CONCEPTUAL

FRAMEWORK
Module No. 2

BATHEOAX
Conceptual Framework and Accounting Standards

LEARNING OUTCOMES TOPICS INCLUDED

At the end of this module, you are expected to: Included in this module are the following:
1. Describe the scope and purpose of the 1. Underlying concepts of Conceptual
Conceptual Framework; Framework
2. Describe the objective of general purpose 2. The objective of financial reporting
financial reporting; 3. Qualitative characteristics of useful financial
3. Identify the qualitative characteristics of information
useful financial information; 4. Elements of financial statements
4. Describe the underlying assumption of the 5. Recognition and derecognition of the
Conceptual Framework and elements and elements of financial statements
apply the recognition and derecognition 6. Measurement, presentation and disclosure
criteria of the elements of financial of those elements
statements; 7. Concept of capital and capital maintenance
5. Describe the measurement bases, the
factors to be considered when selecting a
measurement basis, and how information
should be presented and disclosed in
financial statements.
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Pre-Activity
Try to answer the following questions.
1. Translate Conceptual Framework in Filipino.
2. Did you once feel the need to read a financial statement?
3. What do you think is the meaning of cost-benefit analysis?

PURPOSE AND STATUS

The main purpose of the Conceptual Framework is to guide the International Accounting
Standards Board (IASB) when it develops International Financial Reporting Standards. It sets
out the concepts that underlie the preparation and presentation of financial statements for
external users.

Purpose
Assist them to develop consistent accounting policies when no IFRS
Preparers Standard applies to a particular transaction or other event, or when an
IFRS Standard allows a choice of accounting policy
Assist them in forming on opinion whether financial statements comply
Auditors
with IFRS
Users of
Assist them in interpreting the information contained in financial
Financial
statements prepared in compliance with IFRS
Statements
Assist them in promoting harmonization of regulations, accounting
standards and procedures relating to the presentation of financial
IASB
statements by providing a basis for reducing the number of alternative
accounting treatments permitted by IFRSs
Provide those who are interested in the work of the IASB with
Others
information about its approach to the formulation of IFRSs.

While the Conceptual Framework is the foundation of IFRS Standards, it is important to

remember that it is not an IFRS Standard. Therefore, it does not have the same authority as an
IFRS Standard and does not override any Standard.

In those cases, where there is a conflict, the requirements of the specific IFRS always prevail
over the Conceptual Framework. The conceptual framework will be revised from time to time
on the basis of the Board’s experience of working with it.

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SCOPE
The Conceptual Framework deals specifically with:

1. The objective of general purpose financial reporting;

2. The qualitative characteristics of useful financial information;
3. The definition, recognition and measurement of the elements from which financial
statements are constructed; and
4. Concepts of capital and capital maintenance.

OBJECTIVE OF GENERAL PURPOSE FINANCIAL REPORTING

Objective
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.

Usefulness
Primary users
These group of users are the primary users relies on general purpose financial reports for much
of the financial information they need. Consequently, they are the primary users to whom
general purpose financial reports are directed.

Users Decisions Assessment Information needed

 The entity’s
Buying, selling or economic resources,
Investors
holding equity  Prospects for future claims against the
net cash inflows to entity, changes in
the entity those resources and
 Management’s claims
Lenders, stewardship of the  How efficiently and
trade Providing or settling entity’s economic effectively
creditors and loans and other forms of resources management has
other credit discharged its
creditors responsibilities to
use the entity’s
economic resources

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Other users
Users Information needed
Interested in information about the stability and profitability of their
Employees
employer and its ability to pay remunerations and employee benefits
Suppliers or
Interested in information that enables them to determine whether amounts
trade
owed to them will be repaid when due
creditors
Government Requires information in order to regulate the activities of the entity,
agencies determine tax policies and as a basis for national income and other statistics
Entities affect members of the public in many ways for example the by
Public contributing towards the local economy through the creation of jobs. The
public may therefore vest interest in the financial position of an entity

Limitation
General purpose financial reports do not and cannot provide all of the information that existing
and potential investors, lenders and other creditors need. Those users need to consider
pertinent information from other sources, for example, general economic conditions and
expectations, political events and political climate, and industry and company outlooks.

Information about a reporting entity’s economic resources, claims against the

entity and changes in resources and claims
General purpose financial reports provide information about the financial position, financial
performance and change in the economic resources and claims of a reporting entity. These types
of information provide useful input for decisions about providing resources to an entity.

