Chapter 2-7

Conceptual Framework

Source:
Conceptual Framework and Accounting Standards (Valix, 2020 Edition)
Conceptual Framework
 The Conceptual Framework for the Financial Reporting is a complete,
comprehensive and single document promulgated by the IASB
 Summary of terms and concepts that underlie the preparation and
presentation of FS for external users (general purpose financial reporting)

 Contribute to transparency
 Strengthen accountability
 Contribute to economic efficiency

 In case there is a conflict, the requirements of the IFRS shall prevail over the
Conceptual Framework
Users of Financial Information
 2 Classification of users:
1. Primary users – existing and potential investors, lenders, and other
creditors
a. Existing and potential investors – risk inherent in and return provided
by their investments
b. Lenders and other creditors – ability of the entity to pay

2. Other users – general purpose FS are not directed to them

a. Employees – stability and profitability
b. Customers – continuance of the entity
c. Government and their agencies – allocation of resources and activities
of the entity
d. Public
Scope of the Revised Conceptual
Framework
1. Objective of financial reporting
2. Qualitative characteristics of useful financial information
3. Financial statements and reporting entity
4. 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
Objective of Financial Reporting
 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 of the entity
 FINANCIAL REPORTING
 Financial statements - principal way of providing financial information
 Financial highlights
 Summary of important financial figures
 Analysis of financial statements and significant ratios
 Nonfinancial information
 Directed primarily to PRIMARY USER GROUP
Specific Objectives of Financial Reporting
1. To provide information useful in making decisions about providing resources to the
entity
 Investors – buy, sell, or hold investment
 Lenders – whether to provide or settle loans and other forms of credit
2. To provide information useful in assessing the cash flow prospects of the entity
 Investors – returns of investment (ex. Dividend)
 Lenders – principal and interest payments
3. To provide information about entity resources, claims and changes in resources and
claims
 Financial position of the entity – assets, liabilities, and equity
 Liquidity – short term
 Solvency – long term
 Financial performance – changes in economic resources and claims
Usefulness of Financial Performance

 Provides information on:

1. How well the management discharged its responsibilities
2. Return the entity has produced
3. Past financial performance helpful in predicting future returns
4. Ability to generate future cash flows from operations
Accrual Accounting

 Effects of transactions and other events are recognized when they occur and
not as cash is received or paid
 INCOME – recognized when earned
 EXPENSE – recognized when incurred
Limitations of financial reporting
 Do not and cannot provide all information that primary users need
 Not designed to show value of the entity but the reports provide information
to help primary users estimate the value of the entity
 Intended to provide common information to users
 Based on estimate and judgement rather that exact depiction
Management Stewardship
 Information about how efficiently and effectively management has discharged
its responsibilities
 Such information is useful for:
 Predicting how management will use economic resources
 Assessing entity’s prospects for future net cash flows
 Qualitative
Characteristics
Qualitative Characteristics
 To ensure that the information is useful to the users in making economic
decisions
 2 CLASSIFICATION:
 Fundamental Qualitative Characteristics
 Relevance
 Faithful Representation
 Enhancing Qualitative Characteristics (V-CUT)
 Verifiability
 Comparability
 Understandability
 Timeliness
Fundamental Qualitative Characteristics
 Relate to the content or substance of financial information

1. RELEVANCE
 Materiality concept or the doctrine of convenience
 Information is material if omitting, misstating or obscuring it could
reasonably be expected to influence the economic decisions that
primary users of general purpose financial statements make on the
basis of those statements which provide financial information about a
specific reporting entity
 Financial information is capable of making a difference in a decision if it
has:
1. Predictive Value – predict future outcome
2. Confirmatory Value – provides feedback about previous evaluations
Fundamental Qualitative Characteristics
2. FAITHFUL REPRESENTATION
 Financial reports represents economic phenomena or transactions in words and
numbers
 Substance over form
 To be perfectly faithful representation, a depiction should have:
1. COMPLETENESS
 Adequate disclosure standard or principle of full disclosure
 Notes to financial statements
2. NEUTRALITY
 Without bias in the preparation and presentation
 Prudence / Conservatism – income are not overstated and expenses are not
understated (least effect on the equity)
3. FREE FROM ERROR
 No error or omissions
 Measurement uncertainty (estimate) - describe clearly and accurately
Enhancing Qualitative Characteristics
 INCREASE the usefulness of the financial information
1. COMPARABILITY
 Ability to bring together for the purpose of noting points of likeness and difference
 Uniform application of accounting method between and across entities in the same industry
 Consistency - uniform application of accounting method from period to period within an entity
2. UNDERSTANDABILITY
 Readily understandable by users
 Prepared for users who have a reasonable knowledge of business and economic activities who review
and analyze the information diligently
3. VERIFIABILITY
 Implies consensus
 It can be direct or indirect verification
4. TIMELINESS
 must be available or communicated early enough when a decision is to be made
Cost constraint on useful information
 COST is a pervasive constraint on the information that can be provided by
financial reporting
 The benefit derived from the information should exceed the cost incurred
in obtaining the information
Financial Statements and
Reporting Entity
General Objective of Financial Statements
 Financial Statements provide information about economic resources of the
reporting entity, claims against the entity and changes in the economic
resources and claims
 Three types of financial statements:
1. Consolidated financial statements
 When the reporting entity comprises both the parent and its subsidiaries

