UNIT 2: CONCEPTUAL FRAMEWORK FOR FINANCIAL

REPORTING

Introduction Unit Learning Objective

The Conceptual Framework for By the end of this unit, you should be
Financial Reporting is a single able to discuss the Revised
document promulgated by the Conceptual Framework for Financial
IASB. Reporting.

It is a summary of terms and concepts that underlie the

preparation and presentation of “general-purpose financial
statements” for external users. It is the underlying theory for the
development of accounting standards and revisions of the previously
issued accounting standards.

General-purpose financial statements are financial reports directed

to the general information needs of a wide range of users who are not in a
position to demand reports tailored to their specific information needs.

Revised Conceptual Framework

-It is a comprehensive set of concepts for financial reporting.

Read: IFRS Conceptual Framework Project Summary (Check our GC.)

https://www.ifrs.org/content/dam/ifrs/project/conceptual-
framework/fact-sheet-project-summary-and-feedback-
statement/conceptual-framework-project-summary.pdf

Timing

This unit is expected to consume six (6) study hours – four (4) hours
for reading and comprehension, and two (2) hours for answering the
assessments.

Getting Started!

2.1 PURPOSES OF THE CONCEPTUAL FRAMEWORK

The following are among the purposes of the Conceptual
Framework for Financial Reporting:

a. To assist the Board to develop IFRS Standards (Standards)

based on consistent concepts, resulting in financial

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 information that is useful to investors, lenders and other
creditors;

b. To assist preparers of financial reports to develop

consistent accounting policies for transactions or other
events when no Standard applies or a Standard allows a
choice of accounting policies;

c. To assist all parties to understand and interpret Standards.

The Conceptual Framework is not a standard. If there is a

standard or an interpretation that specifically applies to a
transaction, the standard or interpretation overrides the Conceptual
Framework.

Nothing in this Conceptual Framework overrides any specific

PFRS. In the case of conflict between the two, the latter (PFRS) prevails.

The Conceptual Framework attempts to provide an overall

theoretical foundation for accounting that will guide standard-setters,
preparers, and users of financial information in preparing and presenting
statements. Nothing in this document is designed to provide a specific
treatment for a particular accounting transaction or event, and such is the
accounting standard’s job.

In the absence of a Standard or an Interpretation that specifically

applies to a transaction, management must use its judgment in developing
and applying an accounting policy that results in relevant and reliable
information. In making that judgment, IAS 8.11 requires management to
consider the definitions, recognition criteria, and measurement concepts for
assets, liabilities, income, and expenses in the Framework.

2.2 SCOPE OF CONCEPTUAL FRAMEWORK

Chapter 1 - Objective of financial reporting;

Chapter 2 - Qualitative characteristics of useful financial information;

Chapter 3 - Description of the reporting entity and its boundary;

Chapter 4 - Definitions of an asset, a liability, equity, income and

expenses;

Chapter 5 - Criteria for including assets and liabilities in financial

statements (recognition) and guidance on when to remove them
(derecognition);

Chapter 6 - Measurement bases and guidance on when to use them;

Chapter 7 - Concepts and guidance on presentation and disclosure.

Chapter 8 – Concepts of Capital and Capital Maintenance

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CHAPTER 1: OBJECTIVE OF FINANCIAL REPORTING

Summary of changes: This chapter was issued in 2010 and went through
extensive due process at that time. Therefore, in revising the Conceptual
Framework, the Board did not fundamentally reconsider this chapter.
However, it clarified why information used in assessing stewardship is
needed to achieve the objective of financial reporting.

Stewardship - Users of financial reports need information to help them

assess management’s stewardship. The Conceptual Framework explicitly
discusses this need as well as the need for information that helps users
assess the prospects for future net cash I nflows to the entity.

The objective of financial reporting is to provide financial

information that is useful to users in making decisions relating to
providing resources to the entity.
Users of financial reports are an entity’s existing and potential
investors, lenders and other creditors. Those users must rely on
financial reports for much of the financial information they need.

Financial reporting is directed primarily to the existing and

potential investors, lenders, and other creditors, which compose the primary
user group. Information that meets the needs of the specified primary
users is likely to meet the needs of other users such as employees,
customers, governments, and their agencies.

Users’ decisions involve decisions about buying, selling or holding

equity or debt instruments, providing or settling loans and other forms of
credit, and voting, or otherwise influencing management’s actions. To
make these decisions, users assess prospects for future net cash inflows to
the entity and management’s stewardship of the entity’s economic
resources.