Financial Position
This refers to information about the entity’s economic resources and the claims against the
reporting entity. It is useful in identifying the reporting entity’s financial strengths and
weaknesses which can help users to assess the entity’s liquidity, solvency and its financing
needs. Information about priorities and payment requirements of existing claims helps users to
predict how future cash flows will be distributed among those with a claim against the
reporting entity.

Financial Performance
Information about the performance of a reporting entity helps users to understand the return
that the entity has produced from its economic resources which is an indication of how well
management has discharged its stewardship responsibilities.

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Financial Performance Reflected by Accrual Accounting

Accrual accounting focuses on the effects of events and transactions when they occur and not
necessarily when cash is received or paid. Financial performance reflected by accrual
accounting is considered to provide a better basis for assessing the entity’s past and future
performance than information solely about cash receipt and payments.

Financial performance Reflected by Past Cash Flows

Information about entity’s cash flows during a period is also considered to be useful in the
assessment of the entity’s ability to generate future net cash inflows; it helps users to
understand an entity’s operations, evaluate its financing and investing activities, assess its
liquidity or solvency, and interpret other information about financial performance.

Changes in Economic Resources and Claims

A reporting entity’s economic resources and claims may also change for reasons other than
financial performance, such as issuing additional ownership shares. Information about this type
of change is necessary to give users a complete understanding of why the reporting entity’s
economic resources and claims changed and the implications of those changes for its future
financial performance.

QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL

INFORMATION
These apply to financial information provided in financial statements as well as to financial
information provided in other ways.

Fundamental Qualitative Characteristics

If financial information is to be useful, it must be both relevant and faithfully represent what it
purports to represent. The fundamental qualitative characteristics are relevance and faithful
representation

Relevance
Relevant financial information is capable of making a difference in the decisions made by users.
Financial information is capable of making a difference in decisions if it has predictive value,
confirmatory value or both.

Financial information has predictive value if it can be used as an input to processes employed
by users to predict future outcomes.

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Financial information has confirmatory value if it provides feedback about previous

evaluations. The predictive value and confirmatory value of financial information are
interrelated.

Materiality
Information is material if omitting it or misstating it could influence decisions that users
make on the basis of financial information about a specific reporting entity. Materiality is an
entity‑specific aspect of relevance based on the 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
To be useful, financial information must not only represent relevant phenomena, but it must
also faithfully represent the phenomena that it purports to represent. To be a perfectly faithful
representation, a depiction would have three characteristics. It would be complete, neutral and
free from error.

Complete
A complete depiction includes all information necessary for a user to understand the
phenomenon being depicted, including all necessary descriptions and explanations.

Neutral
A neutral depiction is without bias in the selection or presentation of financial information.
It is not slanted, weighted, emphasized, de-emphasized or otherwise manipulated to increase
the probability that financial information will be received favorably or unfavorably by users.

Free from Error

Free from error means there are no errors or omissions in the description of the phenomenon,
and the process used to produce the reported information has been selected and applied with
no errors in the process. Free from error does not mean perfectly accurate in all respects.

A faithful representation is affected by the level of measurement uncertainty, but measurement

uncertainty does not prevent information from being useful. However, in some cases, the most
relevant information may have a high level of measurement uncertainty and, therefore, may not
faithfully represent the underlying phenomenon, even with additional disclosures. In such
cases, the most useful information might be a different measure that is slightly less relevant
with a lower measurement uncertainty.

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Enhancing Qualitative Characteristics

Comparability, verifiability, timeliness and understandability are qualitative characteristics that
enhance the usefulness of information that is relevant and faithfully represented. They should
be maximized to the extent possible. However, the enhancing qualitative characteristics, either
individually or as a group, cannot make information useful if that information is irrelevant or
not faithfully represented.

Comparability
Information about a reporting entity is more useful if it can be compared with similar
information about other entities and with similar information about the same entity for another
period or another date. Comparability is the qualitative characteristic that enables users to
identify and understand similarities in, and differences among, items.

Consistency, although related to comparability, is not the same. Consistency refers to the use of
the same methods for the same items, either from period to period within a reporting entity or
in a single period across entities.

Although a single economic phenomenon can be faithfully represented in multiple ways,

permitting alternative accounting methods for the same economic phenomenon diminishes
comparability.

