Unit 1: CONCEPTUAL FRAMEWORK

FEBRUARY 2024

Financial Accounting 33A3

Chapter 2 of Gripping GAAP

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Conceptual framework: Learning outcomes

 Identify the purpose/objective of the conceptual framework

 Define and discuss general purpose financial statements and their objective
 Define and apply the qualitative characteristics of useful financial information
and related limitations
 Define and discuss the elements of the financial statements;
 Understand the objective of financial statements
 Understand the going concern assumption;
 Define and discuss the recognition criteria of the elements of the financial
statements;
 Identify the different measurement basis and determine the relevant
measurement base; and
 Understand the concepts of presentation and disclosure

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Background

 New complete final version of the conceptual

framework(CF) was issued in 2018

 The CF is a foundation upon which IFRSs

are built

 CF states the objective of general purpose

financial reporting

 CF explains the various financial reporting

concepts
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Purpose of Conceptual framework

 To help IASB in developing IFRS

 To assist preparers of financial statements to
develop accounting policies
 To help users to understand and interpret
financial statements

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The 8 concepts included in the framework
The objective of general purpose financial reporting
1

General purpose financial statements

2

Qualitative characteristics of useful financial information

3

The elements of the financial statements

4
Recognition and derecognition
5

Measurement basis
6

Presentation and disclosure

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Capital and capital maintenance

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Concept 1(Objective of general purpose
financial reporting)

 To provide financial information about the

reporting entity that is useful to existing and
potential investors, lenders and creditors in
making decisions relating to providing
resources to the entity
If you don’t understand
your objective, you can’t
draw up quality financial
statements.

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Concept 1(Objective of general purpose
financial reporting)
Examples of resources:
 Equity/debt instruments
 Loans/credit
 Management actions(influence management
actions)

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Concept 1(Objective of general purpose financial
reporting)
Limitations of general purpose financial reporting:
 Only provide financial information
 Not designed for all users
 Not designed for all decisions
 Not exact information
 Only provides historic information
 Not designed to show the entity’s value

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Concept 2 (General purpose financial statements)

What is a financial statement?

 A financial report that provides information
about the elements, i.e :
 Assets, liabilities, equity
 Income and expenses

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Concept 2 (General purpose financial statements)

Objective of Financial statements

 To provide financial information
 About the reporting entity’s assets, liabilities,
equity, income and expenses

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Concept 2 (General purpose financial statements)

Structure of financial statements

 Statement of financial position
 Statement of financial
performance(comprehensive income)
 Other statements and notes
 Statement of changes in equity
 Statement of cash flows
 Notes to the financial statements

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Concept 2 (General purpose financial statements)

Statement of financial position

 Contains information about assets, liabilities
and equity that have been recognized
Statement of financial performance
 Contains information about the income and
expenses that have been recognized
Other statements and notes
 Provide extra relevant information e.g. cash
flows, equities, accounting policies etc.

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Concept 2 (General purpose financial statements)

The reporting entity:

 An entity that is required/chooses to prepare
financial statements
The reporting period
 Specified time period
 Usually one year
 Can be 6 months(interim reporting)
 Should be defined clearly in the financial
statements

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Concept 2 (General purpose financial statements)

The going concern assumption:

 Assume the entity will continue to operate for
the foreseeable future
 Entity does not intend to liquidate or cease
operations

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Concept 3 (Qualitative characteristics)

Fundamental characteristics
Relevance
• Capable of making a difference
• In the decisions made by users
• Also include materiality(Omitting the information can
reasonably influence decisions made by users)

Faithful presentation
• The depiction of substance over form
• Information must faithfully represent the substance and
not the form:
• The information needs to be:
• - Complete
• - Neutral
• - Free from error

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Concept 3 (Qualitative characteristics)

Enhancing characteristics

Comparability

• Allows users to identify similarities and differences among

items
• Needs at least two items
• Can be from one year to another, or one entity to another

Verifiability

• Assure users that the information has been independently

assessed by knowledgeable observers
• Gives users confidence in the information provided

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Concept 3 (Qualitative characteristics)

Enhancing characteristics

Timeliness

• Information should be made available timeously so that

users are able to use it in decision making
• Should be available soon after year end
• However, the time issue should not affect faithful
presentation

Understandability

• Information should be understandable to be useful

• Must be clear and concise

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The Cost Constraints

The cost of reporting financial information should be justified by

the benefits of reporting that information. Differences in
reporting may be appropriate because of size of the entity,
public vs private company, user’s needs or any other relevant
factor.

