CHAPTER 2

THE CONCEPTUAL FRAMEWORK

FOR FINANCIAL REPORTING
What is the appropriate approach to setting
principles of accounting?

Based on Positive Theory

Based on Normative Approach
• Principles are developed based on
observing and predicting practices. • Accounting principles are prescribed
• The aim is to predict what would based on what should or ought to be.
happen. • IASB, US FASB and MASB generally
• Accounting practices adopted by take this approach to develop
firms are often explained on the reporting standards.
basis of showing the true image of • In deciding what should or ought to
financial performance of the firm. be, an accounting framework needs
to be developed first to provide a
Criticism starting point or as a foundation for
• It does not predict what should or the formulation of reporting
ought to be. standards.
• It merely explain and predicts what
would happen.
Definition of accounting framework

A structured or coherent system of inter-

related objectives, fundamental
characteristics and concepts that lead to
formulation of high quality and consistent
reporting standards to prescribe the
nature, function and limits of financial
accounting and reporting.
Reasons for developing an accounting
Framework
 To identify foundation for financial reporting
 To identify the objective of financial statements
 To identify the desirable qualitative characteristics of financial information
 To provide a basis for setting of high-quality and consistent reporting
standards
 To serve as a reference point for resolving accounting issues and
disputes.
The MASB Conceptual Framework for Financial
Reporting
• July 1998 – MASB issued a discussion paper MASB DP1,
Framework for the Preparation and Presentation of Financial
Statements.
• July 2007 – the above discussion paper was finalised as the MASB’s
Framework.
• The MASB is currently in the process of updating its conceptual
framework.
• Conceptual Framework is not a MFRS/FRS and hence does not
define standards for any particular measurement or disclosure issue.
If there is a conflict between Conceptual Framework and MFRS/FRS,
the requirements of the MFRS/FRS prevail.
Scope of Conceptual Framework
The conceptual Framework document comes in 4 chapters:
• Chapter 1 – The objective of general purpose financial
reporting
• Chapter 2 – The reporting entity
• Chapter 3 – Qualitative characteristics of useful financial
information
• Chapter 4 – The assumption, elements, recognition and
measurement of the elements from which financial
statements are constructed; and concepts of capital and
capital maintenance. (remaining text of 2007 conceptual
Framework)
The Purpose of Conceptual Framework
• To assist MASB in development of future MFRSs/FRSs and review of
existing MFRSs/FRSs;
• To assist preparers of financial statements in applying MFRSs/FRSs
and in dealing with topics that have yet to form the subject of
MFRSs/FRSs;
• To assist auditors in forming an opinion on whether financial
statements comply with MFRSs/FRSs;
• To assist users of financial statements in interpreting the information
whether financial statements comply with MFRSs/FRSs;
• To provide those who are interested in the work of MASB with
information about its approach on formulation of MFRSs/FRSs.
What is the appropriate objective of financial
reporting?
• An accounting framework needs a starting
point to provide a foundation for the
characteristics, concepts and models to be
developed.
• This requires identifying the appropriate
objective of financial reporting.
What is the appropriate objective of financial reporting?

1. To provide information to comply with laws and other regulations

(characteristic - reliability/cost model)

OR

2. To provide information to all users including meeting the social

needs of society (characteristic – understandability/performance
model based on contribution rather than profit)
OR

3. To provide information to providers of risk capital (characteristic

– relevance/fair value model)
Chapter 1 - Objective of General Purpose
Financial Reporting
Objective chosen
3. To provide information to providers of risk capital
(Investors/Lenders)

Chapter 1 of Conceptual Framework

The objective of general purpose financial
reporting is to provide 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.
Information provided to users
Information provided to users are information about the
nature and amounts of reporting entity’s:
• Economic resources (Assets)
• Claims (Equity and Liabilities)

This information can help users to identify the reporting

entity’s:
• Financial strengths and weaknesses
• Liquidity and solvency
• Needs for additional financing and how successful in
obtaining financing
• Distribution of future cash inflows and outflows
Decisions to be made by users
• Buying, selling or holding equity and debt
instruments
• Providing or settling loans
• Other forms of credit
General Purpose Financial Reporting
• General Purpose Financial Reports do not or
cannot provide all of the information that the
primary users need.
• The users need to consider pertinent information
from other sources eg. Economic conditions,
political events and climate, industry and
company outlooks.
• Provide information to help the primary users to
estimate the value of the reporting entity.
Chapter 3 – Qualitative Characteristics of Useful
Financial Information

