrease of liability that results in increase in equity, other than contribution from equity participants.
 It is the increase in equity resulting from an increase in asset or decrease in liability. We need to exclude
owner transaction if we want to classify an item as an income.
NOTE: Income encompasses both revenue and gains.
 REVENUE
o Arises from ordinary course of business
FAR.02 Conceptual Framework for Financial Reporting

o Presentation in the FS: at gross amount

 GAIN
o Arises from incidental or peripheral operations
o Presentation in the FS: at net amount (net of direct cost)

Comprehensive income is classified into two:

 Profit or Loss (P/L)
 Other Comprehensive Income (OCI)

General Rule is, an income is part of profit or loss unless it will be classified as OCI which are as follows:
1. Unrealized gain or loss on financial asset measured at fair value through OCI
a. Realized Gain or Loss – P/L
b. Unrealized Gain or Loss - OCI
2. Gain or Loss from translating the financial statements of a foreign operation
a. Transaction Gain or Loss – P/L
b. Translation Gain or Loss - OCI
3. Revaluation surplus during the year
4. Unrealized gain or loss from derivative contract designated as cash flow hedge
a. Fair Value Hedge – P/L
b. Cash Flow Hedge – OCI
5. Remeasurements of defined benefit plan including actuarial gain or loss on defined benefit obligation.
Retirement Plan or Post Employment Plan
 Defined Contribution
 Defined Benefit – OCI
o There is no such thing as actuarial gain or loss when it comes to defined
contribution.

EXPENSE
The decrease in economic benefit during the accounting period in the form of outflow or decrease in asset and
increase in liability that results in decrease in equity, other than distribution to equity participants.
 It is the decrease in equity resulting from a decrease in asset or increase in liability. We need to exclude
owner transaction if we want to classify an item as an expense.
NOTE: Expense encompasses both expense and losses
 EXPENSE
o Arises from ordinary course of business
o Presentation in the FS: at gross amount
 LOSS
o Arises from incidental or peripheral operations
o Presentation in the FS: at net amount (net of direct cost)

CHAPTER 5: RECOGNITION AND DERECOGNITION

Recognition is a term which means the process of reporting an asset, liability, income or expense on the face of
the financial statements of an entity.
 We are incorporating an item into the face of the financial statement.
Recognition criteria
a. It meets the definition of an asset, liability, income or expense
b. Recognizing it would provide useful information
The recognition of an item may not provide useful information if:
a. It is uncertain whether an asset or liability exists
b. An asset or liability exists but the probability of an inflow or outflow of economic benefits is low.
REMINDERS ON RECOGNITION
FAR.02 Conceptual Framework for Financial Reporting

 The recognition criteria above apply to assets, liabilities, income and expense. There is no Equity
Recognition Principle/Criteria because it is a residual interest.
o No specific equity recognition principle.
 The expense recognition principle is the application of the matching principle.
o Recognizing expense as you recognize revenue. If there is no effort, there is no accomplishment.
 Expenses are incurred in conformity with the three applicants of the matching principles, namely:
1. Cause and effect association or Strict Matching
 It strictly follows matching principle. If there is no revenue then there are no expenses.
2. Systematic and rational allocation
 Expense recognition is based on cost allocation. Expenses are allocated based on the number
of years benefiting from that cost (i.e., depreciation).
3. Immediate Recognition
 You need to record expense because you already incurred it, without any recognition of
related revenue (i.e., casualty losses).

Derecognition is the OPPOSITE of recognition. It is the removal of a previously recognized asset or liability from
the entity’s statement of financial position.
Derecognition 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 recognized any resulting income and expenses.
 Every time there is derecognition, there will be an income or expense.
b. Continues to recognize any assets or liabilities retained after the derecognition.
NOTE: Not all transfers require derecognition.

CHAPTER 6: MEASUREMENT
Measurement is the process of determining the monetary amounts at which the elements of the financial
statements are to be recognized and carried in the statement of financial position and income statement.
 Process of assigning amounts to those elements that are to be recognized.

The framework acknowledges that a variety of measurement bases are used today to different degrees and in varying
combinations in financial statement including:
 Historical cost – the measurement is based on the transaction price at the time of recognition of the
element. The historical cost of an asset is the consideration paid to acquire the asset plus transaction
costs. The historical cost of a liability is the consideration received to incur the liability minus
transaction costs.
o Amount paid or the consideration paid to acquire the asset plus the transaction cost.
o Original Cost
 Current value – it measures the element updated to reflect the conditions at the measurement date.
1. 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. Fair value is not an entity specific
measurement.
- Fair market value (old term)
- Amount is not generated by the entity itself; it is based on the external market
condition or external amount.
2. Value in use is the present value of the cash flows or ither economic benefits, that an entity
expects to derive from the use of an asset and from its ultimate disposal. 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.

- Value in use – related to asset

- Fulfilment value – related to liability
 Both are entity generated measurement or entity specific value.
 Initially, there’s no transaction cost, it is included when there’s an ultimate
disposal or fulfilment.
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3. Current cost of 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 transaction costs that would
be incurred on that date. Current cost of liability is the consideration that would be received
for an equivalent liability at the measurement date minus transaction costs that would be
incurred on that date.
- Updated historical cost

CHAPTER 7: PRESENTATION AND DISCLOSURE

Information about assets, liabilities, equity, income and expenses is communicated through presentation and
disclosure in the financial statements.
- Through preparation of financial statements.
Effective communication makes the information more useful. Effective communication requires:
1. Focusing on presentation and disclosure objectives and principles rather than on rules.
2. Classifying information by grouping similar items and separating dissimilar items.
3. Aggregating information in a manner that it is not obscured either by excessive detail or by excessive
summarization.
NOTE: Classification refers to the sorting of assets, liabilities, equity, income or expenses with similar nature,
function and measurement basis for presentation and disclosure purposes. Aggregation is the adding together of
assets, liabilities, equity, income or expenses that have shared characteristics and are included in the same
classification.
CLASSIFICATION – sorting out or grouping of items
AGGREGATION – creating groups or forms

CHAPTER 8: CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE

CONCEPTS OF CAPPITAL
FINANCIAL CAPITAL PHYSICAL CAPITAL
Concept of Capital Invested money or purchasing Productive capacity of the entity
power
Adopted by most entities? Yes No
Measurement Historical cost Current Cost

CAPITAL MAINTENANCE APPROACH

The “capital maintenance approach” or net assets approach means that net income occurs only after the capital used
from the beginning of the period is maintained.
- Net income is derived based from the movement of assets/equity.

Net changes in equity xxx

Less: Additional investment by owners (xxx)
Add: Withdrawals and distributions to owners xxx
Comprehensive Income xxx
Less: Other Comprehensive Income (xxx)
Add: Other Comprehensive Loss xxx
Profit or Loss / Net Income xxx