UNIT 1: THE CONCEPTUAL

FRAMEWORK FOR FINANCIAL

REPORTING

Resources:
• Reader: The Conceptual Framework for
Financial Reporting
• Introduction to IFRS: Chapter 1
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 UNIT 1: LEARNING OUTCOMES

At the end of this learning unit, a student should be able to:

• Understand the basic theory of accounting.
• Understand the qualitative characteristics of information in
the financial statements.
• Understand the definitions of the elements in the financial
statements and their recognition and measurement criteria.
• Answer theoretical questions about the Conceptual
Framework.
• Apply theory in discussion questions.
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 UNIT 1: CONTENTS

1.1. Background
1.2. Chapter 1 – The objective of general purpose financial reporting
1.3. Chapter 2 - Qualitative characteristics of useful financial information
1.4. Chapter 3 – Financial statements and the reporting entity
1.5. Chapter 4 – The elements of the financial statements
1.6. Chapter 5 – Recognition and derecognition
1.7. Chapter 6 – Measurement
1.8. Chapter 7 – Presentation and disclosure
1.9. Chapter 8 – Concepts of capital and capital maintenance
1.10. Exam Technique
1.11. Additional Resources
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1.12 Homework
 Textbook ref: Chap 1:3.1 – 3.2

1.1 BACKGROUND

What is the Conceptual Framework?

It is NOT A STANDARD!
It is a practical tool that assists:

Board (IASB) Preparers All

to develop Standards to develop consistent to understand and interpret

accounting policies Standards
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 Textbook ref: Chap 1:3.1 – 3.2

1.1 BACKGROUND

What is the aim (objective) of the conceptual framework?

Addresses the following fundamental issues:

What are assets,

What is the objective of What makes financial liabilities, equity, income
financial reporting? information useful? and expenses, when
should they be
recognised and how
should they be
measured, presented Page 5 of 37

and disclosed?
 Textbook ref: Chap 1:3.1 – 3.2

1.1 BACKGROUND

Chap 1: The objective of general purpose financial reporting

Chap 2: The qualitative characteristics of useful financial information

Chap 3: Financial statements and the reporting entity

Chap 4: The elements of financial statements

Chap 5: Recognition and derecognition

Chap 6: Measurement

Chap 7: Presentation and disclosure

Chap 8: Concepts of capital and capital maintenance

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Reader ref: CF1.1 – 1.23 Textbook ref: Chap 1:4
CHAPTER 1: OBJECTIVE OF GENERAL PURPOSE
FINANCIAL REPORTING

To provide financial information useful to users in making decisions

Type of decisions?
Users’ decisions involve decisions about:

voting and influencing

buying, holding or selling providing or settling loans
management
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Reader ref: CF1.1 – 1.23 Textbook ref: Chap 1:4
CHAPTER 1: OBJECTIVE OF GENERAL PURPOSE
FINANCIAL REPORTING

How are these decisions made?

To make these decisions, users assess:

prospects for future net cash inflows to

the entity
management’s stewardship of the
entity’s economic resources

What do you need to make these assessments?

To make both these assessments, users need information about both:

economic resources, claims and how efficiently and effectively

changes in those resources and management has discharged its
claims responsibilities Page 8 of 37
 Textbook ref: Chap 1:4
CHAPTER 1: OBJECTIVE OF GENERAL PURPOSE
FINANCIAL REPORTING

Food for thought

Look up the meaning of Stewardship

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Reader ref: CF2.1 – 2.43 Textbook ref: Chap 1:5
CHAPTER 2: THE QUALITATIVE CHARACTERISTICS OF
USEFUL FINANCIAL INFORMATION

Reader ref: CF2.1 – 2.4

Those attributes that make financial information useful

Reader ref: CF2.5 – 2.22 Reader ref: CF2.23 – 2.38

FUNDAMENTAL qualitative ENHANCING qualitative
characteristics characteristics

Relevance Comparability
Verifiability
Faithful representation Timeliness
Understandability Page 10 of 37
Reader ref: CF2.5 – 2.22 Textbook ref: Chap 1:5
CHAPTER 2: THE QUALITATIVE CHARACTERISTICS OF
USEFUL FINANCIAL INFORMATION

FUNDAMENTAL qualitative characteristics

Relevant (materiality):
Information is relevant if it is capable of making a difference to the decisions made by users
• - predictive value or
• - confirmatory value

• Materiality should be considered

• Entity-specific

Faithful representation (Complete, neutral and free from error):