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Concept 4 (Elements of financial statements)

ASSETS

LIABILITIES EQUITY

INCOME EXPENSES

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Concept 4 (Elements of financial statements)
We use
ASSETS this one

Old definition New definition

• A resource • A present economic

• Controlled by the resource
entity • Controlled by the
• As a result of past entity
events and • As a result of past
• From which future events
economic benefits are
expected to flow to
the entity

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 Concept 4 (Elements of financial statements)
Asset definition breakdown
1. Economic 2.Controlled by the
3. Past event
resource entity
• is defined as a right • Control • Occurred before
that has the • Direct the use of reporting date
potential to produce the economic
economic benefits resource
• Obtain the benefits
• Right from the resource
• Not physical object • Prevent others
• Gives access from directing the
use of the resource
• Potential to • Legal rights
produce economic
benefits
• The right must be
able to produce
benefits for the
entity
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 LECTURE EXAMPLE 1
Co-Pilot (Pty) Ltd is a company that sells pencils. The company purchased land on
which they built a shop where customers come to purchase pencils. The accountant of
Co-Pilot (Pty) Ltd is concerned that the new asset definition in the conceptual
framework will result in certain items which are currently considered to be an asset, to
no longer meet the new definition and vice versa.

He has provided you with the following list of assets that he would like a brief
explanation as to whether they will still be an asset under the new definition:

1.Inventory (pencils)
2.Land
3.Cash in a savings account

Required:
You are required to use the new definition of asset and prove if the assets listed above
meets the new definition of an asset.
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SOLUTION TO EXAMPLE 1
a) Inventory
Definition Application

Present economic Co-Pilot (Pty) Ltd has the right to sell the
resource pencils (their inventory)

(right and potential to The right to sell the pencils has the potential to
produce economic produce economic benefits through the inflow
benefits) of cash or another economic resource when
the pencils are sold
Controlled by the entity Co-Pilot (Pty) Ltd has legal ownership of the
pencils as they purchased the pencils
As a result of past events The past event is when Co-Pilot (Pty) Ltd
purchased the pencils (and gained control of
them)

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b) Land
Definition Application

Present economic Co-Pilot (Pty) Ltd has the right to decide how
resource to use their land. They decided to build a shop
from which they sell their pencils

(right and potential to The benefits obtained is from an inflow of

produce economic income to the business
benefits)
Controlled by the entity Co-Pilot (Pty) Ltd has legal ownership of the
land as they purchased the land
As a result of past events The past event is when Co-Pilot (Pty) Ltd
purchased the land and gained control of the
land.

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c) Cash in savings account
Definition Application

Present economic Co-Pilot (Pty) Ltd has the right to receive cash
resource from the bank.

(right and potential to The benefits obtained is from the use of the
produce economic cash (to purchase inventory, equipment etc.).
benefits)
Controlled by the entity Co-Pilot (Pty) Ltd has a legal contract with the
bank (when they set up the account)
As a result of past events The past event is when Co-Pilot (Pty) Ltd
accepted the contract (T’s & C’s) with the bank
and depositing the cash with the bank.

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Exercise

Do example 1 and 2 in Chapter 2 in the textbook

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 Concept 4 (Elements of financial statements)
We use
LIABILITIES this one

Old definition New definition

• A present obligation of the • A present obligation of the

entity entity
• Arising from past events • To transfer an economic
• The settlement of which is resource
expected to result in an • As a result of past events
outflow from the entity
• Of resources embodying • A present obligation is a
economic benefits duty or responsibility that
an entity has no practical
ability to avoid

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 Concept 4 (Elements of financial statements)
Liability definition breakdown

2.Potential to
1. Present
require a transfer of 3. Past event
obligation
economic resource
• A present obligation • Required to transfer • Entity already
is a duty or an asset obtained economic
responsibility that • e.g in case of benefit
an entity has no accounts payable, • Taken action
practical ability to cash will be • And as a result the
avoid transferred to settle entity will need to
• Types transfer economic
• Legal obligation resource
• Constructive
obligation
• Conditional
obligations(No
ability to avoid)

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 LECTURE EXAMPLE 2
Travelling (Pty) Ltd is a travel agency that rents office space from Sam
Golding Ltd for R10 000 per month. The company has a December financial
year end.
As of 31 December 2020, Travelling (Pty) Ltd still owes Sam Golding Ltd rent
for the month of December.

