ACCA Financial Reporting (FR / F7)

CHAPTER 1: CONCEPTUAL FRAMEWORK

CHAPTER 1: CONCEPTUAL
FRAMEWORK

LEARNING OUTCOME
At the end of the chapter, you should be able to:

TLO A1a : Describe what is meant by a conceptual framework for financial reporting
TLO A1b : Discuss whether a conceptual framework is necessary and what an alternative system
might be
TLO A1c : Discuss what is meant by relevance and faithful representation and describe the
qualities that enhance these characteristics
TLO A1d : Discuss whether faithful representation constitutes more than compliance with
accounting standards
TLO A1e : Discuss what is meant by understandability and verifiability in relation to the provision
of financial information
TLO A1f : Discuss the importance of comparability and timeliness to users of financial statements
TLO A1g : Discuss the principle of comparability in accounting for changes in accounting policies
TLO A2a : Define what is meant by ‘recognition’ in financial statements and discuss the recognition
criteria
TLO A2b : Apply the recognition criteria to:
I) assets and liabilities.
II) income and expenses.
TLO A2c : Explain and compute amounts using the following measures:
I) historical cost
II) current cost
III) value in use
IV) fair value
TLO A2d : Discuss the advantages and disadvantages of historical cost accounting
TLO A2e : Discuss whether the use of current value accounting overcomes the problems of
historical cost accounting
TLO A2f : Describe the concept of financial and physical capital maintenance and how this affects
the determination of profits

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1.1 Overview
Learning Outcome (ACCA Study Guide Area A)
A1a: Describe what is meant by a conceptual framework for financial reporting

Regulation in financial reporting practice is important to ensure an entity adopts accounting treatment that
is consistent in preparing and presenting financial statements, which provide information that is useful to
a wide range of users, to assists their decisions making.

Regulatory bodies set accounting standards to ensure that entities adopt similar accounting treatments for
similar items and account for similar transactions in the same way over time. This makes it possible to
compare the financial statements of different entities and to compare an entity’s performance for the
current year with its performance in previous years.

Without regulation, management would adopt whichever accounting treatment presented its results and
position in the best possible light. Sometimes management might deliberately mislead users of the financial
statements.

Diagram 1.1: Overview of conceptual framework

1.1.1 The Conceptual Framework

15.1.1
In March 2018, the International Accounting Standards Board (IASB) finished its revision of The Framework
for Financial Reporting (the Framework).

The primary purpose of financial information is to be useful to existing and potential investors, lenders
and other creditors (users) when making decisions about the financing of the entity and exercising rights
to vote on, or otherwise influence, management’s actions that affect the use of the entity’s economic
resources.

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The purpose of the Framework is to:

 assist the IASB to develop and revise its standards
 assist entities to develop consistent accounting policies when no standard applies to a particular
transaction or other event, or when a standard allows a choice of accounting policy, and
 assist all stakeholders to understand and interpret the standards
IFRSs take precedence over the Framework. However, should new IFRSs depart from the Framework, the
IASB will explain the reasons in the Basis for Conclusions on that standard.

1.2 Scope of Conceptual Framework

Learning Outcome (ACCA Study Guide Area A)
A1b: Discuss whether a conceptual framework is necessary and what an alternative system might be

1.2.1 Scope of IASB’s Conceptual Framework

The revised 2018 conceptual framework covers 8 area:

Diagram 1.2.1: Conceptual framework for financial reporting

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CHAPTER 1: CONCEPTUAL FRAMEWORK

1.2.2 The Objective of Financial Reporting

Diagram 1.2.2: Objective of financial reporting

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1.2.3. The needs for adopting IFRS

 Widely accepted as a set of high-quality and transparent global standards to achieve consistency and
comparability across the world

 Produced with co-operation of other internationally renowned standard setters, with the aspiration of
achieving consensus and global convergence

 Companies that uses IFRS and have their FS audited in accordance to IFRS will have an enhanced status
and reputation

 The International Organisation of Securities Commission (IOSCO) recognize IFRS for listing purposes –
thus companies that adopt IFRS need to produce only one set of FS for any securities listing for
countries that are members of IOSCO – hence easier and cheaper to raise finance in international
markets

 Companies with foreign subsidiaries will find process of consolidation simplified if all subsidiaries adopt
IFRS. It enables accounting staff to be transferred between group of companies in different countries.