Verifiability
Verifiability means that different knowledgeable and independent observers could reach
consensus, although not necessarily complete agreement, that a particular depiction is a faithful
representation.

Verification can be direct or indirect. Direct verification means verifying an amount or other
representation through direct observation. Indirect verification means checking the inputs to a
model, formula or other technique and recalculating the outputs using the same methodology.

Timeliness
Timeliness means having information available to decision‑makers in time to be capable of
influencing their decisions. Generally, the older the information is the less useful it is.

Understandability
Classifying, characterizing and presenting information clearly and concisely makes it
understandable.

Financial reports are prepared for users who have a reasonable knowledge of business and
economic activities and who review and analyze the information diligently. They may, at times,
seek the aid of an adviser. Excluding information that is inherently complex and cannot be easy
to understand from financial reports might make the information in those financial reports

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easier to understand. However, those reports would be incomplete and therefore potentially
misleading.

Applying the enhancing qualitative characteristics is an iterative process that does not follow
a prescribed order. Sometimes, one enhancing qualitative characteristic may have to be
diminished to maximize another qualitative characteristic. For example, a temporary
reduction in comparability as a result of prospectively applying a new financial reporting
standard may be worthwhile to improve relevance or faithful representation in the longer
term. Appropriate disclosures may partially compensate for non‑comparability.

Cost Constraint on Useful Financial Reporting

Cost is a pervasive constraint on the information that can be provided by financial reporting.
Reporting financial information imposes costs, and it is important that those costs are justified
by the benefits of reporting that information. There are several types of costs and benefits to
consider.

Users of financial information also incur costs of analyzing and interpreting the information
provided. If needed information is not provided, users incur additional costs to obtain that
information elsewhere or to estimate it.

ELEMENTS OF FINANCIAL STATEMENTS

Underlying Assumption of the Conceptual Framework
Going Concern
The financial statements are normally prepared on the assumption that an entity is a going
concern and will continue in operation for the foreseeable future. Hence, it is assumed that the
entity has neither the intention nor the need to liquidate or curtail materially the scale of its
operations; if such an intention or need exists, the financial statements may have to be prepared
on a different basis and, if so, the basis used is disclosed.

The elements of financial statements

Financial statements portray the financial effects of transactions and other events by grouping
them into broad classes:

 Financial Position - the elements directly related to the measurement of financial

position are assets, liabilities and equity.
 Financial performance - the elements directly related to the measurement of profit are
income and expenses.

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Asset
An asset is defined as a present economic resource1 controlled by the entity2 as a result of past
events and from which future economic benefits are expected to flow to the entity 3.

1. Present economic resource

A right, or an economic resource, is not a physical object, such as an item of property, plant
and equipment, but a set of rights over the object –the right to use, sell, or pledge the object,
as well as other undefined rights.
2. Control
Control both encompasses a power and benefits elements. An entity must have the present
ability to direct how a resource is used and be able to obtain the economic benefits from that
resource in order to control it.
3. Potential to produce future economic benefits
The future economic benefit embodied in an asset is the potential to contribute, directly or
indirectly, to the flow of cash and cash equivalents to the entity.

Liabilities
A liability is defined as a present obligation of the entity1 to transfer an economic resource2 as a
result of past events3.

1. Present obligation
This is an essential characteristic of a liability. An obligation is a duty or responsibility to act
or perform in certain way. Obligations are established by contract, legislation or similar
means. Obligations may also arise, however, from an entity’s customary practices, published
policies or specific statements if the entity has no practical ability to act in a manner
inconsistent with those practices, polices or statements. These are sometimes referred to as a
“constructive obligation”
2. Obligation to transfer an economic resource
The settlement of a present obligation usually involves the entity giving up resources
embodying economic benefits in order to satisfy the claim of the other party Settlement may
be by payment of cash, transfer of other assets, provision of services, replacement of that
obligation with another obligation or conversion of the obligation to equity.
3. Present obligation as a result of past events
Liabilities result from past transactions or other past events. Thus, for example, the
acquisition of goods and the use of services give rise to trade payables (unless paid for in
advance or on delivery) and the receipt of a bank loan results in an obligation to repay the
loan.

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Equity
Equity is the residual interest in the assets of the entity after deducting all its liabilities. In other
words, they are claims against the entity that do not meet the definition of liability.

Income
Income is increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in increases in equity, other than
those relating to contributions from equity participants. It encompasses both revenue and gains.

