The objective of general

purpose financial reporting

The Conceptual Framework states that:
'The objective of general purpose financial reporting is to
provide 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.'
The Conceptual Framework makes it clear that this
information should be prepared on an accruals basis.
Accruals basis
The effects of transactions and other events are
recognised when they occur (and not as cash or its
equivalent is received or paid) and they are recorded in
the accounting records and reported in the financial
statements of the periods to which they relate.
Accruals basis – Level2

Right and obligation

Underlying assumption

Going concern is the underlying assumption in

preparing financial statements.
The entity is normally viewed as a going concern, that
is, as continuing in operation for the foreseeable future.
It is assumed that the entity has neither the intention nor
the necessity of liquidation or of curtailing materially
the scale of its operations.
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Qualitative characteristics of
useful financial information
Chapter 3 of the Conceptual Framework distinguishes
between fundamental and enhancing qualitative
characteristics, for analysis purposes. Fundamental
qualitative characteristics distinguish useful financial
reporting information from information that is not
useful or misleading. Enhancing qualitative
characteristics distinguish more useful information from
less useful information.
The two fundamental qualitative
characteristics are relevance and faithful
representation.
Relevance

Relevant information is capable of making a

difference in the decisions made by users. It is
capable of making a difference in decisions if it has
predictive value, confirmatory value or both.
The relevance of information is affected by its
nature and its materiality.
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.
Faithful representation

Financial reports represent economic phenomena in

words and numbers. To be useful, financial
information must not only represent relevant
phenomena but must faithfully represent the
phenomena that it purports to represent.
To be a faithful representation information must be
complete, neutral and free from error.
A complete depiction includes all information necessary
for a user to understand the phenomenon being depicted,
including all necessary descriptions and explanations.
A neutral depiction is without bias in the selection or
presentation of financial information. This means that
information must not be manipulated in any way in order
to influence the decisions of users.
Free from error means there are no errors or omissions in
the description of the phenomenon and no errors made in
the process by which the financial information was
produced. It does not mean that no inaccuracies can arise,
particularly where estimates have to be made.
Substance over form
This is not a separate qualitative characteristic under
the Conceptual Framework. The IASB says that to do
so would be redundant because it is implied in faithful
representation. Faithful representation of a transaction
is only possible if it is accounted for according to its
substance and economic reality.
Enhancing qualitative characteristics
Comparability

Comparability is the qualitative characteristic that

enables users to identify and understand similarities
in, and differences among, items. 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 date.
Consistency, although related to comparability, is not the same.
It refers to the use of the same methods for the same items (i.e.
consistency of treatment) either from period to period within a
reporting entity or in a single period across entities.
The disclosure of accounting policies is particularly important
here. Users must be able to distinguish between different
accounting policies in order to be able to make a valid
comparison of similar items in the accounts of different entities.
Comparability is not the same as uniformity. Entities should
change accounting policies if those policies become
inappropriate.
Corresponding information for preceding periods should be
shown to enable comparison over time.
 Verifiability
Verifiability helps assure users that information faithfully
represents the economic phenomena it purports to
represent. It means that different knowledgeable and
independent observers could reach consensus that a
particular depiction is a faithful representation.
Information that can be independently verified is generally
more decision-useful than information that cannot.
 Timeliness
Timeliness means having information available to
decision-makers in time to be capable of influencing
their decisions. Generally, the older information is the
less useful it is.
Information may become less useful if there is a delay in
reporting it. There is a balance between timeliness and
the provision of reliable information. If information is
reported on a timely basis when not all aspects of the
transaction are known, it may not be complete or free
from error.
 Understandability
Classifying, characterising 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 analyse the information
diligently. Some phenomena are inherently complex and
cannot be made easy to understand. Excluding information
on those phenomena might make the information easier to
understand, but without it those reports would be
incomplete and therefore misleading. Therefore matters
should not be left out of financial statements simply.
 The cost constraint on useful financial reporting
This is a pervasive constraint, not a qualitative characteristic.
When information is provided, its benefits must exceed the
costs of obtaining and presenting it. This is a subjective area
and there are other difficulties: others, not the intended users,
may gain a benefit; also the cost may be paid by someone
other than the users. It is therefore difficult to apply a cost-
benefit analysis, but preparers and users should be aware of
the constraint.
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The elements of
financial statements
 Elements of financial statements

