Conceptual Framework for Financial Reporting JAGCPA

Financial statements are prepared and presented for external users by many entities around the world.
Although such financial statements may appear similar from country to country, there are differences
which have probably been caused by a variety of social, economic and legal circumstances and by
different countries having in mind the needs of different users of financial statements when setting
national requirements.

The International Accounting Standards Board is committed to narrowing these differences by seeking
to harmonise regulations, accounting standards and procedures relating to the preparation and
presentation of financial statements.

Board believes that financial statements prepared for this purpose meet the common needs of most
users. This is because nearly all users are making economic decisions, for example:
(a) to decide when to buy, hold or sell an equity investment.
(b) to assess the stewardship or accountability of management.
(c) to assess the ability of the entity to pay and provide other benefits to its
employees.
(d) to assess the security for amounts lent to the entity.
(e) to determine taxation policies.
(f) to determine distributable profits and dividends.
(g) to prepare and use national income statistics.
(h) to regulate the activities of entities.

Purpose and status

This Conceptual Framework sets out the concepts that underlie the preparation and presentation of
financial statements for external users. The purpose of the Conceptual Framework is:
(a) to assist the Board in the development of future IFRSs and in its review of
existing IFRSs;
(b) to assist the Board in promoting harmonisation of regulations, accounting standards and procedures
relating to the presentation of financial statements by providing a basis for reducing the number of
alternative accounting treatments permitted by IFRSs;
(c) to assist national standard-setting bodies in developing national standards;
(d) to assist preparers of financial statements in applying IFRSs and in dealing with topics that have yet
to form the subject of an IFRS;
(e) to assist auditors in forming an opinion on whether financial statements comply with IFRSs;
(f) to assist users of financial statements in interpreting the information contained in financial
statements prepared in compliance with IFRSs; and
(g) to provide those who are interested in the work of the IASB with information about its approach to
the formulation of IFRSs.
This Conceptual Framework is not an IFRS and hence does not define standards for any particular
measurement or disclosure issue. Nothing in this Conceptual Framework overrides any specific IFRS.

The Board recognises that in a limited number of cases there may be a conflict between the Conceptual
Framework and an IFRS. In those cases where there is a conflict, the requirements of the IFRS prevail
over those of the Conceptual Framework.
Conceptual Framework for Financial Reporting JAGCPA

Scope
The Conceptual Framework deals with:
(a) the objective of financial reporting;
(b) the qualitative characteristics of useful financial information;
(c) the definition, recognition and measurement of the elements from which financial statements are
constructed; and
(d) concepts of capital and capital maintenance.

Objective of general purpose financial reporting

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. Those decisions involve buying, selling or holding
equity and debt instruments, and providing or settling loans and other forms of credit.

Qualitative characteristics of useful financial information

If financial information is to be useful, it must be relevant and faithfully represents what it purports to
represent. The usefulness of financial information is enhanced if it is comparable, verifiable, timely and
understandable.

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.

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. In other words, 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. Consequently, the Board
cannot specify a uniform quantitative threshold for materiality or predetermine what could be material
in a particular situation.

Faithful representation
Financial reports represent economic phenomena in words and numbers. 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. Of course, perfection is
seldom, if ever, achievable. The Board’s objective is to maximise those qualities to the extent possible.

Enhancing qualitative characteristics

Comparability, verifiability, timeliness and understandability are qualitative characteristics that enhance
the usefulness of information that is relevant and faithfully represented.

Comparability
Comparability is the qualitative characteristic that enables users to identify and understand similarities
in, and differences among, items. Unlike the other qualitative characteristics, comparability does not
relate to a single item. A comparison requires at least two items.
Conceptual Framework for Financial Reporting JAGCPA

Verifiability
Verifiability means that different knowledgeable and independent observers could reach consensus, general agreement
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, for example, by counting cash. 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. However, some information
may continue to be timely long after the end of a reporting period because, for example, some users
may need to identify and assess trends.

Understandability
Financial reports are prepared for users who have a reasonable knowledge of business and economic
activities and who review and analyse the information diligently. At times, even well-informed and
diligent users may need to seek the aid of an adviser to understand information about complex
economic phenomena.

The 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.

Underlying assumption

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 position
The elements directly related to the measurement of financial position are assets, liabilities and equity.
These are defined as follows:
(a) An asset is a resource controlled by the entity as a result of past events and from which future
economic benefits are expected to flow to the entity.
(b) A liability is 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.
(c) Equity is the residual interest in the assets of the entity after deducting all its liabilities.
Conceptual Framework for Financial Reporting JAGCPA

Performance
The elements of income and expenses are defined as follows:

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.
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.

Income
The definition of income encompasses both revenue and gains. Revenue arises in the course of the
ordinary activities of an entity and is referred to by a variety of different names including sales, fees,
interest, dividends, royalties and rent.
Gains represent other items that meet the definition of income and may, or may not, arise 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.

Recognition is the process of incorporating in the balance sheet or income statement an item that
meets the definition of an element and satisfies the criteria for recognition.

An item that meets the definition of an element should be recognised 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.

Measurement is the process of determining the monetary amounts at which the elements of the
financial statements are to be recognised and carried in the balance sheet and income statement. This
involves the selection of the particular basis of measurement.

A number of different measurement bases are employed to different

degrees and in varying combinations in financial statements. They
include the following:
(a) Historical cost. Assets are recorded at the amount of cash or cash equivalents paid or the fair value of
the consideration given to acquire them at the time of their acquisition. Liabilities are
recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances
(for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to
satisfy the liability in the normal course of business.
(b) 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.
(c) Realisable (settlement) value. Assets are carried at the amount of cash or cash equivalents that could
currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement
values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the
liabilities in the normal course of business.
(d) Present value. Assets are carried at the present discounted value of the future net cash inflows that
the item is expected to generate in the normal course of business. Liabilities are carried at the present
Conceptual Framework for Financial Reporting JAGCPA

discounted value of the future net cash outflows that are expected to be required to settle the liabilities
in the normal course of business.

Concepts of capital and capital maintenance

A financial concept of capital is adopted by most entities in preparing their financial statements. Under a
financial concept of capital, such as invested money or invested purchasing power, capital is
synonymous with the net assets or equity of the entity. Under a physical concept of capital, such as
operating capability, capital is regarded as the productive capacity of the entity based on, for example,
units of output per day.

Financial capital maintenance. Under this concept a profit is earned only if the financial (or money)
amount of the net assets at the end of the period exceeds the financial (or money) 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.

Physical capital maintenance. Under this concept a 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.