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CONCEPTUAL FRAMEWORK
&
ACCOUNTING STANDARDS
1

Conceptual Framework for Financial Reporting

Learning Objectives
• State the purpose, status, and scope of the Conceptual
Framework.
• State the objective of financial reporting.
• Identify the primary users of financial statements.
• Explain briefly the qualitative characteristics of useful
information and how they are applied in financial
reporting.
• Define the elements of financial statements and state their
recognition criteria and their derecognition.
• State the measurement bases used in financial reporting.

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Standards (by: Zeus Vernon B. Millan)

Purpose of the Conceptual Framework

• The Conceptual Framework prescribes the concepts for general

purpose financial reporting. Its purpose is to:
a. assist the International Accounting Standards Board (IASB) in
developing Standards that are based on consistent concepts;
b. assist preparers in developing consistent accounting policies
when no Standard applies to a particular transaction or when a
Standard allows a choice of accounting policy; and
c. assist all parties in understanding and interpreting the
Standards.

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Status of the Conceptual Framework

• The Conceptual Framework is not a PFRS. When there is a
conflict between the Conceptual Framework and a PFRS, the
PFRS will prevail.
• In the absence of a standard, management shall consider the
Conceptual Framework in making its judgment in developing
and applying an accounting policy that results in useful
information.

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Scope of the Conceptual Framework

The Conceptual Framework is concerned with general purpose
financial reporting. General purpose financial reporting involves the
preparation of general purpose financial statements. The Conceptual
Framework provides the concepts regarding the following:
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

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Objective of general purpose financial reporting

• The objective of general purpose financial reporting
is to provide financial information about the reporting entity
that is useful to primary users in making decisions about
providing resources to the entity.
• The objective of general purpose financial reporting forms
the foundation of the Conceptual Framework.

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Primary Users

• Primary users – are those who cannot demand information

directly from reporting entities. The primary users are:
(a) Existing and potential investors
(b) Lenders and other creditors.

• Only the common needs of primary users are met by the financial
statements.

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Qualitative Characteristics
I. Fundamental qualitative characteristics
(1) Relevance
(a) Predictive value
(b) Feedback value
 Materiality – entity-specific aspect of relevance
(2) Faithful representation
(a) Completeness
(b) Neutrality
(c) Free from error

II. Enhancing qualitative characteristics

(1) Comparability
(2) Verifiability
(3) Timeliness
(4) Understandability
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Fundamental vs. Enhancing

• The fundamental qualitative characteristics are the

characteristics that make information useful to users.
• The enhancing qualitative characteristics are the
characteristics that enhance the usefulness of information

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Relevance

• Information is relevant if it can affect the decisions of users.

• Relevant information has the following:
a. Predictive value – the information can be used in making predictions
b. Confirmatory value – the information can be used in confirming
past predictions

 Materiality – is an ‘entity-specific’ aspect of relevance.

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Faithful Representation

• Faithful representation means the information provides a true,

correct and complete depiction of what it purports to represent.
• Faithfully represented information has the following:
a. Completeness – all information necessary for users to
understand the phenomenon being depicted is provided.
b. Neutrality – information is selected or presented without bias.
c. Free from error – there are no errors in the description and in
the process by which the information is selected and applied.

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Enhancing Qualitative Characteristics

1. Comparability – the information helps users in identifying

similarities and differences between different sets of information.
2. Verifiability – different users could reach consensus as to what
the information purports to represent.
3. Timeliness – the information is available to users in time to be
able to influence their decisions.
4. Understandability – users are expected to have:
a. reasonable knowledge of business activities; and
b. willingness to analyze the information diligently.

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Financial statements and the 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 ability to generate future net cash inflows; and
b. management’s stewardship over economic resources.

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Financial statements and the Reporting entity

Reporting period
• Financial statements are prepared for a specific period of time (i.e., the
reporting period) and include comparative information for at least
one preceding reporting period.