 Companies that adopts IFRS find their FS easily comparable with other companies who also adopts
IFRS. This could obviate the need for any reconstruction from local GAAP to IFRS when analyst assess
performance

1.2.4 IFRS vs US GAAP

Beside IFRS, General Accepted Accounting Principles (GAAP) also become one of reference for company
reporting preparation. GAAP refer to a common set of accepted accounting principles, standards, and
procedures that companies and their accountants must follow when they compile their financial
statements. The comparison between IFRS and GAAP are as follow:

Table 1.2.4: Comparison between IFRS and US GAAP

IFRS US GAAP

Formulated accordance to principles sets in CF Based on description with series of detailed rules

Principle based system Rule based system

Relies on generally accepted accounting principles

and exercises judgment in dealing with Less flexible (rules and requirements lengthy and
transactions and in applying the principles to complex) but often more comparable
different industries

Disadvantage: Accountants and auditors expect to find specific

 Inconsistencies between reporting entities rules to cover every situation in every industry
 Manipulation of FS that they are involved in. Hence, less burden.
 Burden on accountants and auditors

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1.3 The Qualitative Characteristic of Useful Financial Information

Learning Outcome (ACCA Study Guide Area A)
A1c: Discuss what is meant by relevance and faithful representation and describe the qualities that
enhance these characteristics.
A1d: Discuss whether faithful representation constitutes more than compliance with accounting standards
A1e: Discuss what is meant by understandability and verifiability in relation to the provision of financial
information
A1f: Discuss the importance of comparability and timeliness to users of financial statements

Financial information that is useful should be relevant and faithfully represent what it purports to
represent.

The usefulness of financial information is further enhanced if it is comparable, verifiable, timely and
understandable.

Diagram 1.3: Qualitative Characteristics

1.3.1 Fundamental qualitative characteristics

15.1.2

Qualitative characteristics are the attributes that make information provided in financial statements useful
to others

Relevance

Has the ability to influence the economic decision of users, where information that is relevant has both
following values:

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Table 1.3.1.1: Relevance value

Predictive value Confirmatory value

 Helps users to predict future outcomes  Helps users to confirm or correct
previous evaluations and assessments

Materiality has a direct impact on the relevance of information.

Information is material if omitting, misstating or obscuring it could reasonably be expected to influence

decisions that the primary users of general purpose financial statements make on the basis of those
financial statements, which provide financial information about a specific reporting entity.

Materiality is an entity-specific aspect of relevance, based on the size, nature or magnitude (or both) of
the items to which the information relates in the context of an individual entity’s financial report.

Faithful Representation (formally known as reliability)

To be useful, financial information must not only be relevant, it must also represent faithfully the
phenomena it purports to represent. Faithful representation means representation of the substance of
an economic phenomenon instead of representation of its legal form only (Substance over form).

A faithful representation is, to the maximum extent possible, complete, neutral and free from error.

a. Complete
To ensure all impacts of transactions must be recorded and not omitted with necessary
narrations

b. Neutral
Free from bias – FS will not be considered as neutral if specific information was deliberately
selected and presented in order to achieve a predetermined result or outcome

Neutrality is supported by the exercise of prudence. Prudence is the exercise of caution when
making judgements under conditions of uncertainty. Prudence does not allow for overstatement
or understatement of assets, liabilities, income or expenses.

c. Free from error (Accuracy)

Free from material misstatement or omission as material error, or either an omission or
misstatement can cause the financial statements to be false or misleading.