To make both these assessments, users need information about

both the entity’s economic resources, claims against the entity and changes
in those resources and claims how efficiently and effectively management
has discharged its responsibilities to use the entity’s economic resources.

General-purpose financial reports do not and cannot provide all

the information that the users need. These users need to consider
pertinent information from other sources, such as general economic
conditions, political events, and industry outlook.

General-purpose financial reports are not designed to show

the value of an entity. They provide, however, the information to help the
primary users estimate the value of the entity.

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CHAPTER 2: QUALITATIVE CHARACTERISTICS
(Fundamental & Enhancing)

Summary of changes: This chapter was issued in 2010 and went through
extensive due process at that time. Therefore, in revising the Conceptual
Framework the Board did not fundamentally reconsider this chapter.
However, the Board clarified the roles of prudence, measurement
uncertainty and substance over form in assessing whether information
is useful.

Prudence - Neutrality is supported by the exercise of prudence. Prudence

is the exercise of caution when making judgements under conditions of
uncertainty. Prudence does not allow for overstatement or
understatement of assets, liabilities, income or expenses.

Measurement uncertainty - Measurement uncertainty does not prevent

information from being useful. However, in some cases the most relevant
information may have such a high level of measurement uncertainty that
the most useful information is information that is slightly less relevant but
is subject to lower measurement uncertainty.

For information to be useful it must both be relevant and

provide a faithful representation of what it purports to represent.
Relevance and faithful representation are the fundamental
qualitative characteristics of useful financial information, and the
guiding concepts that apply throughout the revised Conceptual
Framework.

FUNDAMENTAL QUALITATIVE CHARACTERISTICS

(Relevance & Faithful Representation)

RELEVANCE

Relevance is the capacity of the information to influence a decision.

Information that does not bear an influence on any economic decision
is useless.

Financial information is capable of making a difference in a decision

if it has predictive value and confirmatory value.

Financial information has predictive value if it can be used as an

input to processes employed by users to predict future outcome.

Financial information has confirmatory value when it enables

users to confirm or correct earlier expectations.

Illustration 1

If the interim income statement for the first quarter is ₱2,000,000

(confirmatory value), and this trend continues for the entire year, it is
logical to assume that the net income after four quarters or one year would
be ₱8,000,000 (predictive value).

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 Inherent in the concept of relevance is the practical rule of
MATERIALITY. This rule dictates that strict adherence to GAAP is not
required when the items are not significant enough to affect evaluation,
decision and fairness of the financial statements. This concept is also
known as the doctrine of convenience. The materiality of an item
depends on its relative size rather than absolute size. What may be
material for one entity may be immaterial for another.

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.

Illustration 2

An omission of ₱1,000,000 in the financial statements of a multi-

billion-dollar entity like Apple or Alphabet may not be important to it but
maybe so critical for small start-up entities.

When is an item material then? There is no hard and fast rule in

determining whether an item is material or not. Very often, this is
dependent on sound judgment, professional expertise, and common sense
honed by years of experience.

Information is material, usually if its omission or misstatement

could influence the economic decision that the users make based on the
financial information about an entity.

FAITHFUL REPRESENTATION
(Completeness, Neutrality & Free from Error)

General-purpose financial reports represent economic phenomena

in words and numbers. To be useful, financial information must not only
be relevant, but it must also represent faithfully the phenomena it purports
to represent. Faithful representation means representing the substance of
an economic phenomenon instead of representing its legal form only.

A financial report is faithfully represented when it represents the

actual effects of the transactions during the accounting period.

To perfectly have faithful representation, a depiction should

possess three characteristics:

Completeness

Completeness requires that all relevant information be presented

to facilitate understanding and avoid erroneous implications.
Completeness is the result of the adequate disclosure standard or the
principle of full disclosure.

However, keep in mind the previously discussed concept of

materiality. Completeness and materiality must be harmonized for a

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faithfully represented financial report. Completeness, in this context,
does not mean the disclosure of all possible data but merely the
substantial disclosure of all RELEVANT data, setting aside the
immaterial items. Too much data often leads to complicated and
incomprehensible reports.

Neutrality
A neutral depiction is without bias in the preparation or
presentation of financial information. The financial information should not
enrich one party at the expense of another.

Information contained in the financial statements must be free from

bias. It is well to remember that general purpose financial statements are
directed to the common needs of many users and not to the particular
desires of specific users.