Required:
Using the definition of a liability, explain whether the rent owed for the month
of December 2020 is a liability from Travelling (Pty) Ltd’s perspective.

(Source: Gripping GAAP 2022/23 Adapted)

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SOLUTION TO EXAMPLE 2
Definition Application

Present obligation • Travelling (Pty) Ltd has a duty to pay Sam

Golding Ltd the monthly rental

No practical ability to avoid • Travelling (Pty) Ltd has a rental agreement with
the obligation Sam Golding Ltd which is legally enforceable
Obligation involves the Travelling (Pty) Ltd must pay Sam Golding Ltd R10
transferring of an economic 000 in cash
resource

As a result of past events Travelling (Pty) Ltd used the office space during
December 2020 to run their business (benefit
obtained)

Potential to transfer This is in the form of R10 000 cash

economic resources

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Exercise

Do example 4 in the textbook

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 Concept 4 (Elements of financial statements)
EQUITY
‘residual (remaining) interest in the assets of the entity after deducting all its
liabilities’

Equity = Asset – Liabilities

Assets = Liabilities + Equity

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LECTURE EXAMPLE 3
Wood Hub Ltd is a company that sells desks and chairs.
1. On 2 January 2020, Wood Hub Ltd purchased property for R1 200
000 (R1 million relates to the building R200 000 relates to the land).
The transactions were funded through equity.
2. On 10 January 2020, Wood Hub Ltd purchased a car for R20 000.
Wood Hub Ltd agreed to pay the R20 000 on 28 February 2020.

Required:
Using the accounting equation, show the effect that the above
transactions have on the accounting equation.

(Source: Fundamentals of Financial Accounting – Adapted)

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 SOLUTION TO EXAMPLE 3
Transaction Assets = Liabilities + Equity

2 Jan An increase in assets +200 000 = 0 + +200 000

2020 and an increase in +1 000 000 +1 000 000
equity (capital)
Subtotal 1 200 000 = 0 + 1 200 000

10 Jan An increase in assets +20 000 = +20 000 + 0

2020 and an increase in
liabilities
Subtotal 1 220 000 = 20 000 + 1 200 000

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 Concept 4 (Elements of financial statements)
We use
INCOME this one

Old definition New definition

• Increase in economic • Increases in assets, or

benefits • Decreases in liabilities, that
• During the accounting period result in increases in equity,
• In the form of • Other than those relating to
• Inflows or enhancements of contributions from holders of
assets or equity claims
• Decreases of liabilities
• That results in an increase in
equity
• Other than those relating to
contributions from equity
participants

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EXAMPLE 4

Travelling (Pty) Ltd is a travel agency that rents office space from Sam
Golding Ltd for R10 000 per month. On 1 November 2020,Travelling
(Pty) Ltd paid Sam Golding Ltd rent for the month of November 2020.
Sam Golding Ltd 2020 reporting period ends on 31 December
2020.

Required:
Using the definition of income, explain whether the rent received by
Sam Golding Ltd on 1 November 2020, satisfies the definition of
Income?

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 SOLUTION TO EXAMPLE 4
Definition Application

Increase in assets or • Rental income from the letting of the office space
decrease in liabilities increases Sam Goldings Ltd’s assets (bank) by
R10 000
That results in an increase • The amount received increases equity as the
in equity assets increased
Other than those relating to • The amount that is received is from a tenant and
contributions from holders of not a holder of equity and therefore no
equity contributions from holders of equity

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Exercise

Do example 4 in the textbook

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 Concept 4 (Elements of financial statements)
We use
Expense this one

Old definition New definition

• Decrease in economic • Decreases in assets, or

benefits • Increases in liabilities that
• During the accounting period result in decreases in equity,
• In the form of • Other than those relating to
• outflows or depletion of distributions to holders of
assets or equity claims
• Incurrences of liabilities
• That results in a decrease in
equity
• Other than those relating to
distributions to equity
participants

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 EXAMPLE 5
Eco-Plastics (Pty) Ltd is a company that sells environmentally friendly
plastic grocery bags. The company has a bank account which they
transact from. The bank charges for the month of September 2020 was
R500.
Eco-Plastics (Pty) Ltd has an October 2020 financial year end.

Required:
Using the definition of expenses, explain whether the bank charges in the
amount of R500, satisfies the definition of an expense?

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 SOLUTION TO EXAMPLE 5
Definition Application

Decreases in assets • The bank charges increases Eco-Plastics (Pty)

Ltd’s liabilities

Or increases in liabilities, • The transaction increased the liabilities but did

that result in decreases in not change the assets.
equity, • Therefore, equity decreases.
Other than those relating to • The bank charges involves the bank and not a
distributions to holders of holder of an equity claim. Therefore, it is not a
equity claims distribution to a holder of equity.

