CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS

LEARNING MODULES

CONCEPTUAL FRAMEWORK
LESSON 1 FOR FINANCIAL REPORTING
LEARNING OBJECTIVE
Explain the conceptual framework for financial reporting.

CFAS LECTURE SERIES

Financial reporting is a method of reporting the results and financial position of a reporting entity primarily
to satisfy the need for information of the users. A reporting entity is an entity whose general purpose
financial statements are relied upon by other parties or users in making and evaluating decisions about the
allocation of resources. A reporting entity can be a single entity or a group comprising a parent and its
subsidiaries. Users of financial statements and accounting information include the primary users, i.e.
existing and potential investors, lenders, and other creditors, who are likely to be interested in financial
information about a company, and other users, i.e. managers, employees, financial analysts, financial
advisers, government agencies, and the general public .

Accounting concepts and principles guide accountants in recording and communicating economic
information. These concepts and principles are either explicit or implicit. Those that are specifically
mentioned in the Conceptual Framework for Financial Reporting and the Philippine Financial Reporting
Standards (PFRS) are called explicit concepts and principles while those that are not mentioned are called
implicit concepts and principles. Accounting standards refer to the PFRS and previously called generally
accepted accounting principles (GAAP). Technically, the standards and interpretations adopted by the
Financial Reporting Standard Council (FRSC), the official accounting standard-setting body in the Philippines,
include the (1) Philippine Financial Reporting Standards, (2) Philippine Accounting Standards, and (3)
Interpretations. The following illustration provides basic information about the accounting standard-setting
bodies and other relevant organizations.

1. International Accounting Standards Board (IASB) is the standard-setting body of the International
Financial Reporting Standards Foundation with the main objectives of developing and promoting global
accounting standards. The standards issued by IASB, generally known as the international financial
reporting standards (IFRSs) also include the international accounting standards (IAS) and interpretations.
2. International Financial Reporting Interpretations Committee (IFRIC) is a committee that prepares
interpretations of how specific issues should be accounted for under the application of IFRS where the
standards do not include specific authoritative guidance and there is a risk of divergent and unacceptable
accounting practices.

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3. Financial Reporting Standards Council is the official accounting standard-setting body in the
Philippines created under the Philippine Accountancy Act of 2004 (R.A. 9298). It is composed of fifteen
(15) individuals wherein the chairperson must be a present senior accounting practitioner.
4. Philippine Interpretations Committee (PIC) is a committee formed by the Accounting Standards
Council, the predecessor of FRSC, to review the interpretations of the IFRIC for approval and adoption by
the FRSC.
5. Board of Accountancy is the professional regulatory board created under R.A. 9298 to supervise the
registration, licensure, and practice of accountancy in the Philippines. The board comprises a chairperson
and 6 members appointed by the president of the country.
6. Securities and Exchange Commission (SEC) is the government agency tasked with regulating
corporations and partnerships, capital and investment markets, and the investing public. The rulings
promulgated by the commission affect the accounting requirements and the adoption and application of
accounting policies of the reporting entities.
7. Bureau of Internal Revenue (BIR) administers the provisions of the National Internal Revenue Code
which sometimes influence the choice of accounting methods and procedures.
8. Bangko Sentral ng Pilipinas (BSP) influences the selection and application of accounting policies by
banks and other relevant entities.
9. Cooperative Development Authority (CDA) influences the selection and application of accounting
policies by cooperatives.
10. IFRS Advisory Council serves as advisor of the IASB on its programs and projects.
11. International Federation of Accountants (IFAC) is a non-profit, non-governmental, non-political
organization of accountancy bodies that represents the worldwide accountancy profession with a miss ion
of developing and enhancing the profession in providing consistently high-quality services to the public.
12. International Organization of Securities Commissions (IOSCO) is an international body of security
commissions wherein the SEC of the country is a member.