The exercise of prudence supports a neutral depiction. Prudence is

the exercise of caution when making judgments under conditions of
uncertainty.

In accounting, the convention of conservatism, also known as

the doctrine of prudence, is a policy of anticipating possible future losses
but not future gains. This policy tends to understate rather than overstate
net assets and net income, and therefore lead companies to "play safe."
When given a choice between several outcomes where the probabilities of
occurrence are equally likely, you should recognize that transaction
resulting in a lower amount of profit, or at least the deferral of a profit.

It states that when choosing between two solutions, the one that
will be least likely to overstate assets and income should be selected.
Essentially, "expected losses are losses but expected gains are not gains."

The conservatism principle is the foundation for the lower of cost

or market rule, which states that you should record inventory at the lower
of either its acquisition cost or its current market value.

Another concept of prudence or conservatism is illustrated in IAS

37 – Provisions, Contingent Liabilities, and Contingent Assets, where a
contingent liability is recognized in the financial statements despite its
chances of outflow being probable only. In contrast, a contingent asset is
recognized only when its existence is virtually certain.

Freedom from Error

A report that is free from error does not connote a perfectly infallible
report. This principle substantially complies with the clear, reasonable,
and good faith disclosure of items in the financial reports.

Implicit to this is the principle of “substance over form.” A

faithfully represented report inherently represents the substance of
an economic phenomenon or transaction rather than merely
representing its legal form.

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Illustration 3

A lease contract that bears a provision of a transfer of ownership at

the termination of the lease period may hint that, in substance, the contract
is an installment sale rather than a contract of lease. Thus, in disclosing this
fact in a financial report, it is wise to present it as a sale contract rather
than a lease contract.

ENHANCING QUALITATIVE CHARACTERISTICS (VCUT)

Enhancing qualitative characteristics, as contrasted with the

fundamental qualitative characteristics, relate to the form rather than the
substance of the financial reports.

These four qualitative characteristics enhance the usefulness of

information, but they cannot make non-useful information useful.

COMPARABILITY

Comparability is the enhancing qualitative characteristic that

enables users to identify and understand similarities and
dissimilarities among items in the financial reports.

Comparability may be made horizontally or dimensionally.

Horizontal comparability is the quality of information that allows

comparisons within a single entity through time or from one accounting
period to the next.

Dimensional comparability is the quality of information that

allows comparisons between two or more entities engaged in the same
industry.

For information to be comparable, things must look alike, and

different things must look different. Comparability is not enhanced by
making, unlike things look-alike or making like things look different.

Implicit in the concept of comparability is the principle of

consistency. This principle prescribes that accounting methods and
practices should be applied uniformly from period to period.

Comparability is the goal, and consistency is the means to achieve

that goal.

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Illustration 4

An entity that has adopted the straight-line method of depreciation

in 2020 is advised to use the same method of depreciation in the
subsequent year for more comparable reports. The usage of another
depreciation method, such as the declining balance method, for the
subsequent years, may result in the distortion of data leading to erroneous
comparisons and ultimately erroneous decisions.

Consider the following simple financial reports:

Rickrolled, Inc. 2021

Revenue ₱1,000,000
Expenses, including ₱700,000
depreciation expense of
P200,000, computed under the
double-declining method for 10
years
Income ₱300,000
Rickrolled, Inc. 2020
Revenue ₱1,000,000
Expenses, including ₱P700,000
depreciation expense of
P100,000, computed under the
straight-line method for 10
years
Income ₱300,000

In this scenario, suppose that the change was not apparent and was
not disclosed in any other accompanying reports, the users may be led to
believe that the expenses incurred by Rickrolled, Inc. remained unchanged
for the periods presented, where in fact, there was actually savings of
₱100,000 as the additional ₱100,000 expense is only brought about by the
change in depreciation method employed by the company.

However, consistency does not mean that no change in

accounting methods can be made. If the change results in more
useful and meaningful information, then such change may be
allowed. In doing so, the entity may be required to disclose the
effects of the change and the reasons, therefore.

UNDERSTANDABILITY

Understandability requires that financial information must be

comprehensible or intelligible if it is to be most useful. Accordingly, the
information should be presented in a form and expressed in a language
that a user understands.

