Conceptual Framework

Objectives of Financial Reporting

Conceptual Framework
The conceptual Framework for Financial Reporting is a complete, comprehensive, and
single document promulgated by the International Accounting Standard Board (IASB).
This is the collection of the terms and concepts that underlie the preparation of financial
statements for external users. Which means that Conceptual Framework is the guide for general
purpose financial reporting.
Conceptual framework is the attempt to provide an overall theoretical foundation for
accounting. This serves as the guide for standard setters, preparers, and users of financial
information in the preparation and presentation of statements.
It is the underlying theory for the development of accounting standards and revision of
previously issued accounting standards.
The conceptual frameworks provide the foundation for standards that:
• Contribute to transparency by enhancing international comparability and quality of
information.
• Strengthen accountability by reducing information gap between providers of the capital
and the people whom they have entrusted their money.
• Contribute to the economic efficiency by helping investors to identify opportunities and
risk across the world.
Purposes of Revised Conceptual Framework:
1. To assist the International Accounting Standards Board to develop IFRS Standards based
on consistent concepts.
2. To assist preparers of financial statements to develop consistent accounting policy when
no Standard applies to a particular transaction or other event or where an issue is not yet
addressed by an IFRS.
3. To assist preparers of financial statements to develop accounting policy when a standard
allows a choice of an accounting policy.
4. To assist all parties to understand and interpret the IFRS standards.
Authoritative Status of Conceptual Framework
If there is a standard or an interpretation that applies to a transaction, the standard or the
interpretation overrides the Conceptual Framework.
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.
 However, it is to be stated that the Conceptual Framework is not an International Financial
Reporting Standard. Nothing in the Conceptual Framework overrides any specific International
Financial Reporting Standard.
In case where there is a conflict, the requirements of the Financial Reporting Standards
shall prevail over the Conceptual Framework.
Users of Financial Information
Under the Conceptual Framework for the Financial Reporting, the users of Financial
information may be classified into two, namely:
• Primary Users – The primary users of the financial information are the parties whom
general purpose financial reports are primarily directed. Such primary users cannot require
reporting entities to provide information directly to them and must rely on general purpose
financial reports for how much of the financial information is needed. The following are
the primary users and the utility of the financial statement to them.
1. Existing and potential investors – are concerned with the risk inherent in
and return provided by their investments. The investors need information to
help them determine whether they should buy hold or sell. Shareholders are
also interested in information that assist them to evaluate a company’s
capability to pay dividends.
2. Lenders and other creditors – Existing and potential lenders and other
creditors are interested in information which enables them to determine
whether their loans, interest, and other amounts owing to them will be paid
when due.
• Other Users – by residual definition, are those that are not primary users. They may find
the financial statements useful but are not directed to them primarily. The following are
the other users:
1. Employees – Employees are interested in information about the stability
and profitability of the company, especially the capability to provide
renumeration, retirement benefits, and employment opportunities.
2. Customers – they are mostly concerned with the continuance of the
company especially when they have a long-term involvement with or are
dependent on the entity.
3. Government and their agencies – are interested in the allocation of
resources and therefore the activities of the company. The information
provided in the financial statement aids the government concerning
company regulation, determination of taxation policies, as a basis for
national income and similar statistics.
4. Public – Entities affect members of the public in varieties of way i.e.
substantial contribution to the local economy such as employment and
informing the public concerning the company’s trend and the range of their
activities.
Scope of Revised Conceptual Framework
a. Objective of Financial Reporting
b. Qualitative characteristics of useful financial information
c. Financial statements and reporting entity
d. Elements of Financial Statements
e. Recognition and derecognition
f. Measurement
g. Presentation and disclosure
h. Concepts of capital and capital maintenance
Objective of Financial Reporting
The objective of financial reporting forms the foundation of the Conceptual Framework.
And that is “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”. Therefore, making the objective of Financial Reporting as the “why” or
goal of accounting.
Financial reporting is the provision of the financial information about the entity to the
external users that is useful to them in making economic decisions and for assessing the
effectiveness of the entity’s management.
The principal way of providing financial information to external users is through annual
financial statements but also emphasizes financial highlights, summary of important financial
figures, analysis of financial statements and significant ratios.
Financial reports also include non-financial information such as description of major
products and a listing of corporate officers and directors.
Target Users
Financial reporting is directed primarily to the existing and potential investors, lenders, and
other creditors which compose the primary user group.
The reason is that existing and potential investors, lenders, and other creditors have the
most critical and immediate need for information in financial reports. As a matter of fact, the
primary users are those that provides resources to the company. The information that meets the
needs of a primary users is likely to meet the need of other users such as employees, customers,
governments and their agencies.