Going concern
• Financial statements are normally prepared on the assumption that the
reporting entity is a going concern, meaning the entity has neither
the intention nor the need to end its operations in the foreseeable
future.

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Financial statements and the Reporting entity

Reporting entity
• A reporting entity is one that is required, or chooses, to prepare
financial statements, and is not necessarily a legal entity. It can be a
single entity or a group or combination of two or more entities.

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Elements of Financial Statements

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Asset

• Asset 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.” (Conceptual Framework 4.3 & 4.4)

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Three aspects in the definition of an asset

1. Right – asset refers to a right, and not necessarily to a physical
object, e.g., the right to use, sell, lease or transfer a building.
2. Potential to produce economic benefits – the right has a
potential to produce economic benefits for the entity that are
beyond the benefits available to all others. Such potential need
not be certain or even likely – what is important is that the right
already exists and that, in at least one circumstance, it would
produce economic benefits for the entity.
3. Control – means the entity has the exclusive right over the
benefits of an asset and the ability to prevent others from
accessing those benefits.

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Liability

• Liability is “a present obligation of the entity to transfer

an economic resource as a result of past events.” (Conceptual
Framework 4.26)

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Three aspects in the definition of a liability

1. Obligation – An obligation is “a duty or responsibility that an
entity has no practical ability to avoid.” (CF 4.29) An obligation can be
either legal obligation or constructive obligation.
2. Transfer of an economic resource – the obligation has
the potential to require the transfer of an economic resource
to another party. Such potential need not be certain or even
likely – what is important is that the obligation already exists
and that, in at least one circumstance, it would require the
transfer of an economic resource.

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Three aspects …… liability (continuation)

3. Present obligation as a result of past events – A present
obligation exists as a result of past events if:
a. the entity has already obtained economic benefits or taken an
action; and
b. as a consequence, the entity will or may have to transfer an
economic resource that it would not otherwise have had to
transfer.
(Conceptual Framework 4.43)

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Executory contracts
• An executory contract “is 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.” (CF 4.56)
• An executory contract establishes a combined right and obligation to
exchange economic resources.
• The contract ceases to be executory when one party performs its
obligation.
 If the entity performs first, the entity’s combined right and
obligation changes to an asset.
 If the other party performs first, the entity’s combined right and
obligation changes to a liability.

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Equity

• “Equity is the residual interest in the assets of the entity after

deducting all its liabilities.” (Conceptual Framework 4.63)
• Equity equals Assets minus Liabilities

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Income and Expenses

• Income
Income is “increases in assets, or decreases in liabilities, that result in
increases in equity, other than those relating to contributions from
holders of equity claims.” (Conceptual Framework 4.68)

• Expenses
Expenses are “decreases in assets, or increases in liabilities, that result
in decreases in equity, other than those relating to distributions to
holders of equity claims.” (Conceptual Framework 4.69)

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Recognition & Derecognition

The recognition process

• Recognition is the process of including in the statement of financial
position or the statement(s) of financial performance an item that
meets the definition of one of the financial statement elements (i.e.,
asset, liability, equity, income or expense). This involves recording
the item in words and in monetary amount and including that
amount in the totals of either of those statements.

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Recognition & Derecognition

Recognition criteria
• An item is recognized if:
a. it meets the definition of an asset, liability, equity, income or
expense; and
b. recognizing it would provide useful information, i.e., relevant and
faithfully represented information.

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Recognition & Derecognition

Relevance
• The recognition of an item may not provide relevant information if,
for example:
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. (Conceptual Framework 5.12)

However, the presence of one or both of the foregoing does not

automatically lead to the non-recognition of an item. Other factors
should also be considered.

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Recognition & Derecognition

Faithful representation
• The level of measurement uncertainty and other factors can affect an
item’s faithful representation, but not necessarily its relevance.

