EACC3708

LEARING UNIT 2

CONCEPTUAL FRAMEWORK ·

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

• Demonstrate an understanding of the Conceptual Framework, its status and purpose and
when it should be used.
• Demonstrate an understanding of the objectives of general purpose financial reporting and
the information needs of the users of financial statements.
• Demonstrate an understanding and application of the qualitative characteristics of useful
financial information.
• Demonstrate an understanding and application of the financial statements and the reporting
entity.
• Demonstrate an understanding and application of the definitions of elements of financial
statements and their recognition, derecognition and measurement criteria.
• Argue whether items meet the definitions and recognition/derecognition criteria and whether
elements should be recognised in the financial statements and argue appropriate
measurement
• Identify, recognise, measure, present and disclose elements in the financial statements.
• Answer theoretical questions on the Conceptual Framework
• Apply the theory in discussion questions.
• Use the Conceptual Framework to solve all accounting problems: entries, classification, and
disclosure
UNIT OVERVIEW ·

What is the Conceptual Framework?

It is NOT a standard, it is a
practical tool that assists :

>
-

Board (IASB) to
develop standards

Preparers
>
develop accounting policies
-

to consistent

>
-

All to understand and interpret Standards

Objective of the conceptual framework

Addresses the following fundamental issues:
• What is the objective of financial reporting?
• What makes financial information useful?
• What are assets, liabilities, equity, income and expenses, when should they be recognised
and how should they be measured, presented and disclosed?

Process of financial reporting:

The Conceptual Framework for Financial Reporting 2018 has been issued on 29 March 2018.
The revised version includes some new concepts, provides updated definitions and recognition
criteria for assets and liabilities and clarifies some important concepts. It is arranged in eight
chapters as follows:
• Chapter 1 – The objective of financial reporting
• Chapter 2 - Qualitative characteristics of useful financial information
• Chapter 3 – Financial statements and the reporting entity
• Chapter 4 – The elements of the financial statements
• Chapter 5 – Recognition and derecognition
• Chapter 6 – Measurement
• Chapter 7 – Presentation and disclosure
• Chapter 8 – Concepts of capital and capital maintenance

1. OBJECTIVE OF FINANCIAL REPORTING

To provide financial information useful to users in making decisions

buying, holding or selling
Types of decisions -
Users’ decisions involve
decisions about: > providing or settling loans

voting and influencing management

prospects for future net cash inflows

How are these To make these decisions,
> to the entity
-
decisions made? -
users assess: management’s stewardship of the
entity’s economic resources
economic resources, claims and

E
changes in those resources and claims
What do you need
To make assessments, users
to make these -

need information about: how efficiently and effectively

assessments?
management has discharged its
responsibilities

2. QUALITATIVE CHARACTERISTICS OF USEFUL 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 Information must faithfully represent the substance of what it

(Complete, neutral and purports to represent
free from error): • Complete (non-disclosure)
• Neutral (without bias, supported by prudence)
• Free from error (not absolutely accurate – think about estimates)

ENHANCING qualitative characteristics

Comparability Comparability in the accounting treatment should be consistent for:

• the same items over time;
• the same items in the same period; and
• similar items of different but similar companies over time and in
the same period.

Verifiability Verifiability is a characteristic of financial information that enables

users to confirm that the presented information does in fact faithfully
present the events or transactions it purports to present.

Timeliness Information will be able to influence the decision of users when it is

reported timely. Usually older information could still be useful over a
longer period of time when it is used for purposes of identifying and
assessing certain trends.

Understandability • To achieve the stated objective of financial reporting, the financial

statements should be understandable to the average user who
has a reasonable knowledge of business and a willingness to
study the information with the necessary diligence.
• Classifying, characterising and presenting information clearly and
concisely makes it understandable.
3. FINANCIAL STATEMENTS AND THE REPORTING ENTITY

The objective of general purpose financial reporting is to provide financial information that
is useful. Examples of these financial information includes:
• Statement of financial position
• Statement of profit or loss and other comprehensive income
• Cash flow statement
• Statement of changes in equity
• Notes and supplementary schedules

mean
Principles to apply when preparing the information above
cemen
↓ >
Going concern assumption Accrual basis of accounting
Financial statements are normally prepared on
the assumption that the reporting 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 enter liquidation or to cease trading.

4. ELEMENTS OF FINANCIAL STATEMENTS

ASSETS

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

Combined:
1) A present right,
2) that the has the potential to produce 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 definition of an
asset

(1) A present right • Rights that correspond to the obligation of another (par 4.6(a))
• Rights that do not correspond to the obligation of another (par 4.6(b))
• Rights can be established by:

Es Contract/legislation
Buying “know how”
As a result of past practice of another entity

Exam Technique
• Explain the right that has been established for the entity - i.e. what
benefit is the entity entitled to?
• Important! The existence of a right does not mean it is an asset; the
rest of the components of the definition should also be present.