However, complex economic activities make it impossible to reduce

the financial information to the simplest terms. Financial statements
cannot realistically be comprehensible to everyone. Medical personnel or
even those in the legal field without much background on accounting and
management may not easily understand a report which appears to be
simple if seen through the lenses of accountants.

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 Understandability simply means that users who have reasonable
knowledge of business, economic activities, and accounting in general,
who review and analyze the financial reports, should understand such
reports.

VERIFIABILITY

Verifiability means that different knowledgeable and independent

observers could reach a consensus, although not necessarily complete
agreement, that a particular depiction is a faithful representation.

Verifiable financial information provides results that would be

substantially duplicated by measurers using the same measurement method.

TIMELINESS

Timeliness requires that financial information must be available or

communicated early enough when a decision is to be made.

Information no matter how relevant or faithfully represented

furnished after a decision has already been made is useless and of no value.
Generally, the older the information, the less useful it is. The famous
proverb, “What good is the grass if the horse is already dead” is clearly at
play in this qualitative characteristic of a good financial report.

However, some information may continue to be relevant despite

the end of the reporting period, as some users may need to identify and
assess future trends.

Enhancing qualitative characteristics should be maximized to the

extent necessary. However, enhancing qualitative characteristics
(individually or collectively) cannot render information useful if that
information is irrelevant or not represented faithfully.

COST CONSTRAINT

The benefit of providing the information needs to justify the cost of

providing and using the information

Distinct and separate from the fundamental and enhancing

qualitative characteristics of financial information is the concept of COST.
Cost is a pervasive content on the information that can be provided by
financial reporting. Reporting financial information imposes cost and it is
important that such cost is justified by the benefit derived from the
financial information.

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CHAPTER 3: FINANCIAL STATEMENTS AND THE
REPORTING ENTITY

This chapter is new.

It describes the objective and scope of financial statements and

provides a description of the reporting entity

Boundary of a reporting entity: Determining the appropriate boundary

of a reporting entity can be difficult if, for example, the entity is not a legal
entity. In such cases, the boundary is determined by considering the
information needs of the users of the entity’s financial statements.

Those users need information that is relevant and that faithfully

represents what it purports to represent. A reporting entity does not
comprise an arbitrary or incomplete collection of assets, liabilities, equity,
income and expenses.

Reporting entity

Reporting entity is defined as an entity that is required, or chooses,

to prepare financial statements. It is not necessarily a legal entity—it could
be a portion of an entity or comprise more than one entity.

Financial statements

It is a particular form of financial reports that provide information

about the reporting entity’s assets, liabilities, equity, income and expenses.

Consolidated financial statements - provides information about assets,

liabilities, equity, income and expenses of both the parent and its
subsidiaries as a single reporting entity

Unconsolidated financial statements - provides information about

assets, liabilities, equity, income and expenses of the parent only

Combined financial statements - provides information about assets,

liabilities, equity, income and expenses of two or more entities that are not
all linked by a parent-subsidiary relationship

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CHAPTER 4: THE ELEMENTS OF FINANCIAL STATEMENTS

Summary of changes: The definitions of an asset and a liability have been

refined and the definitions of income and expenses have been updated
only to reflect that refinement. The definition of equity as the residual
interest in the assets of the entity after deducting all its liabilities is
unchanged. The Board’s research project on Financial Instruments with
Characteristics of Equity is exploring the distinction between liabilities
and equity.

No practical ability to avoid - The revised Conceptual Framework

discusses how 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.

Executory contract - An executory contract is a contract that is equally

unperformed. It establishes a single asset or liability for the inseparable
combined right and obligation to exchange economic resources.

Substance of contracts - To represent contractual rights and obligations

faithfully, financial statements must report their substance. In some cases,
the substance of such rights and obligations is clear from a contract’s legal
form. But, in other cases, the terms of the contract, or of a group or series
of contracts, may require analysis to identify the substance of the rights
and obligations.