Revenue arises in the course of the ordinary activities of an entity. Gains represent increases in
economic benefits and as such are no different in nature from revenue.

Expense
Expenses are decreases in economic benefits during the accounting period in the form of
outflows or depletions of assets or incurrences of liabilities that result in decreases in equity,
other than those relating to distributions to equity participants. It encompasses losses as well as
those expenses that arise in the course of the ordinary activities of the entity.

Expenses that arise in the course of the ordinary activities of the entity. Losses represent other
items that meet the definition of expenses and may, or may not, arise in the course of the
ordinary activities of the entity. Losses include, for example, those resulting from disasters such
as fire and flood, as well as those arising on the disposal of non‑current assets.

Recognition of the Elements of Financial Statements

Recognition is the process of incorporating in the statement of financial position or statement of
financial performance an item that meets the definition of an asset, a liability, equity, income or
expenses.

An item that meets the definition of an element should be recognized if:

a) it is probable that any future economic benefit associated with the item will flow to or
from the entity; and
b) the item has a cost or value that can be measured with reliability

The probability of Future Economic Benefit

The concept of probability is used in the recognition criteria to refer to the degree of uncertainty
that the future economic benefits associated with the item will flow to or from the entity.
Assessments of the degree of uncertainty attaching to the flow of future economic benefits are
made on the basis of the evidence available when the financial statements are prepared.

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Reliability of Measurement
The recognition of an item has a cost or value that can be measured with reliability. In many
cases, cost or value must be estimated; the use of reasonable estimates is an essential part of the
preparation of financial statements and does not undermine their reliability. When, however, a
reasonable estimate cannot be made the item is not recognized but would be disclosed in the
notes, explanatory material or supplementary schedules.

When to recognized?
Elements Probability of future economic benefits Reliability Measurement
when it is probable that the future has a cost or value that can be
Asset
economic benefits will flow to the entity measured reliably.
when it is probable that an outflow of the amount at which the
resources embodying economic benefits settlement will take place can
Liability
will result from the settlement of a be measured reliably
present obligation
when an increase in future economic can be measured reliably.
Income benefits related to an increase in an asset
or a decrease of a liability has arisen
when a decrease in future economic can be measured reliably.
Expenses benefits related to a decrease in an asset
or an increase of a liability

Different Recognition Bases for Expenses

Basis Detail
Referred to as the matching of costs with revenues that involves
Direct association
the simultaneous or combined recognition of revenues and
between cost incurred and
expenses that result directly and jointly from the same
income earned
transactions or other events
Expenses are recognized when economic benefits are expected
Systematical and rational to arise over several accounting periods and the association
allocation with income can only be broadly or indirectly determined with
the use of asset
An expense is recognized immediately in the income statement
when an expenditure produces no future economic benefits or
Immediate recognition when, and to the extent that, future economic benefits do not
qualify, or cease to qualify, for recognition in the balance sheet
as an asset.

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Derecognition of the Elements of Financial Statements

Derocognition occurs when the item no longer meets the definition of an asset or liability. An
asset is derecognized when the entity loses control of all or part of the recognized asset. A
liability is derecognized when the entity no longer has a present obligation for all or part of the
recognized liability.

Measurement of the Elements of Financial Statements

Measurement is the process of determining the monetary amounts at which the elements of the
financial statements are to be recognized and carried in the statement of financial position or
statement of financial performance. This involves the selection of the particular basis of
measurement.

Different Measurement Bases for Assets and Liabilities

Bases Asset Liabilities
amount of proceeds received in
amount of cash or cash
exchange for the obligation, or in some
equivalents paid or the fair
circumstances, at the amounts of cash or
Historical cost value of the consideration given
cash equivalents expected to be paid to
to acquire them at the time of
satisfy the liability in the normal course
their acquisition
of business.
amount of cash or cash undiscounted amount of cash or cash
equivalents that would have to equivalents that would be required to
Current cost be paid if the same or an settle the obligation currently
equivalent asset was acquired
currently
amount of cash or cash undiscounted amounts of cash or cash
Realizable
equivalents that could currently equivalents expected to be paid to
(Settlement)
be obtained by selling the asset satisfy the liabilities in the normal
value
in an orderly disposal course of business
present discounted value of the present discounted value of the future
future net cash inflows that the net cash outflows that are expected to
Present value
item is expected to generate in be required to settle the liabilities in the
the normal course of business normal course of business

Presentation and Disclosure

Information about assets, liabilities, equity, income and expenses is communicated through
presentation and disclosures in financial statements. Effective communication of financial
statements makes that information more relevant and contributes to a faithful representation of

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an entity’s assets, liabilities, equity, income and expenses. It also enhances the understandability
and comparability of information in financial statements.

CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE

Concepts of Capital
Financial Concept
Under a financial concept, capital is synonymous with the net assets or equity of the entity.
Financial concept of capital should be adopted if the users of financial statements are primarily
concerned with the maintenance of nominal invested capital or the purchasing power of
invested capital.

Physical Concept
Under a physical concept, capital is regarded as the productive capacity of the entity based on,
for example, units of output per day. Physical concept of capital should be adopted if the users
of financial statements are primarily concerned with the operating capability of the entity.

Concepts of Capital Maintenance and Determination of Profit

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.

Financial Capital Maintenance

Profit is earned only if the financial amount of the net assets at the end of the period exceeds the
financial amount of net assets at the beginning of the period, after excluding any distributions
to, and contributions from, owners during the period. Financial capital maintenance can be
measured in either nominal monetary units or units of constant purchasing power.

The financial capital maintenance concept, however, does not require the use of a particular
basis of measurement. Selection of the basis under this concept is dependent on the type of
financial capital that the entity is seeking to maintain.

Physical Capital Maintenance

Profit is earned only if the physical productive capacity (or operating capability) of the entity (or
the resources or funds needed to achieve that capacity) at the end of the period exceeds the
physical productive capacity at the beginning of the period, after excluding any distributions to,
and contributions from, owners during the period. It requires the adoption of the current cost
basis of measurement.

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Self-Check
Basing on your readings, answer the following questions.
1. Enumerate the scope of Conceptual Framework.
2. Enumerate the qualitative characteristics of useful financial information.
3. What is the difference between relevance and faithful representation?
4. What are the elements of financial statements?
5. What are the recognition criteria that meets the definition of an element?
6. What are the different measurement bases of the elements of financial statements?

Exercise 2.1 TRUE OR FALSE

Determine whether the following statements are true or false.
___________1. When there is a conflict between the Conceptual Framework and IFRS
Standard, the former overrides the requirements of the latter.
___________2. Understandability means that different knowledgeable and independent
observers could reach consensus.
___________3. Financial information is capable of making a difference in decisions if it has
predictive value, confirmatory value or both.
___________4. The enhancing qualitative characteristics, either individually or as a group,
can make information useful regardless if that information is irrelevant or not
faithfully represented.
___________5. Obligations may also arise from an entity’s customary practices, published
policies or specific statements if the entity has no practical ability to act in a
manner inconsistent with those practices, polices or statements.
___________6. Under a financial concept, capital is synonymous with the net assets or equity
of the entity
___________7. A liability is defined as a present obligation of the entity to receive an
economic resource as a result of past events.
___________8. Comparability, verifiability, neutral and understandability are qualitative
characteristics that enhance the usefulness of information that is relevant and
faithfully represented.
___________9. Information is material if omitting it or misstating it could influence decisions
that users make on the basis of financial information about a specific
reporting entity.
___________10. Information about the performance of a reporting entity helps users to
understand the return that the entity has produced from its economic
resources which is an indication of how well management has discharged its
stewardship responsibilities.

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Exercise 2.2 IDENTIFICATION

Identify the terminologies best described by the following statements.
___________1. It is recognized 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.
___________2. It is the process of capturing for inclusion in the statement of financial
position or the statement of financial performance an item that meets the
definition of an asset, a liability, equity, income or expenses.
___________3. It is the qualitative characteristic that enables users to identify and understand
similarities in, and differences among, items
___________4. These portray the financial effects of transactions and other events by
grouping them into broad classes
___________5. It is a pervasive constraint on the information that can be provided by
financial reporting
___________6. Obligations that arise from an entity’s customary practices, published policies
or specific statements.
___________7. A depiction that includes all information necessary for a user to understand
the phenomenon being depicted, including all necessary descriptions and
explanations.
___________8. It is a duty or responsibility to act or perform in certain way.
___________9. It means having information available to decision‑makers in time to be
capable of influencing their decisions.
___________10. It refers to the use of the same methods for the same items, either from period
to period within a reporting entity or in a single period across entities.

CONCEPTUAL FRAMEWORK | Module No. 2