The conceptual framework is a statement of generally accepted theoretical principles, which serves as the
frame of reference for financial reporting. The conceptual framework assists the IASB in developing new
accounting standards as well as in evaluating those already in existence. It also assists the preparers of
financial statements in developing consistent accounting policies when no standard applies to a particular
transaction or when a standard allows a choice of accounting policy. It also assists all interested parties in
understanding and interpreting the standards. Moreover, the conceptual framework promotes transparency
by enhancing the international comparability and quality of financial information, strengthen accountability by
reducing the information gap between providers of capital and the management, and contribute to the
economic efficiency by helping investors to improve capital allocation, lower the cost of capital, and reduce
the international reporting costs.

The conceptual framework is not a standard. If there is a conflict between a standard and the conceptual
framework, the requirements of the standard will prevail. In the absence of the standard that specifically
applies to a transaction, the management may contemplate the guidance of the hierarchy of reporting
standards. The management may consider first the requirements in other standards dealing with similar
transactions , second, the applicability of the conceptual framework, third, the pronouncements issued by
other standard-setting bodies , and lastly, other accounting literature and industry practices .

The revised conceptual framework sets out a comprehensive set of concepts which include the objective of
financial reporting, the qualitative characteristics of useful financial information, financial statements and the
reporting entity, definitions of an asset, a liability, equity, income and expenses, criteria for including assets

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and liabilities in financial statements, recognition and derecognition, measurement bases , and presentation
and disclosure. The succeeding discussion will revolve around these concepts.

1. The objective of financial reporting

The objective is the foundation of the conceptual framework. All the other aspects of the conceptual
framework revolve around this objective. The illustration below depicts a comprehensive explanation of the
objective of financial reporting.

Financial reports provide information about the financial position of an entity’s economic resources and the
claims against these resources. They also provide information about changes in an entity's economic
resources and claims. Information about the entity's economic resources and the claims against it helps
users to assess the entity's liquidity - the availability of sufficient funds to meet deposit withdrawals and
other short-term financial commitments as they fall due and solvency - the availability of cash over the long
term to meet financial commitments as they fall due, and its needs for additional finance, and how successful
it is likely to be in obtaining it.

Changes in an entity's economic resources and claims result from its financial performance and also from
other transactions and events such as the issue of shares or an increase in borrowings. Information about a
reporting entity's financial performance helps users to understand the return that the entity has produced on
its economic resources. This is an indicator of how efficiently and effectively management has used the
resources of the entity and helps predict future returns. Information about an entity's financial performance
helps users to assess the entity's past and future ability to generate net cash inflows from its operations.

Financial information should be prepared using accrual accounting. Information about an entity's economic
resources and claims and its changes during a period is more useful in assessing an entity's past and future
performance than information based solely on cash receipts and payments during that period.

Information about a reporting entity's cash flows during a period also helps users assess the entity's ability
to generate future net cash inflows and provides information about factors that may affect its liquidity or

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solvency. It also gives users a better understanding of the entity's operations and its financing and investing
activities.

2. The qualitative characteristics of useful financial information

The qualitative characteristics of useful financial information identify the types of information that are likely
to be most useful to the primary users in making decisions using an entity’s financial report. The conceptual
framework classifies this into fundamental and enhancing qualitative characteristics.

These are considered as fundamental qualities because it makes the information useful to users.
Relevance Faithful Representation
Accounting information has relevance if it would Faithful representation means that information
make a difference in a business decision. The accurately depicts what happened. Faithfully
relevant information has the following aspects: represented information has the following aspects:
a. It has predictive value if it helps in making a. Information is complete if all necessary
predictions. information is provided. It supports the full-
b. It has a confirmatory value if it confirms or disclosure principle that requires companies to
corrects past predictions. disclose all circumstances and events that would
c. Materiality is a company-specific aspect of make a difference to financial statement users.
relevance. An item is material when its size makes b. Information is neutral if it is not biased toward
it likely to influence the decision of an investor or one position or another.
creditor. c. The information must be free from error
particularly in describing and processing
accounting information.

These are considered as enhancing qualities because it enhances the usefulness of the information.
Comparability Verifiability Timeliness Understandability
Different companies use Information is verifiable The information must be The information must be
the same accounting if independent timely available to clear and concise so
principles. observers, using the decision-makers before that users who have
same methods, obtain it loses its capacity to reasonable knowledge
The company uses the similar results. This influence decisions. and willingness to
same accounting supports the objectivity analyze can interpret it
principles and methods principle. and comprehend its
from year to year which meaning.
is known as the
consistency principle.