Elements of financial statements

Measurement of financial position in Statement of
financial position
Measurement of performance in Statement of profit
or loss and other comprehensive income
Asset. A resource controlled by an entity as a result of past
events and from which future economic benefits are
expected to flow to the entity.
Liability. A present obligation 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.
Equity. The residual interest in the assets of the entity after
deducting all its liabilities.
Income. 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.
Expenses. 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.
 Assets
Assets are usually employed to produce goods or services
for customers; customers will then pay for these. Cash itself
renders a service to the entity due to its command over other
resources.
The existence of an asset, particularly in terms of control, is
not reliant on:
(a) physical form (hence patents and copyrights); nor
(b) legal rights (hence leases).
Transactions or events in the past give rise to assets; those
expected to occur in the future do not in themselves give rise
to assets. For example, an intention to purchase a non-
current asset does not, in itself, meet the definition of an
asset.
 Liabilities
Obligation. A duty or responsibility to act or perform in a
certain way. Obligations may be legally enforceable as a
consequence of a binding contract or statutory requirement.
Obligations also arise, however, from normal business
practice, custom and a desire to maintain good business
relations or act in an equitable manner.
It is important to distinguish between a present obligation
and a future commitment. A management decision to
purchase assets in the future does not, in itself, give rise to a
present obligation.
Provisions
Is a provision a liability?
Provision. A present obligation which satisfies the
rest of the definition of a liability, even if the amount
of the obligation has to be estimated.
 Question
Consider the following situations. In each case, do we have
an asset or liability within the definitions given by the
Conceptual Framework? Give reasons for your answer.
a) Pat Co has purchased a patent for $20,000. The patent
gives the company sole use of a particular
manufacturing process which will save $3,000 a year for
the next five years.
b) Baldwin Co paid Don Brennan $10,000 to set up a car
repair shop, on condition that priority treatment is given
to cars from the company's fleet.
c) Deals on Wheels Co provides a warranty with every car
sold.
 Answer
a) This is an asset, albeit an intangible one. There is a past
event, control and future economic benefit (through cost
savings).
b) This cannot be classified as an asset. Baldwin Co has no
control over the car repair shop and it is difficult to argue
that there are 'future economic benefits'.
c) The warranty claims in total constitute a liability; the
business has taken on an obligation. It would be
recognised when the warranty is issued rather than when a
claim is made.
 Equity
Equity is defined above as a residual, but it may be sub-
classified in the statement of financial position. This will
indicate legal or other restrictions on the ability of the entity
to distribute or otherwise apply its equity. Some reserves are
required by statute or other law, eg for the future protection
of creditors.
The amount shown for equity depends on the measurement
of assets and liabilities. It has nothing to do with the market
value of the entity's shares.
 Income
Both revenue and gains are included in the definition of
income. Revenue arises in the course of ordinary activities
of an entity.
Gains. Increases in economic benefits. As such they are no
different in nature from revenue.
Gains include those arising on the disposal of non-current
assets. The definition of income also includes unrealised
gains, eg on revaluation of marketable securities.
 Expenses
As with income, the definition of expenses includes
losses as well as those expenses that arise in the course of
ordinary activities of an entity.
Losses. Decreases in economic benefits. As such they are
no different in nature from other expenses.
Losses will include those arising on the disposal of non-
current assets. The definition of expenses will also
include unrealised losses, eg the fall in value of an
investment.
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Financial Position approach
Dr/Cr – 会计仅仅是记录经济交易的一门语言
捡钱
卖货物
处置固定资产
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Recognition of the elements of
financial statements
Items which meet the definition of assets or liabilities may
still not be recognised in financial statements because they
must also meet certain recognition criteria.
An item that meets the definition of an element and satisfies
the following criteria for recognition:
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.
一切向钱看
一切向钱看
Assets which cannot be recognised