2. Unconsolidated financial statements

 when the reporting entity is the parent alone

3. Combined financial statements

 When the reporting entity comprises two or more entities that are not linked with parent
and subsidiary relationship
Reporting Entity
 Reporting entity is an entity that is required or chooses to prepare financial
statements
 not necessarily a legal entity

 REPORTING PERIOD
 Period when financial statements are prepared for general purpose financial
reporting
 Financial statements must be prepared on an annual basis or a period of
twelve months
 Interim financial statements are not required but optional
 Comparative information for at least one preceeding period - to identify and
assess change in trends
 Events occurred after reporting period – included if necessary
Underlying Assumption
Underlying Assumption
 Are basic notions or fundamental premises on which the accounting process is
based
 Postulates
 GOING CONCERN – only one assumption provided on the Conceptual
Framework
 Implicit assumptions:
1. Accounting entity
2. Time Period
3. Monetary Unit
Underlying Assumption – GOING CONCERN
 Going Concern or continuity assumption
 The accounting entity is viewed as continuing in operation indefinitely
 Assets are normally recorded at cost
 Implicit Assumptions:
1. ACCOUNTING ENTITY
 The entity is separate from the owners, managers, and employees who constitute the entity
2. TIME PERIOD
 Indefinite life of the entity is subdivided into accounting periods which are usually of equal length for
the purpose of preparing financial reports
 Calendar year – 12-month period that ends on December 31
 Fiscal year – 12-month period that ends on any month
 Natural business year – 12-month period that ends on any month when the business is at the lowest
3. MONETARY UNIT
 Quantifiability – should be stated in terms of a unit of measure which is the Peso in the Philippines
 Stability of Peso – purchasing power is stable or constant
Elements of Financial
Statements
Elements of Financial Statements
 Refer to the quantitative information reported in the statement of financial
position and income statements
 Conceptual Framework identifies no elements that are unique to the
statement of changes in equity because such statement comprises items that
appear in the statement of financial position and the income statement
Elements of Statement Financial Positions
1. ASSET
 Present economic resource controlled by the entity as a result of past events
 Economic resource is a right that has the potential to produce economic benefits
 Essential characteristics of asset
1. The asset is a present economic resource
2. The economic resource is a right that has the potential to produce economic benefits
3. The economic resource is controlled by the entity as a result of past events
2. LIABILITY
 Present obligation of an entity to transfer economic resource as a result of past events
 Essential characteristics of liability
1. The entity has an obligation
2. The obligation is to transfer an economic resource
3. The obligation is a present obligation that exists as a result of past events
3. EQUITY
 is the residual interest in the assets of the entity after deducting all of the liabilities
Elements of Statement of Financial Performance
1. INCOME
 Increases in assets and decreases in liabilities that result in increases in equity,
other than those relating to contributions from equity holders
 Revenue – arises in the course of ordinary regular activities
 Gains – represent other items that meet the definition of income
2. EXPENSE
 Decreases in assets and increases in liabilities that result in decreases in equity,
other than those relating to distributions to equity holders
 Expenses – arise in the course of ordinary regular activities
 Losses – do not arise in the course of ordinary regular activities
Recognition and
Measurement
Recognition
 Process of capturing for inclusion in the financial statements an item that
meets the definition of an asset, liability, equity, income and expense
 Carrying amount – asset, liability, and equity