Measurement uncertainty
• Measurement uncertainty exists if the asset or liability needs to be
estimated. A high level of measurement uncertainty does not
necessarily lead to the non-recognition of an asset or liability if the
estimate provides relevant information and is clearly and accurately
described and explained.
• However, measurement uncertainty can lead to the non-recognition of
an asset or a liability if making an estimate is exceptionally difficult
or exceptionally subjective.
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Recognition & Derecognition

Derecognition
• Derecognition is the removal of a previously recognized asset or
liability from the entity’s statement of financial position.
• Derecognition occurs when the item ceases to meet the definition
of an asset or liability.

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Unit of account

• Unit of account is “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.”
(Conceptual Framework 4.48)

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Measurement bases

1. Historical cost
2. Current value
a. Fair value
b. Value in use and fulfilment value
c. Current cost

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Historical cost

• The historical cost of:

a. an asset is the consideration paid to acquire the asset plus
transaction costs.
b. a liability is the consideration received to incur the liability minus
transaction costs.
• Historical cost is updated over time to depict the following:
 Depreciation, amortization, or impairment of assets
 Collections or payments that extinguish part or all of the asset or
liability
 Unwinding of discount or premium when the asset or liability is
measured at amortized cost

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Fair value

• 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 at the measurement date.” (Conceptual Framework 6.12)

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Value in use and fulfilment 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.” (Conceptual Framework 6.17)
• 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.” (Conceptual Framework 6.17)

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Current cost

• The current cost of:

a. 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 the transaction costs that would be
incurred at that date.”
b. a liability is “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.”
(Conceptual Framework 6.21)

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Entry values vs. Exit values

• Current cost and historical cost are entry values (i.e., they reflect
prices in acquiring an asset or incurring a liability), whereas fair
value, value in use and fulfilment value are exit values (i.e., they
reflect prices in selling or using an asset or transferring or fulfilling a
liability).

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Considerations when selecting a measurement basis

• When selecting a measurement basis, it is important to consider the

following:
a. The nature of information provided by a particular
measurement basis (e.g., measuring an asset at historical cost may
lead to the subsequent recognition of depreciation or impairment, while
measuring that asset at fair value would lead to the subsequent
recognition of gain or loss from changes in fair value).
b. The qualitative characteristics, the cost-constraint, and
other factors (e.g., a particular measurement basis may be more
verifiable or more costly to apply than the other measurement bases).

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Measurement of Equity

• Total equity is not measured directly. It is simply equal to difference

between the total assets and total liabilities.
• Because different measurement bases are used for different assets
and liabilities, total equity cannot be expected to be equal to the
entity’s market value nor the amount that can be raised from either
selling or liquidating the entity.
• Equity is generally positive, although some of its components can be
negative. In some cases, even total equity can be negative such as
when total liabilities exceed total assets.

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Presentation and Disclosure

• Information is communicated through presentation and disclosure
in the financial statements.
• Effective communication makes information more useful. Effective
communication requires:
a. focusing on presentation and disclosure objectives and
principles rather than on rules.
b. classifying information by grouping similar items and separating
dissimilar items.
c. aggregating information in a manner that it is not obscured
either by excessive detail or by excessive summarization.

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Presentation and disclosure objectives and principles

• The objectives are specified in the Standards.

• The principles include:
a. the use of entity-specific information is more useful that
standardized descriptions, and
b. duplication of information is usually unnecessary.

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Classification

• Classifying means combining similar items and separating

dissimilar items.
• Offsetting of assets and liabilities is generally not appropriate.

Classification of income and expenses

• Income and expenses are classified as recognized either in:
a. profit or loss; or
b. other comprehensive income.

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Aggregation

• Aggregation is “the adding together of assets, liabilities, equity,

income or expenses that have shared characteristics and are
included in the same classification.” (Conceptual Framework 7.20)

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Concepts of Capital and Capital Maintenance

• Financial concept of capital – capital is regarded as

the invested money or invested purchasing power.
Capital is synonymous with equity, net assets, and net
worth.

• Physical concept of capital – capital is regarded as

the entity’s productive capacity, e.g., units of output per
day.

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