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Concept 5 (Recognition and derecognition)
Recognition
The process of:
 Capturing in the financial statements
 An item that meets the definition of an element
 In such a way that:
- It is depicted in both words and amount
- The amount is included in one or more totals in the financial
statements

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 Concept 5 (Recognition and derecognition)
We use
Recognition criteria this criteria

Old criteria New criteria

• An item that meets the • Assets and liabilities, and any

definition of an element should resulting income, expenses or
be recognized if: changes in equity, must only be
recognized if the user would
• The future economic benefits find this information useful, i.e.,
are probable we only recognize the
elements if it means we are
• The item has a cost or value
providing information that is:
that is reliably measured
• Relevant; and
• A faithful representation

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 Concept 5 (Recognition and derecognition)
Recognition criteria breakdown

1. Relevant 2 Faithful presentation

• This is affected by: • Only affected by

• Existence uncertainty; measurement
and uncertainty
• Outcome uncertainty • Estimations are a
normal part of
accounting
• Estimates does not
mean that the
information presented
is not useful.
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 Concept 5 (Recognition and derecognition)
Derecognition

 Derecognition is the removal of all or part of a recognised asset

or liability from the company’s statement of financial position.
 Derecognize any assets or liabilities that fails to meet the
relevant definition.
 Derecognize any asset or liability transferred, consumed,
collected, fulfilled or expired

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 Concept 5 (Recognition and derecognition)
Derecognition cont….

Derecognition of an asset
 Derecognition normally occurs when the entity has lost control of all or
part of the previously recognized asset

Derecognition of a liability
 Derecognition happens when the entity no longer has a present
obligation for all or part of the recognised liability

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Concept 6 (Measurement)
 The elements of Financial statements are quantified in the financial
statements
 Measure=Quantify
 Should have a value

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Concept 6 (Measurement)
Measurement
Basis

Current value Historical cost

Fair value

Value in use

Current cost

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 Concept 6 (Measurement)
Historical cost
This is the value of the costs incurred in acquiring or creating the
asset or the consideration paid to acquire or create the asset
plus the transaction costs:

 Historic cost of an asset – Minimum economic benefits

that the entity expects to recover (transaction costs less
accumulated depreciation/amortization less accumulated
impairment)
 Historical cost of a liability – The maximum economic
benefit the entity expects to transfer out in order to settle a
liability

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 Concept 6 (Measurement)

Current value
 measures provide monetary information about assets,
liabilities and related income and expenses, using
information updated to reflect conditions at the
measurement date.
Can be:
 fair value
 value in use
 Current cost

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Fair value Price that would be received to sell an asset or
paid to transfer a liability at measurement date

Example
• Investment property
• PPE (measured under revaluation model)
• Financial assets and financial liabilities
Value in use (asset) Present value of the cash flows or economic
benefits that the entity expects to derive from
the use of an asset and from its disposal

Value in use (liability) Present value of cash or other economic

benefits that the entity expects to be obliged to
transfer as it fulfils its liabilities
Current cost (asset) Cost of an equivalent asset at measurement
date

(consideration paid + transaction cost)

Current cost (liability) Consideration that would be received or
equivalent liability at measurement date

(consideration received – transaction cost)

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Concept 6 (Measurement)

Factors to consider:
 Measurement must provide:
 Relevant; and a
 Faithful representation of the substance of the transaction

 In addition, we should strive to achieve information that

is
 Comparable
 Verifiable
 Timely

 Consider initial and subsequent measurement

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 Concept 7 (Presentation and Disclosure)

Classification of assets and

Classification
liabilities

• Classification of assets, • Sometimes appropriate to

liabilities, equity, income or separate an asset or liability
expenses into components
• Classifying similar items • e.g. current asset and non-
together current asset
• e.g. current liability and non-
current liability

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Concept 7 (Presentation and Disclosure)

Offsetting Aggregation

• Occurs when an entity • Adding together elements

recognises and measures that have shared
both assets and liabilities as characteristics and that are
separate units of account but included in the same
group them in a single net classification
amount in the SoFP

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SUMMARY
A summary of this chapter can be found in Gripping GAAP – page 72

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TASKS
 Practice the examples in the textbook
 Do the practical question
 Do the tutorial questions
 Consult if you need help

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