(2) potential to • Potential only, not certainty

produce economic • An economic resource is a right that has the potential to produce
benefits economic benefits.
• For that potential to exist, it does not need to be certain, or even
likely, that the right will produce 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

Exam Technique
• Explain the economic benefits that may be potentially 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 right that
contains the potential, not the future 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 automatically an
asset
(3) that is controlled If the entity has:
by the entity • the present ability to direct the use and obtain economic benefits
that may flow from it (decide who and how to use the resource).
• includes the present ability to prevent other parties from directing
the use and obtaining the economic benefits

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.

Exam Technique
• It is important to explain the link between the past event that led to
the entity having control over the right.
• The past event should be identified as the specific event that
established the entity's control over the right.
LIABILITIES

(1) A present obligation

(2) to transfer an economic resource
(3) as a result of a past event

(1) A present • An obligation is a duty or responsibility that the entity has no

obligation practical ability to avoid
• Normally, if one party has an obligation another party has a right
• Established by contact, legislation, past practice

Exam technique
• Explain the obligation that the entity cannot avoid
• Important! The existence of an obligation does not mean it is a
liability; the rest of the components of the definition should also be
present.

(2) to transfer an • the obligation must have the potential to require the entity to
economic resource transfer an economic resource to another party
• does not have to be certain, just possibly
• Probability may be low – this affects the recognition, not definition

(3) as a result of a Only if:

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

OTHER COMPONENTS

eme
Equity Definition

The residual interest in the assets of the entity after deducting all its liabilities

Qu
Income Definition

Increases in assets, or
decreases in liabilities,
that result in increases in equity,
other than those relating to contributions from holders of equity claims

E Expense Definition

Decreases in assets, or
increases in liabilities,
that result in decreases in equity,
other than those relating to distributions to holders of equity claims
5. RECOGNITION AND DERECOGNITION

Recognition refers to:

• Including items that meets the definition of one of the elements of financial statements—an
asset, a liability, equity, income or expenses - in the financial statements.
• Only items that meet the definition of an asset, a liability or equity are recognised in the
statement of financial position.
• Only items that meet the definition of income or expenses are recognised in the statement(s)
of financial performance.
• Not all items that meet the definition of the elements are recognise

Provided an element’s definition is met, an element is recognised in the financial statements when
the recognition provides users of financial statements with information about the items that is both:

Recognition may not always provide relevant info, i.e.:

d
Relevant
• low probability of a flow of economic benefits • existence uncertainty

Whether recognition of an item results in a faithful representation

m Faithfully represented may be affected by, for example:
• measurement uncertainty

The following factors should be considered:

• probability of an in/outflow of economic benefits
• existence uncertainty
• measurement uncertainty

DERECOGNITION
Derecognition is the removal of all or part of a recognised asset or liability from an entity’s statement
of financial position.

When?
• Normally when that item no longer meets the definition of an asset or of a liability:
• asset: when the entity loses control of all or part of the recognised asset
• liability: when the entity no longer has a present obligation

6. MEASUREMENT

Quantifying (giving value) the elements that are recognised

Measurement bases:
• Historical cost
• Current value
7. PRESENTATION AND DISCLOSURE

Presentation: On the face of the financial statements

Disclosure: The notes to the financial statements

This is the communication with the users: The providing of useful information

Effective Communication
Effective communication of information in financial statements ('FS') makes that information more
relevant and contributes to a faithful representation of an entity's A/L/E/l and E. It also enhances
the understandability and comparability of information in FS (CF7.2).

Effective communication requires:

Focusing on presentation and disclosure objectives and principles rather than focusing on rules:
• For example, the use of entity-specific information is more useful than standardized
descriptions; and
• Avoiding duplicate information (CF7.6).

Classifying information in a manner that groups similar items and separates dissimilar items:
• Apply classification to unit of account or separate A/L into components with different
characteristics (CF7.9); and
• Offsetting is generally not appropriate (CF7.10).

Aggregate A/L/E/I/E with shared characteristics/with same classification (CF7.20).

The statement of profit or loss:

• The statement of profit or loss is the primary source of information about an entity's financial
performance for the reporting period.
• Profit or loss could be a section of a single statement of financial performance or a separate
statement.
• The statements) of financial performance include(s) a total (subtotal) for profit or loss (CF7.16).
in principle, all income and expenses are classified and included in the statement of profit or
loss (CF7.17).

Other comprehensive income:

In exceptional circumstances, the Board may decide to exclude from the statement of profit or
loss income or expenses arising from a change in current value of an asset or liability and include
those income and expenses in other comprehensive income (CF7.17).