• Information must faithfully represent the substance of what it purports to represent
• - Complete (non-disclosure)
• - Neutral (without bias, supported by prudence)
• - Free from error (not absolutely accurate – think about estimates)
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Reader ref: CF2.23 – 2.43 Textbook ref: Chap 1:5
CHAPTER 2: THE QUALITATIVE CHARACTERISTICS OF
USEFUL FINANCIAL INFORMATION

Food for thought

(1) Look up the meaning of the

enhancing qualitative
characteristics
(2) To what does the ‘cost constraint
on useful financial reporting’ refer
to? Page 12 of 37
Reader ref: CF3.1 – 3.18 Textbook ref: Chap 1:6
CHAPTER 3: FINANCIAL STATEMENTS AND THE
REPORTING ENTITY

The objective of general purpose financial reporting is:

• to provide financial information that is useful (chapter 1)
• Statement of financial position Qualitative characteristics
• Statement of profit or loss and other
comprehensive income
• Cash flow statement
• Statement of changes in equity
• Notes and supplementary schedules

Principles to apply when preparing the information above

Accrual basis of accounting Going concern assumption

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Reader ref: CF3.1 – 3.18 Textbook ref: Chap 1:6
CHAPTER 3: FINANCIAL STATEMENTS AND THE
REPORTING ENTITY

Food for thought

Look up the meaning of:

(1) accrual basis of accounting;
(2) going concern assumption;
(3) reporting entity
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Reader ref: CF4.1 – 4.72 Textbook ref: Chap 1:7

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

Asset
Income
Liability

Equity
Expense

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Reader ref: CF4.3 – 4.25 Textbook ref: Chap 1:7.1

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

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

Asset Combined:
• (1) A present right,
• (2) that the has the potential to produce
Definition economic benefits,
• (3) that is controlled by the entity as a result of
past events.

• All three criteria (1 – 3) above needs to be

met to conclude that an item meets the
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definition of an asset
Reader ref: CF4.3 – 4.25 Textbook ref: Chap 1:7.1

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

• (1) A present right,

• Rights that correspond to the obligation of

another (par 4.6(a))

Asset • Rights that do not correspond to the obligation of

another (par 4.6(b))
• Rights can be established by:
• Contract/legislation
Definition • Buying “know how”
• As a result of past
practice of another entity

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Reader ref: CF4.3 – 4.25 Textbook ref: Chap 1:7.1

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

• (1) A present right,

• Explain the right that has been established for the

Asset
entity - i.e. what benefit is the entity entitled to?
• When you try to identify the right, look for
examples similar to the ones in Par 4.6 and 4.11

Exam • Important! The existence of a right does not

technique mean it is an asset; the rest of the components of
the definition should also be present.

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Reader ref: CF4.3 – 4.25 Textbook ref: Chap 1:7.1

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

• (2) that the has the potential to produce

economic benefits,

• Potential only, not certainty

Asset
• An economic resource is a right that has the potential
to produce economic benefits.
• For that potential to exist, it does not need to be
certain, or even likely, that the right will produce
Definition economic benefits. It is only necessary that the right
already exists and that, in at least one circumstance,
it would produce for the entity economic benefits
beyond those available to all other parties.
• Probability of the potential may be low, may still be
an asset (this might affect the recognition, but not the
definition) Page 19 of 37

• Examples (par 4.16)

Reader ref: CF4.3 – 4.25 Textbook ref: Chap 1:7.1

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

• (2) that the has the potential to produce

economic benefits,

• Explain the economic benefits that may be potentially

Asset produced that has been established for the entity -

i.e. what benefit is the entity possibly entitled to?

• Remember that the economic resource is the present

Exam right that contains the potential, not the future
technique economic benefits, that the right may produce. I.e.
the right that the entity currently has.
• The economic resource is not the future economic
benefits that the holder will receive if the option is
exercised.
• Incurring of an expense does not mean there is
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automatically an asset.
Reader ref: CF4.3 – 4.25 Textbook ref: Chap 1:7.1

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

• (3) that is controlled by the entity as a result of

past events
• If the entity has:
• the present ability to direct the use and obtain
economic benefits that may flow from it (decide who

Asset and how to use the resource).

• includes the present ability to prevent other parties
from directing the use and obtaining the economic
benefits
Definition
• Established by:
• Legal right or
• other means of ensuring that no other party has the
present ability to direct the use and obtain the
benefits that may flow from it.
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Reader ref: CF4.3 – 4.25 Textbook ref: Chap 1:7.1

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

• (3) that is controlled by the entity as a result of

Asset
past events

• It is important to explain the link between the past

event that led to the entity having control over the
Exam right.
technique • The past event should be identified as the specific
event that established the entity's control over the
right.