The recognition criteria do not cover items which many

businesses may regard as assets.
A skilled workforce is an undoubted asset but workers can
leave at any time so there can be no certainty about the
probability of future economic benefits.
A company may have come up with a new name for its
product which is greatly increasing sales but, as it did not
buy the name, the name does not have a cost or value that
can be reliably measured, so it is not recognised.
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Measurement of the elements
of financial statements
Measurement. The process of determining the monetary
amounts at which the elements of the financial statements
are to be recognised and carried in the statement of financial
position and statement of profit or loss and other
comprehensive income.
A number of different measurement bases are used in
financial statements. They include
– Historical cost
– Current cost
– Realisable (settlement) value
– Present value of future cash flows
Current cost.
Assets are carried at the amount of cash or cash
equivalents that would have to be paid if the same or an
equivalent asset was acquired currently.
Liabilities are carried at the undiscounted amount of cash
or cash equivalents that would be required to settle the
obligation currently.
Realisable value. The amount of cash or cash
equivalents that could currently be obtained by
selling an asset in an orderly disposal.
Present value. A current estimate of the present
discounted value of the future net cash flows in the
normal course of business.
Historical cost is the most commonly adopted
measurement basis, but this is usually combined with
other bases, eg inventory is carried at the lower of cost
and net realisable value.
Recent standards use the concept of fair value, which is
defined by IFRS 13 as ‘the price that would be received
to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the
measurement date’.
 Example

A machine was purchased on 1 January 20X8 for $3m.