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Faithful representation is affected by measurement uncertainty. Measurement uncertainty does not

prevent information from being useful. For example, in some cases, relevant information may have a high
level of measurement uncertainty, which may reduce its usefulness. Slightly less relevant information with
a lower measurement uncertainty may be preferable in such cases.

1.3.2 Enhancing qualitative characteristics

To improve the usefulness of information that is relevant and faithfully represented

Comparability

Enables users to identify and understand similarities in, and differences among, items. To ensure
information is comparable, there must be:

 consistent application of accounting policies from one period to the next;

 disclosure of accounting policies being applied so that users able to distinguish between different
accounting policies in order to be able to make a valid comparison of similar items in the accounts of
different entities.

Timeliness

Having information available for decision makers in time (timely information), capable of influencing their
economic decisions. As a general rule, older information is less useful than recent information.

Verifiability

Information is verifiable (capable of being verify) in the sense that it should ensure credibility and
objectivity. It requires that independent observers reach the same or similar conclusions that:

 not biased or contains material errors and

 recognition of the chosen method of assessment is applied free from material error and subjectivity

Understandability

Classifying, characterising and presenting information clearly and concisely makes it understandable. While
some phenomena are inherently complex and cannot be made easy to understand, to exclude such
information would make financial reports incomplete and potentially misleading. Financial reports are
prepared for users who have a reasonable knowledge of business and economic activities and who review
and analyse the information with diligence.

Enhancing qualitative characteristics should be maximised to the extent necessary. However, enhancing
qualitative characteristics (either individually or collectively) cannot render information useful if that
information is irrelevant or not represented faithfully.

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Cost Constraint on Financial Reporting

Cost is a pervasive constraint on the information that can be provided by general purpose financial
reporting and it is therefore important to determine whether the benefits to users of the information
justify the cost incurred by the entity providing it.

1.3.3 Underlying Assumption

The Conceptual Framework of Accounting mentions the underlying assumption of going concern. In
addition, the concepts of accrual, accounting entity, monetary unit, and time period are also important in
preparing and interpreting financial statements.

Going concern basis

Going concern is referred to by the IASB’s Conceptual Framework as the 'underlying assumption'

The accrual basis of accounting assumes that an entity is a going concern. Under this basis, financial
statements are prepared on the assumption that the entity will continue in operation for the foreseeable
future (that is 12 months after the reporting date), in that management has neither the intention nor the
need to liquidate the entity by selling all its assets, paying off all its liabilities and distributing any surplus
to the owners.

Examples of the importance of the Going Concern basis are as follows:

a. The measurement of receivables from trade customers is made on the basis that there is no time limit
over which management will chase slow payers. If the entity were to cease operation in, say, three
months, a number of balances might have to be regarded as bad (irrecoverable) debts.

b. The measurement of non-current assets is made on the basis that they can be utilised throughout their
planned life. Otherwise, they would have to be valued at what they could immediately be sold for,
which might not be very much, in the case of assets used in markets where there is excess capacity.

Break-up basis

One of the key assumptions made under the accruals basis is that the business will continue as a going
concern. However, this will not necessarily always be the case. There may be an intention or need to sell
off the assets of the business. Such a sale typically arises where the business is in financial difficulties and
needs the cash to pay its creditors. Where this is the case an alternative method of accounting must be
used (in accordance with IAS 1 Presentation of Financial Statements). In these circumstances the financial
statements will be prepared on a basis other than going concern, which is commonly referred to as the
‘break-up’ basis. The break-up basis values assets and liabilities today as if the entity was about to cease
trading and had to dispose of all its assets and liabilities.

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The effect of this is seen primarily in the statement of financial position as follows:
a. Classification of assets
All assets and liabilities would be classified as current rather than non-current.

b. Valuation of assets
Assets would be valued on the basis of the recoverable amount on sale. This is likely to be
substantially lower than the carrying amount of assets held under historical cost accounting.