The information must be both relevant and faithfully represented if it is to be useful. In practice, an entity
must often find a balance between the two, to present the most relevant information that can be faithfully
represented. The same principle applies to enhance qualitative characteristics. Sometimes, one
characteristic may have to be diminished to maximize another. For example, applying a new standard may
reduce comparability in the short term, but may improve relevance or faithful representation in the longer
term.

Cost is a pervasive constraint on the information that can be provided by financial reporting. The conceptual
framework explains that it is important that the benefits justify the costs of reporting financial information.

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3. Financial statements and the reporting entity

Financial statements are a particular form of financial reports that provide information about the reporting
entity’s assets, liabilities, equity, income, and expenses. The financial statements comprise the statement of
financial position which presents the recognized assets, liabilities, and equity, the statement of financial
performance which displays the recognized income and expenses, and other statements and notes which
provides information on cash flows, contributions from/distributions to owners, and other relevant
information.

Financial statements are prepared for a specified period of time and provide information on assets,
liabilities, and equity that existed at the end of the reporting period, or during the reporting period, and
income and expenses for the reporting period. Financial statements also provide comparative information
(current period and at least one preceding reporting period), and forward-looking information (historical
data and subsequent events).

Financial statements are normally prepared on the assumption that the reporting entity is a going concern,
which means the entity will operate indefinitely.

A reporting entity is an entity that is required, or chooses, to prepare financial statements. It does not
necessarily a legal entity. It can be a portion of an entity or comprise more than one entity. If the reporting
entity comprises both the parent and its subsidiaries, viewed as a single reporting entity, the financial
statements are referred to as consolidated financial statements. If the reporting entity is the parent alone,
the financial statements are referred to as unconsolidated financial statements. If the reporting entity
comprises two or more entities that are not linked by a parent-subsidiary relationship, the financial
statements are referred to as combined financial statements.

4. Elements of financial statements

Transactions and other events are grouped in broad classes, and in this way, their financial effects are
shown in the financial statements. These broad classes are elements of financial statements. The
conceptual framework lays out these elements as follows.

a. Asset
Measurement of
b. Liabilities
Elements of financial position
c. Equity
financial
statements
Measurement of d. Income
financial performance e. Expenses

An asset is 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.
 The framework stresses economic resources instead of simply resource as assets are not just physical
goods but as a set of rights.
 A right includes the right over physical objects and intellectual property. A right may also correspond to
an obligation of another party such as the right to receive cash, goods, or services, the right to
exchange economic resources with another party on favorable terms, right to benefit from an obligation
of another party to transfer an economic resource if a specified uncertain future event occurs .

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 The framework emphasizes the potential to produce economic benefits and not the future economic
benefits that the right may produce. In other words, an asset can exist even if the probability that it will
produce benefits is low. The most important is that the right already exists, and it would give economic
benefits for the entity at least once circumstance.
 The framework also emphasizes control which means the entity has the exclusive right over the benefits
of an asset and the ability to prevent others from accessing those benefits. Control does not mean the
entity can ensure that the resource will produce economic benefit. It only means that if the resource
produces benefits, it is the entity who will obtain those benefits and not another party.

A liability is a present obligation of the entity to transfer an economic resource as a result of past events. An
obligation is a duty or responsibility that the entity has no practical ability to avoid.
 An obligation can be either a legal obligation ( arising from contracts, legislation, or other operation of
law) or a constructive obligation (arising from an entity’s actions ).
 The framework emphasizes the obligation’s potential to cause a transfer of economic resources
and not future economic benefits. It means that to transfer an economic resource does not need to be
certain or even with low probability, liability can still exist.
 The framework also emphasizes that a past event can result in a present obligation if 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.
 The “no practical ability to avoid” criterion is applied in the following circumstances:
a. If a duty or responsibility arises from the entity’s customary practices, published policies, or
specific statements—the entity has an obligation if it has no practical ability to act in a manner
inconsistent with those practices, policies, or statements.
b. If a duty or responsibility is conditional on a particular future action that the entity itself may take—
the entity has an obligation if it has no practical ability to avoid taking that action.