Fundamental Qualitative
Characteristics Enhancing Qualitative
Characteristics
a) Relevance
 Materiality a) Comparability
b) Verifiability
b) Faithful c) Timeliness
Representation d) Understandability
 Completeness
 Neutrality
 Free from error
Fundamental Qualitative Characteristics
a) Relevance
 Relevant financial information is capable of making a difference in
the decisions made by users.
 Information is relevant when it influences economic decisions of
users by helping them evaluate past, present and future events or
confirming, correcting past evaluations.
 Financial information is capable of making a difference in decisions if
it has predictive value, confirmatory value or both.
 Judgement is required in deciding whether an information is relevant.
 Both the nature and materiality of the item are important
considerations in deciding its relevance.
 Information is considered material if omitting it or misstating it could
influence decisions made by users.
Fundamental Qualitative Characteristics
b) Faithful Representation
Financial reports represented economic phenomena in
words and numbers.
Financial information must faithfully represent the
phenomena that it is suppose to represent.
To be a perfectly faithful representation, it has 3
characteristics : complete, neutral, and free from error.
Applying the Fundamental Qualitative
Characteristics
a) Identify economic phenomenon that has the potential to
be useful to users of financial information;
b) Identify the type of information about that phenomenon
that would be most relevant and can be faithfully
represented;
c) Determine whether that information is available and can
be faithfully represented;
d) If so, the process of satisfying the fundamental
qualitative characteristics ends. If not, the process is
repeated with next most relevant type of information.
Enhancing Qualitative Characteristics
a) Comparability – information is useful if it can be
compared with similar information of other entities and
with similar information of the same entity for another
period.
b) Verifiability – direct and indirect verification
c) Timeliness – information available to decision makers in
time to be capable of influencing their decisions.
d) Understandability – financial information can be easily
read and understood by users.
Applying the Enhancing Qualitative
Characteristics
Enhancing qualitative characteristics should be
maximised to the extent possible.
It is a process that does not follow a prescribed order.
Sometimes one enhancing qualitative characteristics may
have to be diminished to maximise another qualitative
characteristics.
The Cost Constraint on Useful Financial
Reporting
• Reporting financial information imposes costs and it is
important that those costs are justified by the benefits of
reporting that information.
• Costs incurred by providers of financial information
include collecting, processing, verifying and disseminating
financial information.
• Costs incurred by users include analysing and interpreting
the information provided.
• Benefits derived from information should exceed the cost
of providing it.
Chapter 4 – Remaining Text (The 2007
Framework)
1. Underlying Assumption
2. The elements of financial statements
3. Recognition of elements of financial statements
4. Measurement of elements of financial statements
5. Concepts of capital maintenance
1. Underlying Assumption
Going Concern
If the business is ongoing, going concern basis can be
applied. Assets and liabilities are recognised in the
balance sheet based on cost models, revaluation model
or fair market value.
If the business cannot continue – going concern basis
cannot be applied. Financial statements need to be
prepared on other basis eg. Liquidation basis.
Elements of Financial Statements

Elements of
Elements of Performance
Financial Position • Income
• Assets • Expenses
• Liabilities • Capital
• Equity maintenance and
adjustments
Elements of Financial Statements
ASSET INCOME
• Resources controlled by • Recognised increase in asset or
entity (tangible/intangible) decrease in liability in current
reporting period
• As a result of past events • Result in increased equity
• Inflow of future economic Eg.
benefits • Sales of goods or services – Asset
cash/bank increase
LIABILITIES
• Present obligation of entity
• Arising from past events
• Settlement is expected to EXPENSE
result in outflow of entity • Recognised decrease in asset or
increase in liability in current
resources reporting period
• Result in decreased equity
Eg.
EQUITY • Purchased of goods, payment of
Asset - Liabilities salary – asset cash/bank decrease
Examples of elements
Are the following assets?
1. Fish in the sea (from the fishermen’s perspective)
2. Cattle in the farm (from the owner of the farm’s
perspective)
3. Inventory of cooking oil in the grocery shop (from the
owner of the shop’s perspective)
Recognition of elements of financial statements
• Recognition is the process of incorporating in the balance
sheet or income statement an item that meets the
definition of an element and satisfies the following criteria
for recognition:
a) It is probable that any future economic benefit
associated with the item will flow to or from the entity.
b) The item has a cost or value that can be measured with
reliability.
Example:
On 1 August 2013, company ABC Bhd purchased a second
hand motor van by cash RM10,000. The van is to be used
by the company to sent goods to customers.

Answer:
• The van is an asset because it is controlled by the
company. It is a result of past events and there will be an
inflow of future economic benefits from the used of the
van since the company use it to sent goods to
customers.

• The amount to be recognised is RM10,000.

Measurement of elements of financial statements

• Measurement is the process of determining the monetary

amounts at which the elements of financial statements are
recognised and carried in the balance sheet and income
statement.
• This involves the selection of the particular basis of
measurement such as:
a) Historical cost
b) Current cost
c) Realisable value
d) Present value
Concepts of capital

Physical concept
Financial concept of capital
of capital Capital is regarded
Capital is the net as the productive
asset or equity of the capacity of the entity
entity based on eg. Units
of output per day.
Concepts of capital
• Selection of the appropriate concept of capital should be
based on the needs of users.
• A financial concept of capital should be applied if users
are primarily concerned with nominal invested capital or
purchasing power of invested capital.
• A physical concept of capital should be applied if users
are primarily concerned with the operating capability of
the entity.
• Most entities adopt financial concept of capital.
Concepts of capital maintenance
Physical capital
maintenance
Financial capital Profit is earned only if the
maintenance physical productive capacity
A profit is earned only if the (operating capability) of the
financial amount of net assets at entity at the end of the
the end of the period exceed the period exceeds the physical
financial amount of net assets at productive capacity at the
the beginning of the period, after beginning of the period, after
excluding contribution from and
excluding contribution from
distribution to owners during the
period. and distribution to owners
during the period.
Concepts of capital maintenance
• Refer to example on pg. 60 of textbook