1.4 Understanding of Financial Statement

Learning Outcome (ACCA Study Guide Area A)
A2a: Define what is meant by ‘recognition’ in financial statements and discuss the recognition criteria
A2b: Apply the recognition criteria to:
I) assets and liabilities
II) income and expenses

1.4.1 Objective and scope of financial statements

15.1.3

The objective of financial statements is to provide information about an entity's assets, liabilities, equity,
income and expenses that is useful to financial statements users in assessing the prospects for future net
cash inflows to the entity and in assessing management's stewardship of the entity's economic resources.

When considering the objective of general-purpose financial reporting, the Board reintroduced the
concept of ‘stewardship’. The importance of stewardship by management is inherent within the existing
Framework and within financial reporting, so this statement largely reinforces what already exists.

Users base their expectations of returns on their assessment of:

 the amount, timing and uncertainty of future net cash inflows to the entity, and
 management’s stewardship of the entity’s resources.

This information is provided in the: -

1. statement of financial position;

2. the statement(s) of financial performance; and
3. other statements and notes.

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Diagram 1.4.1: Scope of financial statement

1.4.2 Presentation and closure

15.1.4
According to IAS 1 (presentation of financial statement), an entity should meet the fair presentation
requirement which require it to be comply with IFRS standard. Financial statements should meet fair
presentation of the financial position, financial performance and cash flows of an entity.

Fair presentation requires the faithful representation of the effects of transactions, other evernts and
conditions in accordamce with the definations and recognition criteria for assets, liabilities, income and
expensesset out in the Conceptual Framework.

IAS 1 highligted following principles for presentation of financial statement:

 Compliance with IFRS should be disclosed

 All relevant IFRS must be followed if compliance with IFRS is disclosed
 Use of an inappropriate accounting treatment cannot be rectified either by disclosure of
accounting policies or notes/explanatory material

IAS 1 states what is required for a fair presentation:

 Selection and application of accounting policies

 Presentation of information in manner which provides relevant, realible, comparable and
understandable information
 Additional disclosure where required

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Reporting entity

A reporting entity is an entity that is required, or chooses, to prepare financial statements. A reporting
entity is not necessarily a legal entity. It can comprise:-

 A single entity – for example, one company;

 A portion of an entity – for example, a division of one company;
 More than one entities – for example, a parent and its subsidiaries reporting as a group.

As a result, we have a few types of financial statements:

 Consolidated: a parent and subsidiaries report as a single reporting entity;

 Unconsolidated: e.g. a parent alone provides reports, or
 Combined: e.g. reporting entity comprises two or more entities that are not all linked by parent-
subsidiary relationship.

Generally, consolidated financial statements are more likely to provide useful information to users of
financial statements than unconsolidated financial statements.

Therefore, it is important to determine the boundaries of a reporting entity. Determining the appropriate
boundary of a reporting entity is driven by the information needs of the primary users of the reporting
entity’s financial statements.

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1.4.3 Elements of Financial Statements

15.1.5
i. Asset & Liability (Statement of Financial Position)

Diagram 1.4.3(a): Elements of financial statement

*No practical ability to avoid

The ‘no practical ability to avoid’ criterion is applied in the following circumstances:

(a) if a duty or responsibility arises from the entity’s customary practices, published policies or specific
statements—the entity has an obligation if it has no practical ability to act in a manner inconsistent with
those practices, policies or statements.

(b) if a duty or responsibility is conditional on a particular future action that the entity itself may take—
the entity has an obligation if it has no practical ability to avoid taking that action

ii. Income and Expenses (Statement of Financial Performance)

Diagram 1.4.3(b): Elements of financial statement

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1.4.4 Recognition
15.1.6
Only items that meet the definition of an asset, a liability or equity are recognised in the statement of
financial position and only items that meet the definition of income or expenses are to be recognised in
the statement of financial performance.

Not all items that meet the definition of one of the elements listed above are recognized in the financial
statements. The Framework requires recognising the elements only when the recognition provides useful
information – relevant with faithful representation, because the aim is to provide information that is
useful to investors, lenders and other creditors.