Equity is the residual interest in the assets of the entity after deducting all its liabilities.

Income is the increases in economic benefits during the period in the form of increases in assets or
decreases in liabilities, which result in increases in equity, excluding those relating to investments by the
business owner.

Expenses are decreases in economic benefits during the period in the form of decreases in assets, or
increases in liabilities, that result in decreases in equity, excluding those relating to distributions to the
business owner.

The elements of financial statements are further made up of a unit of accounts, which refers to the right(s)
or obligation(s), or group of rights and obligations, to which recognition criteria and measurement concepts
are applied. In selecting a unit of account, the framework emphasizes the aspects of relevance and faithful
representation to which such transaction relates to a particular element of financial statements.

In the case of executory contracts (a contract that is equally unperformed, either party has not fulfilled any
of its obligations, or both parties have partially fulfilled their obligations to an equal extent), the combined
right and obligation to exchange economic resources establishes either a single asset or liability. However, to
include such assets and liability in the financial statements depends on the recognition criteria and
measurement basis selected. Moreover, the financial statements must report faithfully the substance of the
contractual rights and obligations over its form.

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5. Recognition and derecognition

Recognition 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.
The recognition process is appropriate if it results in both relevant information about elements of financial
statements and a faithful representation of those elements because the aim is to provide information that is
useful to investors, lenders, and other creditors.

An item is recognized if:

However, the relevance of accounting information may be affected by the low probability of a flow of
economic benefits and the uncertainty of their existence . The faithful representation of an item may be
affected by the uncertainty of their measurement, inconsistent recognition due to accounting mismatch, and
their presentation and disclosure.

On the other hand, derecognition is the removal of all or part of a recognized asset or liability from an
entity’s statement of financial position. It normally occurs when the entity loses control of all or part of the
recognized asset or when the entity no longer has a present obligation for all or part of the recognized
liability. It aims to faithfully represent any assets and liabilities retained after the transaction that led to the
derecognition and the change in the entity’s assets and liabilities as a result of that transaction.

6. Measurement

The recognition process requires expressing each element in monetary terms. This process necessitates
reporting entities to select an appropriate measurement basis for each element as prescribed by the
standards. The conceptual framework describes each measurement basis and the factors when selecting a
measurement basis.

Historical cost provides information derived, at least in part, from the price of the transaction or other
event that gave rise to the item being measured.
 The historical cost of assets is reduced if they become impaired and the historical cost of liabilities is
increased if they become onerous.
 Using the amortized cost of financial assets and liabilities is an application of this measurement basis.

The current value reflects the changes in values at the measurement date. This measurement basis
includes the following:
 Fair value refers to 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. In other words, it reflects
market participants’ current expectations about the amount, timing, and uncertainty of future cash
flows.
 Value in use for assets and fulfillment value for liabilities reflects entity-specific current expectations
about the amount, timing, and uncertainty of future cash flows. Value in use is the present value of the
cash flows or other economic benefits that an entity expects to derive from the use of an asset and
from its ultimate disposal. Fulfillment value is the present value of the cash, or other economic
resources, that an entity expects to be obliged to transfer as it fulfills a liability.

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 The current cost reflects the current amount that would be paid to acquire an equivalent asset or
would be received to take on an equivalent liability.

Current cost and historical cost are entry values as they reflect the prices in acquiring an asset or incurring
a liability while fair value, value in use, and fulfillment value are exit values as they reflect the prices in selling
or using an asset or transferring or fulfilling a liability. Current cost differentiates from historical cost as the
former reflects the conditions at the measurement date.