That was its original cost. It has a useful like of 10 years
and under the historical cost convention it will be
carried at original cost less accumulated depreciation.
So in the financial statements at 31 December 20X9 it
will be carried at: $3m – (0.3 x 2) = $2.4m
The current cost of the machine, which will probably
also be its fair value, will be fairly easy to ascertain if it
is not too specialised. For instance, two year old
machines like this one may currently be changing hands
for $2.5m, so that will be an appropriate fair value.
The net realisable value of the machine will be the amount
that could be obtained from selling it, less any costs
involved in making the sale. If the machine had to be
dismantled and transported to the buyer’s premises at a cost
of $200,000, the NRV would be $2.3m.
The replacement cost of the machine will be the cost of a
new model less two year’s depreciation. The cost of a new
machine may now be $3.5m. Assuming a 10-year life, the
replacement cost will therefore be $2.8m.
The present value of the machine will be the discounted value of
the future cash flows that it is expected to generate. If the machine
is expected to generate $500,000 per annum for the remaining 8
years of its life and if the company’s cost of capital is 10%, present
value will be calculated as: $500,000 x 5.335* = $2667,500
* Cumulative present of $1 per annum for 8 years discounted at
10%
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OT1
Conceptual framework
 B1-1
How does the Conceptual Framework define an asset?
A. A resource owned by an entity as a result of past events and from
which future economic benefits are expected to flow to the entity
B. A resource over which an entity has legal rights as a result of past
events and from which economic benefits are expected to flow to the
entity
C. A resource controlled by an entity as a result of past events and from
which future economic benefits are expected to flow to the entity
D. A resource to which an entity has a future commitment as a result of
past events and from which future economic benefits are expected to
flow from the entity (2 marks)
 B1
Answer C
A resource controlled by an entity as a result of past events and from which
future economic benefits are expected to flow to the entity
 B2-2
Which one of the following would be classified as a liability?
A. Dexter's business manufactures a product under licence. In 12
months' time the licence expires and Dexter will have to pay
$50,000 for it to be renewed.
B. Reckless purchased an investment 9 months ago for $120,000. The
market for these investments has now fallen and Reckless's
investment is valued at $90,000.
C. Carter has estimated the tax charge on its profits for the year just
ended as $165,000.
D. Expansion is planning to invest in new machinery and has been
quoted a price of $570,000. (2 marks)
 B2
Answer C
This is a valid liability.
The licence payment could be avoided by ceasing manufacture.
The fall in value of the investment is a loss chargeable to profit or loss.
Planned expenditure does not constitute an obligation.
 B3-3
Which one of the following would correctly describe the net
realisable value of a two year old asset?
A. The original cost of the asset less two years' depreciation
B. The amount that could be obtained from selling the asset, less
any costs of disposal
C. The cost of an equivalent new asset less two years' depreciation
D. The present value of the future cash flows obtainable from
continuing to use the asset (2 marks)
 B3
Answer B
The amount that could be obtained from selling the asset, less any
costs of disposal
 B4-4
The Conceptual Framework identifies an underlying assumption in
preparing financial statements. This is:
A. Going concern
B. Materiality
C. Substance over form
D. Accruals (2 marks)
 B4
Answer A
The underlying assumption is going concern.
 B5-5
The Conceptual Framework identifies four enhancing qualitative
characteristics of financial information. For which of these
characteristics is disclosure of accounting policies particularly
important?
 Verifiability
 Timeliness
 Comparability
 Understandability (2 marks)
 B5
Answer Comparability
Disclosure of accounting policies is particularly important when
comparing the results and performance of one entity against another
which may be applying different policies.
 B6-6
Which of the following is not a purpose of the IASB's Conceptual
Framework?
 To assist the IASB in the preparation and review of IFRS
 To assist auditors in forming an opinion on whether financial
statements comply with IFRS
 To assist in determining the treatment of items not covered by an
existing IFRS
 To be authoritative where a specific IFRS conflicts with the
Conceptual Framework (2 marks)
 B6
Answer
To be authoritative where a specific IFRS conflicts with the
Conceptual Framework
Whenever there is a conflict between an IFRS and the Conceptual
Framework, the IFRS takes precedence.
OT2
Conceptual framework
 Information relevant to Questions B9-B13
The accountant of Lisbon is considering a number of transactions
and events and how they should be treated in accordance with the
concepts and qualitative characteristics of financial information as
set out in the Conceptual Framework.
During the year ended 31 March 20X6, Lisbon experienced the
following transactions or events.
 Information relevant to Questions B9-B13
(i) Sold an asset to a finance company and leased it back for the
remainder of its useful life. The accountant has decided that
this should be treated as a secured loan.
(ii) The company's statement of profit or loss prepared using
historical costs showed a loss from operating its shops, but
the company is aware that the increase in the value of its
properties during the period far outweighed the operating
loss.
(iii) Inventory has up to this year been valued using FIFO but the
accountant is considering changing to the weighted average
method for the year to 31 March 20X6.
 B9
The accountant is aware that some members of the Board of Lisbon
have little understanding of accounting and he is worried about his
presentation of the financial statements at the Board meeting.
How should he deal with this situation?
A. In doing his presentation he should omit any complex issues, so
that everybody can understand what he is saying.
B. He should open his presentation with the advice that some of them
may not understand all of it.
C. He should classify, characterise and present the information
clearly and precisely.
D. He should deliver his presentation just to those who are financially
qualified.
 B9
Answer C
The Conceptual Framework requires information to be presented
understandably, but without omitting complex issues.
 B10
Which concept or qualitative characteristic has influenced the
decision in (i) above?
A. Faithful representation
B. Verifiability
C. Accruals
D. Comparability
 B10
Answer A
Faithful representation. The substance of the transaction is likely to be
that of a secured loan.
 B11
In looking at issue (ii) above, the accountant decides that the
properties should be revalued.
Which concept or qualitative characteristic has been applied in
making this decision?
A. Materiality
B. Going concern
C. Relevance
D. Timeliness
 B11
Answer C
Relevance. The historical cost of the properties will be less relevant
than their current value.
 B12
Because loss on operating the shops, the accountant is considering the
issue of going concern. If it were decided that Lisbon was no longer a
going concern at 31 March 20X6, which of the following would
apply in accordance with the Conceptual Framework?
A. Financial statements do not need to be prepared.
B. All the assets should be liquidated.
C. The financial statements should be prepared on a different basis.
D. The financial statements should be prepared as normal and the
going concern status disclosed in the notes.
 B12
Answer C
The financial statements should be prepared on a different basis. The
basis of valuation of assets will be affected.
 B13
In applying the principle of comparability, how should the
change of inventory valuation basis be accounted for?
A. The change should just be disclosed.
B. The financial statements for 31 March 20X6 should show both
methods.
C. The notes should show what the profit would have been if the
change had not taken place.
D. The financial statements for the prior period as shown at 31
March 20X6 should be restated using the weighted average
basis.
 B13
Answer D
This is a change of accounting policy so the information will be
amended retrospectively.
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