A key change to this is the removal of a ‘probability criterion’. This has been removed as different financial
reporting standards apply different criterion; for example, some apply probable, some virtually certain and
some reasonably possible. This also means that it will not specifically prohibit the recognition of assets or
liabilities with a low probability of an inflow or outflow of economic resources.

We can summarise the recognition criteria for assets, liabilities, income and expenses, based on the
definition of recognition given above:

Diagram 1.4.4: Recognition criteria

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1.4.5 Derecognition
15.1.7
Derecognition means removal of all or part of a recognised asset or liability from an entity’s statement of
financial position. Derecognition normally occurs when: -

 For an asset, when the entity loses control of all or part of the recognised asset
 For a liability, when the entity no longer has a present obligation for all or part of the recognised
liability

Derecognition should aim to faithfully represent both:

 assets and liabilities retained after the transaction that led to the derecognition
 the change in assets and liabilities as a result of the transaction that led to the derecognition

1.5 Measurement
Learning Outcome (ACCA Study Guide Area A)
A2c: Explain and compute amounts using the following measures:
I) Historical cost
II) Current cost
III) Value in use
IV) Fair Value
A2d: Discuss the advantages and disadvantages of historical cost accounting
A2e: Discuss whether the use of current value accounting overcomes the problems of historical cost
accounting

The Framework discusses two basic measurement basis:

1.5.1 Historical cost

15.1.8
This measurement is based on the transaction price at the time of recognition of the element. For an
asset, this would be the cost incurred in acquiring/creating the asset. For a liability, this would be the value
of the consideration received to incur/take on the liability.

The historical cost of both an asset and a liability should be adjusted over time to reflect the usage (in the
form of depreciation or amortisation). For example, historical cost of assets is reduced if they become
impaired and historical cost of liabilities is increased if they become onerous.

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1.5.2 Current value

It measures the element updated to reflect the conditions at the measurement date. Here, several
methods are included:

 Fair value;
 Value in use;
 Current cost.

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 (in line with IFRS 13 Fair Value
Measurement).

It reflects market participants’ current expectations about the amount, timing and uncertainty of future
cash flows.

Value in use (for assets) or Fulfilment value (for liabilities)

Value in use is the present value of future cash flows that an entity expects to derive from the use of an
asset and from its ultimate disposal.

It reflects entity-specific current expectations about the amount, timing and uncertainty of future cash
flow.

Fulfilment value is the present value of future cash that an entity expects to be obliged to transfer as it
fulfils a liability.

Current cost

Current cost reflects the current amount that would be:

 paid to acquire an equivalent asset; or

 received to take on an equivalent liability

Current cost is different from fair value and value in use, as current cost is an entry value. This looks at the
value in which the entity would acquire the asset (or incur the liability) at current market prices, whereas
fair value and value in use are exit values, focusing on the values which will be gained from the item.

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Example 1.5 (Current Value)

ACE Co bought a factory building for $200,000 on 1 Jan 20X5 and it is now 31 Dec 20X8. A third party
approached ACE Co. offering to buy the factory building at $250,000. Currently, a similar factory building
in that area is available at $280,000. The management accountant has analysed the income generating
ability of the factory building over an estimated remaining useful life of 10 years as follows:

Year Discounted future cash flow ($)

1 38,000
2 35,000
3 32,000
4 25,000
5-10 20,000
150,000

What should be the amount recorded in SOFP as at 31 Dec 20X8 under each of the valuation bases?

i. Historical costs : $200,00

ii. Fair value : $250,000
iii. Current cost : $280,000
iv. Value in use : $150,000

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1.5.3 Advantages and Disadvantages of Historical Cost Accounting

15.1.9

Diagram 1.5.3: Advantages and disadvantages of historical cost accounting

From these disadvantages, various issues arise:

Undervalued of assets will depress a company's share price and make it vulnerable to takeover. In practice,
listed companies avoid this by revaluing land and buildings in line with market values.

