THE CONCEPTUAL FRAMEWORK FOR THE PREPARATION AND

PRESENTATION OF FINANCIAL STATEMENTS

 STUDY OBJECTIVES

• Describe what the concept the Conceptual Framework entails;

• List the specific purposes of the Conceptual Framework regarding the
preparation and presentation of financial statements;
• Explain the main objective of financial reporting according to the Conceptual
Framework;
• Explain the underlying assumption when preparing financial statements as
discussed in the Conceptual Framework;
• Discuss the qualitative characteristics of financial reporting according to the
Conceptual Framework;
• Explain what is implied by the Conceptual Framework when it refers to the
constraints in preparing financial statements;
• Discuss the elements of financial statements as explained in the Conceptual
Framework and indicate which elements are Statement of financial position)
elements and which are Statement of profit or loss and other comprehensive
income elements;
STUDY OBJECTIVES
• Discuss the concepts of recognition of the elements incorporated in
the financial statements as explained in the Conceptual framework;
• Explain what is meant by the measurement of the elements of
financial statements by referring to the measurement methods
discussed in the Conceptual Framework;
INTRODUCTION
• The Conceptual Framework can be described as a group of
interrelated objectives and fundamental theoretical principles
that serve as a frame of reference for Financial Accounting and
more specifically financial reporting.
• The Conceptual Framework is both normative (prescriptive)
and descriptive (explanatory) in nature, with an overriding
requirement for information that is useful in making economic
decisions.
• The Conceptual Framework is an IFRS (International Financial
Reporting Standard) and hence does not define standards for
any particular measurement or disclosure issue.
• The Conceptual Framework does not override any specific
IFRS.
WHAT IS THE CONCEPTUAL FRAMEWORK IN
ACCOUNTING AND WHY IS IT RELEVANT?

• It describes the basic concepts that underlie financial

statement preparation in conformity with IFRS principles.
• It identifies the principal classes of users of an entity’s
general purpose financial statements and states the
objective of financial statements.
• It specifies the fundamental qualities that make financial
information useful.
• It defines the basic elements in financial statements and
discusses the criteria for recognizing them.
• It identified alternative measurement bases used in practice
and describes alternative concepts of capital maintenance
FINANCIAL STATEMENTS AS PART OF
FINANCIAL REPORTING
• The communication of financial information is
referred to as financial reporting.
• Financial forms part of the process of financial
reporting and the purpose of their preparation
is to summarise and present all the transactions
recorded in the journals and ledgers of an entity
in a useful, logical and understandable way to
the users of those financial statements
THE OBJECTIVE OF FINANCIAL
STATEMENTS
• According to the Conceptual Framework the objective of
general purpose financial reporting 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.
• Those decisions involve buying, selling or holding equity and
debt instruments, and providing or settling loans and other
forms of credit.
• Potential and existing investors are interested in the returns
they expect while creditors and other lenders are interested in
principle repayments, interest payments they expect.
USERS OF FINANCIAL STATEMENTS

Primary users:
• Present and potential investors
• Lenders
• Other creditors
Others users
• Employees
• The regulators
• The public
UNDERLYING ASSUMPTION WHEN
PREPARING FINANCIAL STATEMENTS

Going concern
• According to the going-concern assumption, the financial statements of any
entity are prepared on the basis that it will continue to operate for the
foreseeable future.
• This means that the business has the intention nor the need to liquidate or
curtail the scale of its operations materially.
• If such an intention, however, does exist, the financial statements may have
to be prepared on a different basis .

Accrual basis
• Accrual accounting depicts the effects of transactions and other events on a
reporting entity’s resources in the periods in which those effects occur, even
if the cash receipts and payments of those occur in a different period, and is
therefore also applicable.
QUALITATIVE CHARACTERISTICS OF
USEFUL FINANCIAL INFORMATION

• Qualitative characteristics are the

attributes that make the financial
information useful.
• To be useful the financial information must
be relevant and faithfully represents what
it purports to represent and if it is
comparable, verifiable, timely and
understandable.
QUALITATIVE CHARACTERISTICS OF
FINANCIAL STATEMENTS

• Relevance
• Good financial statements should give users the information
that they are looking for so that they can make decisions that
concern them.
• Materiality
• Information is material if its omission or misstatement could
influence economic decisions of users of the financial
statements.
• Faithful representation
• To be reliable, information must faithfully represent the
transactions and other events it could reasonably be expected
to represent.
ENHANCING QUALITATIVE CHARACTERISTICS

• Comparability
• Users must be able to compare the financial statements of an
enterprise over a period of time.
• Verifiability
• This helps to assure users that information faithfully represents
the economic climate it claims to represent.
• Timeliness
• Financial information should be released timeously as it may
become less relevant.
• Understandability
• Information should be understandable to its users.
ELEMENTS OF FINANCIAL STATEMENTS

 The recording of transactions in the journals and ledgers of an entity

provide the information needed to prepare financial statements.
 The information that is going to be used in the presentation of financial
statements is grouped into elements (according to their economic
characteristics) which make up the financial statements.
 These elements are grouped under two headings, namely the elements
that pertain to the financial position in the balance sheet (statement of
financial position) namely
• Assets,
• Liabilities,
• Equity and
the elements that pertain to the financial performance in the income
statement (statement of profit or loss and other comprehensive income)
namely
• Income and
• Expenses
ELEMENTS OF FINANCIAL STATEMENTS

• Assets
• An asset is a resource resulting from a past event, is
controlled by the business and will lead to future
economic benefits.
• Liabilities
• A liability is a present obligation resulting from a past
event and that will lead to an outflow of future
economic benefits.
• Owner’s equity
• The owner’s equity represents the owner’s claim on
the assets of the business.
ELEMENTS OF FINANCIAL STATEMENTS:

Income
• Income is an increase in economic benefits during the accounting
period in the form of inflows or enhancements of assets or
decrease of liabilities that result in increases in equity other than
those relating to the contributions from the equity participants
• The definition of income encompasses both revenue and gains.
Revenue arises in the course of the ordinary activities of an entity
and is referred to by a variety of different names including sales,
fees, interest, dividends, royalties and rent.
• Gains represent other items that meet the definition of income
and may or not arise in the course of ordinary business activities,
for example profit made on the sale of obsolete non-current
assets
ELEMENTS OF FINANCIAL STATEMENTS:

Expenses
• The conceptual framework defines expenses as decreases in
economic benefits during the accounting period in the form of
outflows or depiction of assets or incurrence of liabilities that
result in equity, other than those relating to a distribution of
equity participants.
• The definition of expenses encompasses losses as well as
those that arise in the course of the ordinary activities of the
entity.
RECOGNITION OF THE ELEMENTS OF
FINANCIAL STATEMENTS
• Once the item meets the definition of one of the elements, it needs to
comply with the following before it can be recognised:
• It is probable that future economic benefit associated with the item will
flow to or from the enterprise.
• The cost of the item can be reliably measured
• Recognition is the process of incorporating an item that meets the definition
of an element and satisfies the criteria for recognition in the statement of
financial position or statement of profit or loss or other comprehensive
income.
• It involves the depiction of the item in words and in monetary value (as an
amount) and the inclusion of that amount in the statement of financial
position or statement of profit or loss and other comprehensive income
totals.
RECOGNITION OF THE ELEMENTS
According to the Conceptual Framework, “an item that meets the
definition of or from the entity should be recognised if:
• It is probable that any future economic benefit associated with the
item will flow to or from the entity; and
• The item has a cost or value that can be measured with reliability”.
• Probability refers to the degree of uncertainty that the future
economic benefits associated with the item will flow to or the entity
An example is sales on credit. The possibility that not all trade
debtors will pay their outstanding accounts is highly likely, therefore
an expense (by way of providing credit losses), representing the
expected reduction in economic benefits, is recognised.
• If no cost or value can be attached to an item, and it is also not
possible to make a reasonable estimate of its cost or value, such an
item cannot be recognised
RECOGNITION OF THE ELEMENTS:
ASSETS

Assets:
• An asset is recognised in the statement of financial position
when it is probable that the future economic benefits will flow
to the entity and the asset has a cost or value that can be
measured reliably
RECOGNITION OF THE ELEMENTS:
LIABILITY

Liabilities:
• A liability is recognised in the statement of financial position
when it is probable that an outflow of resources embodying
economic benefits will result from the settlement of a present
obligation and the amount at which the settlement will take
place can be measured reliably
RECOGNITION OF THE ELEMENTS
• Recognition of income
• Income is recognised when an increase in future economic
benefits related to an increase in an asset or decrease of a
liability has arisen.
• Recognition of expenses
• Expenses are recognised when a decrease in future economic
benefits related to a decrease in an asset or decrease of a liability
has arisen.
MEASUREMENT OF THE ELEMENTS
OF FINANCIAL STATEMENTS
Measurement is defined as the process of determining the
monetary amounts at which the elements of the financial
statements are to be recognised and carried in the balance sheet
and income statement.
MEASUREMENT OF THE ELEMENTS
OF FINANCIAL STATEMENTS
• An entity can employ, to different degrees and in varying
combinations, any of these measurement bases:
• Historical cost
• Current cost
• Realisable value
• Present value
• Although the historical cost is the measurement basis most
commonly adopted by entities, it is usually combined with
other measurement bases, for example, inventories are
usually carried at the lower of cost and net realisable value,
and property, plant and equipment are adopted at their
historical cost or revalued (present value) amounts.
MEASUREMENT OF THE ELEMENTS
OF FINANCIAL STATEMENTS
Historical cost means that assets are recorded at the amount
of cash or cash equivalent paid or the fair value of the
consideration given to acquire them at the time of their
acquisition.
Liabilities are recorded at the amount of proceeds received in
exchange for the obligation or at the amounts of cash or cash
equivalents expected to be paid to satisfy the liability in the
normal course of business. The drawback of this approach is
its inability to deal with the effect of changing prices of non-
monetary assets, with the result that some entities prefer the
current cost model to measure the elements of the balance
sheet and income statement.
MEASUREMENT OF THE ELEMENTS
OF FINANCIAL STATEMENTS
Realisable value (settlement value) means that
assets are carried at the amount of cash or cash
equivalents that could currently be obtained by
selling the assets in an orderly disposal.
Liabilities are carried at their settlement values,
i.e. the undiscounted amounts of cash or cash
equivalents expected to be paid to satisfy the
liabilities in the normal course of business.
MEASUREMENT OF THE ELEMENTS
OF FINANCIAL STATEMENTS
Current cost means that assets are carried at the
amount of cash or cash equivalents that would
have to be paid if the same or equivalent asset
was acquired currently.
Liabilities are carried at the undiscounted
amount of cash or cash equivalents that would be
required to settle the obligations currently
MEASUREMENT OF THE ELEMENTS
OF FINANCIAL STATEMENTS
Present value means that assets are carried at
the present discounted value of the future net
cash inflows that the item is expected to generate
in the normal course of business. Liabilities are
carried at the present discounted value of the
future net cash outflows that are expected to be
acquired to settle the liabilities in the normal
course of business.