 Criteria:
 Only items that meet the definition of an asset, liability, equity, income and
expense are recognized
 When recognition provides users with information that is both relevant and
faithfully represented
 An asset or liability and any corresponding income or expense can exist even if
the probability of inflow or outflow of the benefits is low
Recognition…
 POINT OF SALE INCOME RECOGNITION
 Income shall be recognized when earned
 Sale of goods – recognized at point of sale, when significant risk and rewards of ownership of goods are
transferred to the buyer
 EXPENSE RECOGNITION
 Recognized when incurred
 Matching principle – costs and expenses incurred in earning a revenue shall be reported in the same
period
a. Cause and effect association – expense is recognized when the revenue is already recognized
b. Systematic and rational allocation – some costs are expensed by simply allocating them over
the periods benefited
c. Immediate recognition
 Expenditure produces no future economic benefit
 Cost incurred does not qualify or ceases to qualify for recognition of an asset
 DERECOGNITION
 Removal of all or part of a recognized asset or liability from the statement of financial position
Measurement
 Quantifying in monetary terms the elements in the financial statements

 TWO CATEGORIES:
1. HISTORICAL COST
2. CURRENT VALUE
Measurement – HISTORICAL COST
 Entry price or entry value
 Asset - Original acquisition cost
 Liability – consideration received minus transaction cost
 Financial asset and financial liability – at amortized cost (estimate of future cash flows
discounted at a rate determined at initial recognition)
 Historical cost of an asset is updated because of:
1. Depreciation and amortization
2. Payment received as a result of disposal
3. Impairment
4. Accrual of Interest
5. Amortized Cost measurement
 Historical Cost of a liability is updated because of:
1. Payment made or satisfaction of obligation
2. Increase in value
3. Accrual of interest
4. Amortized cost
Measurement – CURRENT VALUE
1. FAIR VALUE
 Exit price or exit value
 Asset – price that would be received to sell an asset
 Liability – price that would be paid to transfer a liability
 Not adjusted for transaction cost
 Present value of cash flows – if FV cannot directly measured
2. VALUE IN USE FOR ASSET
 Present value of the cash flows that an entity expects to derive from the use of an asset
and from ultimate disposal
3. FULFILLMENT VALUE FOR LIABILITY
 Present value of cash that an entity expects to transfer in paying or settling a liability
4. CURRENT COST
 Cost of an equivalent asset at measurement date comprising the consideration paid and
transaction cost
Selecting Measurement basis
 No single factor will determine which measurement basis should be selected
 Historical cost – most commonly adopted
 The IASB did not mandate a single measurement basis because the different
measurement bases could produce useful information under different
circumstances
Presentation and Disclosure
Presentation and Disclosure
 Can be an effective communication tool about the information in financial
statements
 Makes the information more relevant and contributes to a faithful
representation of an entity’s assets, liabilities, income, and expenses

CLASSIFICATION
 Sorting of assets, liabilities, equity, income and expenses on the basis of
shared or similar characteristics
 Income and expenses are classified as components of profit or loss and
components of other comprehensive income
 Statement of financial performance – refer to statement of profit or loss
together with the statement presenting other comprehensive income.
AGGREGATION
 Adding together of assets, liabilities, equity, income and expenses that shared
or have similar characteristics and are included in the same classification
 Detailed information is provided in the Notes to Financial Statements
Concepts of Capital
Capital maintenance
 Financial Performance of an entity is determined using two approaches:
1. Traditional approach
 Traditional preparation of income statement
2. Capital maintenance approach
 Net income occurs only after the capital used from the beginning of the
period is maintained
 Net income is the amount an entity can distribute to its owners
 Return of capital – erosion of the capital invested
 Return on capital – earnings of the investment
 Two concepts of capital maintenance:
1. Financial Capital
2. Physical Capital
Capital maintenance – FINANCIAL CAPITAL
 Financial capital – monetary amount of the
net assets contributed by shareholders and
the amount of the increase in net assets
resulting from earnings retained by the
entity
 Based on historical cost
 Net income – when nominal amount of net
assets at the end of the year exceeds the
nominal amount of net assets at the
beginning of the period, after excluding
distributions to and contributions by owners
during the period.
 Also known as Net asset Approach
Capital maintenance – PHYSICAL CAPITAL
 Physical Capital – quantitative measure
of the physical productive capacity to
produce goods and services
 Measured at current cost
 Net Income – when the physical
productive capital of the entity at the
end of the year exceeds the physical
productive capital at the beginning of the
period, also after excluding distributions
to and contributions from owners during
the period.