Understated depreciation and understated cost of sales lead to overstatement of profits compounded by
price inflation.

Overstated profits can lead to:

 too much dividends being distributed to shareholders, leaving insufficient amounts for
investment
 shareholders to expect higher dividends and employees to demand higher wages
 overstated tax bills

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1.6 Concepts of Capital and Capital Maintenance

Learning Outcome (ACCA Study Guide Area A)
A2f: Describe the concept of financial and physical capital maintenance and how this affects the
determination of profits

The concept of capital maintenance is concerned with how an entity defines the capital that it seeks to
maintain. It provides the linkage between the concepts of capital and the concepts of profit because it
provides the point of reference by which profit is measured.

Diagram 1.6: Concepts of capital

The selection of the appropriate concept of capital by an entity should be based on the needs of the users
of its FS.

Thus, a financial concept of capital should be adopted if the users of FS are primarily concerned with the
maintenance of nominal invested capital. If, however, the main concern of users is with the operating
capability of the entity, a physical concept of capital should be used.

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Example 1.6 (Capital Maintenance)

Consider the following opening and closing SOFP of a company:

Opening Closing
$ $
Inventory (100 items at cost) 500 600
Other net assets 1000 1000
Capital 1500 1600

Assuming that no new capital has been introduced during the year, and no capital has been distributed as
dividends, for financial capital maintenance concept, the profit would be $100, being the excess of closing
capital over opening capital. And yet in physical terms the company is no better off: it still has 100 units of
inventory (which cost $5 each at the beginning of the period, but $6 each at the end) and its other net
assets are identical.

For physical capital maintenance concept, no profit would be recognised because the physical substance
of the company is unchanged over the accounting period. Capital is maintained if at the end of the period
the company is in a position to achieve the same physical output as it was at the beginning of the period.

1.6.1 Current Cost Accounting (CCA)

15.1.10
CCA is based on physical concept of capital maintenance. Profit is recognised after the operating capability
of the business has been maintained.

Based on the same scenario above, assuming that no new capital has been introduced during the year, and
no capital has been distributed as dividends, the profit shown in historical cost accounts would be $100,
being the excess of closing capital over opening capital. And yet in physical terms the company is no better
off: it still has 100 units of inventory (which cost $5 each at the beginning of the period, but $6 each at the
end) and its other net assets are identical. The 'profit' earned has merely enabled the company to keep
pace with inflation.

1.6.2 Advantages and Disadvantages of CCA

15.1.11

Advantages of CCA

(a) By excluding holding gains from profit, CCA can be used to indicate whether the dividends paid to
shareholders will reduce the operating capability of the business.

(b) Assets are valued after management has considered the opportunity cost of holding them, and the
expected benefits from their future use. CCA is therefore a useful guide for management in deciding
whether to hold or sell assets.

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(c) It is relevant to the needs of information users in:

 Assessing the stability of the business entity
 Assessing the vulnerability of the business (eg to a takeover), or the liquidity of the business
 Evaluating the performance of management in maintaining and increasing the business substance
 Judging future prospects

(d) It can be implemented fairly easily in practice, by making simple adjustments to the historical cost
accounting profits. A current cost SOFP can also be prepared with reasonable simplicity.

Disadvantages of CCA

 It is impossible to make valuations of Economic Value or NRV without subjective judgements. The
measurements used are therefore not objective.
 There are several problems to be overcome in deciding how to provide an estimate of replacement
costs for non-current assets.
 The mixed value approach to valuation means that some assets will be valued at replacement cost,
but others will be valued at net realisable value or economic value. It is arguable that the total
assets will, therefore, have an aggregate value which is not particularly meaningful because of this
mixture of different concepts.