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Reader ref: CF4.3 – 4.25 Textbook ref: Chap 1:7.1

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

• Once all the components of the definition of an

Asset
asset have been satisfied, you can conclude just
that it satisfies the definition of an asset.
• Then you move on to the recognition criteria before you
can conclude that the entity may recognize an asset in
Exam its books.
technique

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Reader ref: CF4.3 – 4.25 Textbook ref: Chap 1:7.1

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

A present economic resource (An economic resource

is a right that has the potential to produce economic
benefits) :
 Explain how it is a resource, how can the entity use it

Asset to their advantage? How does the entity have the

right over the potential? How does this resource
have the potential? What economic benefits can be
produced and how?
Exam Controlled by an entity:
technique  Explain how it is controlled? Physical? Prevention of
use by others?
As a result of a past event:
 What past event led to the entity having control over
something from which future economic benefits can
be derived. NB the link!!
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Reader ref: CF4.3 – 4.25 Textbook ref: Chap 1:7.1

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

Food for thought

A company erects a fence to prevent crime.

Should they recognise the cost to erect the fence as

an asset?

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Reader ref: CF4.3 – 4.25 Textbook ref: Chap 1:7.1

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

Food for thought

Consider the following statement:

“Our company’s workforce is it’s biggest asset”

In terms of the Conceptual Framework for Financial

Reporting, do you agree or disagree?

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Reader ref: CF4.26 – 4.47 Textbook ref: Chap 1:7.2

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

• (1) A present obligation

• (2) to transfer an economic resource

Liability • (3) as a result of a past event

Definition • All three criteria (1 – 3) above needs to be

met to conclude that an item meets the
definition of a liability

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Reader ref: CF4.26 – 4.47 Textbook ref: Chap 1:7.2

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

• (1) A present obligation,

• An obligation is a duty or responsibility that the

entity has no practical ability to avoid

Liability • Normally, if one party has an obligation another

party has a right

Definition • Established by contact, legislation, past practice

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Reader ref: CF4.26 – 4.47 Textbook ref: Chap 1:7.2

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

• (1) A present obligation,

• Explain the obligation that the entity cannot avoid

Liability • Important! The existence of an obligation does

not mean it is a liability; the rest of the
components of the definition should also be
Exam present.

technique

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Reader ref: CF4.26 – 4.47 Textbook ref: Chap 1:7.2

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

• (2) To transfer an economic resource

• the obligation must have the potential to require the

entity to transfer an economic resource to another
party
Liability • does not have to be certain, just possibly
• Probability may be low – this affects the
recognition, not definition
Definition • Examples (Par 4.39 – 4.40)

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Reader ref: CF4.26 – 4.47 Textbook ref: Chap 1:7.2

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

• (3) the obligation exists as a result of past events

• Only if:

Liability • the entity has already obtained economic

benefits or taken an action; and
• as a consequence, the entity will or may have
Definition to transfer an economic resource that it would
not otherwise have had to transfer.

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Reader ref: CF4.26 – 4.47 Textbook ref: Chap 1:7.2

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

Food for thought

Consider the inventory process below – when should the company who
ordered the inventory recognise the liability to pay for the goods?
day 1 = company decides to order goods,
day 2 = placed order,
day 3 = supplier manufacture goods,
day 4 = supplier invoice you,
day 5 = deliver goods,
day 6 = pay supplier Page 32 of 37
Reader ref: CF4.63 - 4.67 Textbook ref: Chap 1:7.5

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

The residual interest in the assets of the

entity after deducting all its liabilities
Equity
Definition

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Reader ref: CF4.68; 4.70 – 4.72 Textbook ref: Chap 1:7.6

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

Increases in assets, or decreases in liabilities,

that result in increases in equity, other than

Income those relating to contributions from holders of

equity claims

Definition

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Reader ref: CF4.69; 4.70 – 4.72 Textbook ref: Chap 1:7.7

CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

Decreases in assets, or increases in liabilities,

that result in decreases in equity, other than

Expense those relating to distributions to holders of equity

claims

Definition

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CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

 Make the given information applicable to the

theory.
 State the theory: ‘Match’ it with the given
information

Elements  Reach a conclusion!

 Always start with the element from the
statement of financial position – “Statement
Exam technique of financial Position approach” should be
followed.
 Use the concept of control to determine when
the asset/liability may be recognised:
• When control is transferred, recognition
may be applicable
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 HOMEWORK

• Lesskom (Question 7 in module guide)

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