When selecting a measurement basis, the relevance and faithful representation factors should be considered
because the aim is to provide information that is useful to investors, lenders, and other creditors. The
relevance of the information provided by a measurement basis is affected by the characteristics of the asset
(i.e., the variability of cash flows, sensitivity of the value to market factors or other risks) or liability and the
contribution to future cash flows (i.e., whether cash flows are produced directly or indirectly in combination
with other economic resources, the nature of the entity’s business activities). Whether a measurement basis
can provide a faithful representation is affected by measurement inconsistency (i.e., due to accounting
mismatch, some elements may not faithfully represent some aspects of the entity’s financial position and
financial performance) and measurement uncertainty (a high level of measurement uncertainty does not
necessarily prevent the use of a measurement basis that provides relevant information, and might consider
selecting a different measurement basis).

7. Presentation and disclosure

Information about assets, liabilities, equity, income, and expenses are communicated through presentation
and disclosure in the financial statements. Effective communication of information in financial statements
makes that information more relevant and contributes to a faithful representation of an entity’s assets,
liabilities, equity, income, and expenses. Moreover, the presentation and disclosure objectives are specified in
the standards.

The statement of comprehensive income in the revised framework is now described as the statement of
financial performance which only requires a total or subtotal for profit or loss must be provided. The
statement of profit or loss still contains the primary source for the entity’s financial performance for the
reporting period.

8. Concepts of capital and capital maintenance

The conceptual framework provides two concepts of capital:

A financial concept of capital regarded the invested money or invested purchasing power as the capital
while a physical concept of capital regarded the productive capacity of the entity as the capital.
The selection of the appropriate concept of capital by an entity should be based on the needs of the users of
its financial statements. The chosen concept by an entity will affect the determination of profit due to the
concept of capital maintenance as described below.

Under the financial capital maintenance, a profit is only earned if the financial amount of the net assets at
the end of the period exceeds the financial amount of the net assets at the beginning of the period after
excluding any distributions to, and contributions from, owners during the period. It can be measured in either
nominal monetary units or units of constant purchasing power. Holding gains (increases in the prices of
assets held over the period) are conceptually profits but can only be recognized upon the disposal of the
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assets. Moreover, increases in the invested purchasing power over the period are treated as capital
maintenance adjustment and shall be part of the equity. This concept does not require a particular basis of
measurement and only depends on the type of financial capital the entity seeks to maintain.

Under the physical capital maintenance, a profit is only earned if the productive capacity of the entity at
the end of the period exceeds the productive capacity at the beginning of the period, after excluding any
distributions to, and contributions from, owners during the period. Any changes in the price of the capital are
treated as capital maintenance adjustment of the equity. This concept requires the adoption of the current
cost as a measurement basis.

The concept of capital provides the point of reference in measuring profit as it defines what kind of capital
the entity seeks to maintain. Through this concept, the return on capital and the return of capital can be
distinguished. The return on capital may be regarded as the profit resulting from the excess of inflows of
assets from the amount needed to maintain the capital. In other words, profit refers to the residual amount
that remains after expenses including capital maintenance adjustments, have been deducted from income. If
expenses exceed income, the residual amount is a loss. Furthermore, the accounting model used in preparing
financial statements depends on the measurement bases and capital maintenance concepts selected by the
reporting entities.

SUGGESTED READINGS
This section supplements the discussion of the topic as presented in each lesson. The suggested readings
provide you more learning opportunities to fully grasp the intended learning objectives. It is only optional to
those students who wish to expand their understanding regarding this topic.

1. Conceptual Framework and Accounting Standards (2019) by Millan, pp. 1-27, 37-92.
2. PFRS (2018) by PICPA-Northern Metro Manila Chapter, pp. xi-xl.

SUGGESTED EXERCISES
This section provides suggested exercises for you to practice. The recommended problems and MCQ will give
you familiarity with the questions related to the topic. It is only optional to those who want to test their
acquired knowledge on this particular topic.

1. Conceptual Framework and Accounting Standards (2019) by Millan, pp. 28-36, 93-109.

REFERENCES
1. IFRS. (2018). Conceptual framework project summary. www.ifrs.org.
2. Millan, Z. V. (2019). Conceptual framework and accounting standards 2019 edition . Bandolin Enterprises.
3. PICPA-Northern Metro Manila Chapter. (2018). PFRS.
4. Valix, C., Peralta, J., & Valix, C. A. (2020). Conceptual framework and accounting standards . GIC
Enterprises & Co., Inc.

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