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1.7 Check Understanding

Learning Outcome (ACCA Study Guide Area A):

TLO A1a. Describe what is meant by a conceptual framework for financial reporting
TLO A1b. Discuss whether a conceptual framework is necessary and what an alternative system
might be
TLO A1c. Discuss what is meant by relevance and faithful representation and describe the qualities that
enhance these characteristics
TLO A1d. Discuss whether faithful representation constitutes more than compliance with accounting
standards
TLO A1e. Discuss what is meant by understandability and verifiability in relation to the provision of
financial information
TLO A1f. Discuss the importance of comparability and timeliness to users of financial statements
TLO A1g. Discuss the principle of comparability in accounting for changes in accounting policies
TLO A2a. Define what is meant by ‘recognition’ in financial statements and discuss the recognition
criteria
TLO A2b. Apply the recognition criteria to:
I) assets and liabilities.
II) income and expenses.
TLO A2c. Explain and compute amounts using the following measures:
I) historical cost
II) current cost
III) value in use
IV) fair value
TLO A2d. Discuss the advantages and disadvantages of historical cost accounting
TLO A2e. Discuss whether the use of current value accounting overcomes the problems of historical cost
accounting
TLO A2f. Describe the concept of financial and physical capital maintenance and how this affects the
determination of profits

Question 1 (LO A1a)

Describe what is meant by a conceptual framework

Question 2 (LO A1b)

Explain the main reasons for having a conceptual framework

Question 3 (LO A1b)

Explain the purpose of the Conceptual Framework

Question 4 (LO A1b)

Discuss the extent to which IFRS are relevant to not-for-profit entities

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Question 5 (LO A1c & A1d)

According to the IASB's Conceptual Framework for Financial Reporting, which TWO of the following are
part of faithful representation?

I. It is neutral
II. It is relevant
III. It is presented fairly
IV. It is free from material error

A. I and II
B. II and III
C. I and IV
D. III and IV

Question 6 (LO A1e, LO A1f & LO A1g)

Listed below are some characteristics of financial information.
I. Relevance
II. Comparability
III. Faithful representation
IV. Timeliness

Which of these are fundamental characteristics, according to the IASB's Conceptual Framework for
Financial Reporting?

A. I and II only
B. II and IV only
C. III and IV only
D. I and III only

Question 7 (LO A2f)

Capital maintenance means that:
A. The non-current assets of the business are maintained in an excellent state of repair
B. All assets of the business are maintained in an excellent state of repair
C. The owner has not taken home any of the business assets
D. The money capital at the end of the accounting period is the same as at the beginning

Question 8 (LO A2a & A2b)

The IASB’s Framework recognize a liability as:
A. Obligations to pay which may arise depending on some future events
B. Amounts a business may have to pay after the balance sheet date
C. Present obligations arising from past events which will result in outflow of economic benefit
D. Unpaid portion of expenses incurred in the current accounting period

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ACCA Financial Reporting (FR / F7)
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Question 9 (LO A2c & A2d)

Which of the following are advantage of historical cost accounting?
A. Amount recorded are reliable since it based on original invoices
B. Lead to understatement of assets
C. Easily understood
D. Less opportunity for creative accounting

Question 10 (LO A2e)

Schrute owns a herd of cattle, which produce milk. Schrute then turns this into cheese. On 1 April 20X5,
Shrute purchased a flock of sheep for $100,000, which included transaction costs of $5,000. At 31 March
20X6, the flock was valued at $120,000. Every time animals are sold there is a 5% commission fee payable
to the national farming agency.

Shrute uses the historical cost model and charges all depreciation as an operating expense. In addition to
this, Schrute uses a number of items of specialised farm machinery. This machinery cost Schrute $200,000
on 1 April 20X2 and has a 10-year useful life. At 31 March 20X6, there is only one supplier who still sells
this machinery and the current price of new machinery is $300,000.