The management of a reporting entity is also interest in financial information of the entity.
However, management need not to rely on general purpose financial reports because it is able to
obtain or access additional financial information internally.
Specific Objectives of financial reporting
The overall objective of financial reporting is to provide information that is useful for
decision making. The conceptual Framework places more emphasis on the importance of
providing information needed to assess the management stewardship of the entity’s economic
resources.
Accordingly, the specific objectives of financial reporting are:
• To provide information in making decision and providing resources to the entity.
• To provide information useful in assessing the cash flow prospects of the entity.
• To provide information about the entity resources, claims, and changes in resources and
claims.
Economic decisions
Existing and potential investors need general purpose financial reports in order to enable
them in making decisions whether to buy, sell, or hold equity investments. On the other hand,
existing and potential lenders and other creditors need general purpose financial reports to enable
them in making decisions whether to provide or settle loans and other forms of credits.
Decision by existing and potential investors about buying, selling, or holding equity
instrument depend on the returns that they expect from an investment, for example, dividends.
Similarly, decisions by existing and potential lenders and other creditors about providing or
settling loans and other forms of credit depend on the principal and interest payments or other
returns that they expect.
Consequently, financial reporting should provide information useful in assessing the
amount, timing, and uncertainty of prospects for future net cash inflows to the entity.
Economic resources and claims
General purpose financial reports provide information about the financial position of a
reporting entity. Financial position is information about the entity’s economic resources and the
claims against the reporting entity.
The economic resources are the assets and the claims are the liabilities and equity of the
entity. In other words, statement of financial position comprises the assets, liabilities, and equity
of the entity. In other words, the financial position comprises the assets, liabilities, and equity at a
particular moment in time.
Information about the nature and amounts of an entity’s economic resources and claims
can help users identify the entity’s financial strength and weakness. Otherwise stated, information
about the financial position can help users to assess entity’s liquidity, solvency, and the need for
additional financing.
 Liquidity is the availability of cash in the near future to cover currently maturing
obligations.
Solvency is the availability of cash over a long term to meet financial commitments when
they fall due.
Information about priorities and payment of requirements of existing claims can help users
to predict how future cash flows will be distributed among those with a claim against the reporting
entity.
Changes in economic resources and claims
General purpose financial reports also provide information about the effects of transactions
and other events that change the economic resources and claims.
Changes in economic resources and claims result from financial performance, and from
other events or transactions such as issuing debts or equity instrument.
The financial performance of an entity comprises revenue, expenses, and net income or
loss for a period of time. This reflects the company’s efficient and effective use of the company’s
resources.
The financial performance of an entity is also known as the results of operations and is
portrayed in the income statement and statement of comprehensive income.
Usefulness of financial performance
Information about financial performance helps users to understand the return that the entity
has produced on the economic resources.
Information about the return the entity has produced provides an indication of how well
management has discharged its responsibilities to make efficient and effective use of the entity’s
economic resources.
Information about the past financial performance is usually helpful in predicting the future
returns on the entity’s economic resources.
Information about financial performances during a period is useful in assessing the entity’s
ability to generate future cash inflows from operations.
Accrual accounting
Accrual accounting depicts the effects of transactions and other events and circumstances
on an entity’s economic resources and claims in the periods in which those effects occur even if
the resulting cash receipts and payments occur in a different period. In other words, under the
accrual basis, the effects of transactions and other events are recognized when they occur and not
as cash is received or paid.
 Simply stated, accrual accounting means that income is recognized when earned
regardless when cash is received and expenses is recognized when incurred regardless when it
is paid.
Information about the financial performance measured in accordance with the accrual
accounting provides a better basis for assessing past and future performance than information
solely on cash receipts and payments during the period.
Limitations of financial reporting
• General purpose financial reports do not and cannot provide all of the information that
existing and potential investors, lenders and other creditors need. These users need to
consider pertinent information from other sources, for example, general economic
conditions, political events, and industry outlook
• General purpose financial reports are not designed to show the value of an entity but the
reports provide information to help the primary users estimate the value of the entity.
• General purpose financial reports are intended to provide common information to users
and cannot accommodate every request for information.
• To a large extent, general purpose financial reports are based on estimate and judgement
rather than exact depiction.
Management stewardship
Information about how efficiently and effectively management has discharged its
responsibilities to use the entity’s economic resources helps users to assess management
stewardship to the resources. Such information is also useful for predicting how management will
use the entity’s economic resources in the future periods.
Hence, the information can be useful for assessing the entity’s prospects for future net cash
flows i.e., management can decide not to dispose or sell investments when prices are declining in
order to avoid realized losses.