Conceptual Framework Underlying

Financial Reporting

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Objectives
 Understand the role of a conceptual
framework of accounting
 Be able to define the elements of
financial reporting
 Understand the desirable qualitative
characteristics of financial information
 Understand recognition and
measurements concepts

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Conceptual Framework of Financial
Reporting

What does the current accounting
standard setting authority rely on to
prescribe the accounting standards?
 Conceptual Framework of Financial
Reporting: A system of interactive
objectives and fundamentals which can
lead to a set of consistent standards in
preparing financial reports.
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Conceptual Framework(CF) - Introduction

 CF prescribes the nature, function and limits of

financial accounting and reporting
 Central goal in establishing CF is general
consensus on:
– scope and objectives of financial reporting
– qualitative characteristics that financial information
should possess
– elements of financial reporting

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Benefits of a Conceptual Framework
 Accounting standards more consistent
 Increased international comparability
 Should result in the Boards (eg IASB,
FASB) being more accountable for their
decisions
 Enhanced process of communication
between the Boards and constituents
 More economical accounting standard
development
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Financial Reporting: A Theoretical Structure
A Conceptual Framework for Financial Reporting

First Level
Objectives
Qualitative
Characteristic Elements Second Level
of Accounting
Information
Recognition and
Measurement Concepts Third level

Assumptions Principles Constraints

•
Entity •
Cost & Fair •
Cost/Benefit
•
Going- Value Option •
Industry
Concern •
Revenue Practices
•
Monetary unit •
Matching
•
Periodicity •
Full Disclosure
Environment and Theoretical Structure of Financial Accounting 6
Level One of The Conceptual Framework
 The objective of general-purpose
financial reporting:

Providing useful financial information of
the reporting entity to existing and
potential investors, lenders, and other
users in making decisions regarding
providing resources to the entity.

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Level Two of The Framework
 Qualitative (Characteristics of Accounting
Information)

I. Fundamental Qualities
1) Relevance 2) Faithful Representation
a) Predictive value a) Completeness
b) Confirmatory value b) Neutral
c) Materiality c) Free from error

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(contd.)
II. Enhancing Qualitative Characteristics

1) Comparability(including consistency)

2) Verifiability

3) Timeliness

4) Understandability

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Elements of accounting
 Five elements of accounting are defined
in the Conceptual Framework
 – assets
 – liabilities
 – equity
 – expenses
 – incomes

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Elements (cont.)

Definition of assets:
 Assets are defined as resources controlled by the entity as a
result of past events and from which future economic
benefits are expected to flow to the entity.
 Three key characteristics of definition:
 – There must be future economic benefits
 – The reporting entity must control the future economic
benefits
 – The transaction or other event giving rise to the control
must have occurred

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Elements (cont.)
Definition of liabilities:
Liabilities are defined as present obligations of the

entity arising from past events, the settlement of

which is expected to result in an outflow from the
entity of resources embodying economic benefits.
There are three main characteristics:
1. there must be a future disposition or sacrifice of

economic benefits to other entities

2. it must be a present obligation
3. a past transaction or other event must have

created the obligation

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Elements (cont.)
Definition of expenses:

The definition is dependent upon the definition of
assets and liabilities.

Expenses are defined as 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 equity participants

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Elements (cont.)
Definition of income:

Again, the definition is dependent on those of
‘asset’ and ‘liability’.

Income is defined as 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

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Elements (cont.)

Definition of equity: is a residual interest in the

assets of the entity after deducting all of its liabilities
Directly a function of the definitions given to assets
and liabilities

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Level Three of The Conceptual Framework
 Measurement and Recognition Concepts
I.Assumptions
1) Business Entity
2) Going-concern (continuity)
3) Monetary unit
4) Periodicity (Period of time)
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(contd.)
II. Principles
1) Historical cost principle and fair
value option
2) Revenue recognition
3) Matching/Expense Recognition
4) Full Disclosure (i.e., footnote
disclosure)
III. Constraints
1) Cost-Benefit
2) Industry Practices
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 Constraints

1. Cost-Benefit Relationship – The costs of providing the

information must be weighed against the benefits that
can be derived from using the information.

Examples of costs to provide particular

information that must be considered include costs for

a) collecting and processing

b) auditing
c) potential litigation
d) disclosure to competitors

Benefits are generally more difficult to quantify

than costs.
Constraints

2. Industry Practice – The peculiar nature of some

industries and business concerns sometimes
requires departure from basic theory.

Ex.) In the public utility industry, non-

current assets are reported first on the statement
of financial position to highlight the industry’s
capital-intensive nature.
THANK YOU

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