Using current cost accounting, what is the value of the machinery at 31 March 20X6?
A. $120,000
B. $180,000
C. $200,000
D. $300,000

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1.8 Check Understanding: Answer

Answer: Question 1 (LO A1a)

A conceptual framework could be defined as a coherent system of interrelated objectives and
fundamental principles. It is a statement of generally accepted theoretical principles which form the
frame of reference for Financial Reporting. As the purpose of financial reporting is to provide useful
information as a basis for economic decision making, a conceptual framework will form a theoretical basis
for determining how transactions should be measured (historical value or current value) and reported (ie:
how they are presented or communicated to users).

Answer: Question 2 (LO A1b)

"It enables accounting standards and GAAP to be developed in accordance with agreed principles and
underlying assumptions and concepts. Therefore, avoids 'firefighting', whereby accounting standards are
developed in a piecemeal way in response to specific problems or abuses. Such an approach can lead to
inconsistencies between different accounting standards and also between accounting standards and
relevant local legislation."

The lack of a conceptual framework may mean that certain critical issues are not addressed. For example,
until the Framework for preparation and presentation of financial statements was published there was no
definition of basic terms such as 'asset' or 'liability' in any accounting standard which is obviously
fundamental to a consistent treatment of accounting transactions and events.

In a world where transactions have become more complex and businesses more sophisticated an overall,
conceptual framework can help preparers of financial statements and their auditors deal with complex
transactions and particularly those which are not the subject of an accounting standard.

Answer: Question 3 (LO A1b)

The stated purpose of the Framework is to:
 assist the IASB to develop IFRS Standards based on consistent concepts, resulting in financial
information that is useful to investors, lenders and other creditors
 assist preparers of financial reports to develop consistent accounting policies for transactions or
other events when no Standard applies or a Standard allows a choice of accounting policies
 assist all parties to understand and interpret

Answer: Question 4 (LO A1b)

The main aim of not-for-profit entities is to provide value for money rather than making a profit. Value for
money is achieved by a combination of effectiveness, efficiency and economy.

Effectiveness means achieving the objectives (usually non-monetary) of the organization. The objectives
of not-for-profit and public sector entities will differ depending upon the type of entity. For example, a
school may have the objectives of teaching a certain number of children and achieving certain academic
standards. A hospital may have the objectives of treating out-patients within a particular time scale or
minimising the number of empty beds. Effectiveness is therefore measured by identifiable measures of
achievement in reaching those goals or objectives.

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Efficiency means using the resources available well. It is effectively the quantity of output obtained for a
given measure of input. Efficiency means getting more out of fewer inputs and thereby reducing the cost
of output. In a school it might be measured by the pupil to teacher ratio and in a hospital by the number
of patients seen by a consultant during a surgery.

Economy means keeping the cost of input resources as low as possible. This is achieved by paying less for
the inputs that are required to meet the objectives or provide the service. In a school giving more teaching
time to classroom assistants rather than higher paid teachers would be a form of economy or in a hospital
scheduling duties to a nurse rather than a doctor.

Not-for-profit and public sector organizations do not aim to achieve a profit but will have to account for
their income and costs. Such entities will have to account for their effectiveness, economy and efficiency
even if they do not have to produce financial statements for the public (although in many cases may do
so). Therefore, some measurement accounting standards will be relevant such as those relating to
inventory, non-current assets, leasing etc. However, others relating purely to reporting such as earnings
per share will not be so relevant.

Answer: Question 5 (LO A1c & A1d)

C

Answer: Question 6 (LO A1e, LO A1f & LO A1g)

D

Answer: Question 7 (LO A2f)

D

Answer: Question 8 (LO A2a & A2b)

C

Answer: Question 9 (LO A2c & A2d)

B

Answer: Question 10 (LO A2e)

B

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ACCA Financial Reporting (FR / F7)
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1.9 Chapter 1 Summary

Diagram 1.9 (a): Summary of Conceptual Framework – Part 1

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ACCA Financial Reporting (FR / F7)
CHAPTER 1: CONCEPTUAL FRAMEWORK

Diagram 1.9 (a): Summary of Conceptual Framework – Part 2

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