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 Previous definition of an ASSET Revised definition of an ASSET
A resource controlled by the entity as A present economic resource
a result of past events and from controlled by the entity as a result of
which future economic benefits are past events
expected to flow to the entity
An economic resource is a right that
has the potential to produce economic
benefits.
Main Changes:
• separate definition of an economic resource—to clarify that an asset is the
economic resource, not the ultimate inflow of economic benefits

• deletion of ‘expected flow’—it does not need to be certain, or even likely, that
economic benefits will arise

• a low probability of economic benefits might affect recognition decisions and

the measurement of the asset

Previous definition of an Revised definition of an

LIABILITY LIABILITY
A present obligation of the entity A present obligation of the entity to
arising from past events, the transfer an economic resource as a
settlement of which is expected to result of past events An obligation is
result in an outflow from the entity of a duty or responsibility that the
resources embodying economic entity has no practical ability to avoid
benefits
Main Changes:
• separate definition of an economic resource—to clarify that a liability is the
obligation to transfer the economic resource, not the ultimate outflow of
economic benefits

• deletion of ‘expected flow’—with the same implications as set out above for
an asset

• introduction of the ‘no practical ability to avoid’ criterion to the definition of

obligation

Revised definition of INCOME Previous definition of a

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

Unit of account - the right(s) or obligation(s), or group of rights and

obligations, to which recognition criteria and measurement concepts are
applied

Selecting the unit of account:

1. Relevance - A unit of account is selected to provide relevant
information about the asset or liability and any related income and
expenses.

2. Faithful Representation - A unit of account is selected to provide

a faithful represention of the substance of the transaction or other
event from which the asset, liability and any related income or
expenses have arisen.

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 THE ELEMENTS OF FINANCIAL STATEMENTS EXPLAINED

The objective of financial statements is to provide information

about an entity's assets, liabilities, equity, income, and expenses that is
useful to financial statements users in assessing the prospects for future
net cash inflows to the entity and in assessing management's stewardship
of the entity's resources.

This information is provided in the statement of financial position,

statement(s) of financial performance, and other statements and notes.

Financial statements portray the financial effects of transactions

and other events by grouping them into broad classes according to their
economic characteristics. These broad classes are termed the elements of
financial statements.

The elements of financial statements refer to the quantitative

pieces of information that make up the statement of financial position and
the statement of comprehensive income. These elements are the so-called
building blocks from which financial statements are constructed.

The Statement of Financial Position is composed of:

ASSETS
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.

An asset is recognized when it is probable (The term probable

means that the chance of the future economic benefit arising is more likely
rather than less likely, in other words, the chance of occurrence is more than
50%) that future economic benefits will flow to the entity and the asset
has a cost or value that can be measured reliably.

It is worth noting that ownership is not important in the process

of recognizing an asset. What is essential is the CONTROL exercised by
the entity over the resource. Control may be briefly described as the ability
of the entity to enjoy and reap the benefits derived from an asset while
excluding others from enjoying the same benefits.

The best example would be the right-of-use assets introduced by PFRS

16. The lease asset is the right to use the underlying asset and is presented in
the statement of financial position either as part of property, plant, and
equipment or as its own line item.

LIABILITIES
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 an entity has no practical ability to avoid. Obligations
may be legally enforceable due to a legally enforceable contract or law
(legal) and practice (constructive).

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 A liability is recognized when it is probable that an outflow of
resources embodying economic benefits will be required for the
settlement of a present obligation, and the amount of the obligation can be
measured reliably.

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

The Statement of Comprehensive Income is composed of:

INCOME
Income is an increase in asset or decrease in liability that results
in an increase in equity, other than contribution from equity participants.

Income is recognized when it is probable that an increase in future

economic benefits related to an increase in an asset or a decrease in
liability has arisen and that the increase in economic benefits can be
measured reliably.

In other words, income is recognized when it is earned, regardless of

the flow of cash.

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. Hence, they
are not regarded as constituting a separate element in the IFRS
Framework.

EXPENSE
Expense is the decrease in economic benefit during the accounting
period in the form of an outflow or decrease in asset or increase in
liability that results in decrease in equity, other than distribution to equity
participants.

Expenses are recognized when it is probable that a decrease in

future economic benefits related to a decrease in an asset or an increase in
liability has occurred and that the decrease in economic benefits can be
measured reliably.

In other words, expense is recognized when incurred, regardless of

the flow of cash.

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 The definition of expenses encompasses losses as well as those
expenses that arise in the course of the ordinary activities of the entity.
Expenses that arise in the course of the entity's ordinary activities include,
for example, the cost of sales, wages, and depreciation. They usually take
the form of an outflow or depletion of assets such as cash and cash
equivalents, inventory, property, plant, and equipment. Losses represent
other items that meet the definition of expenses and may, or may not, arise
in the course of the entity's ordinary activities. Losses represent decreases
in economic benefits, and as such, they are no different in nature from
other expenses. Hence, they are not regarded as a separate element in this
Framework.

The EXPENSE RECOGNITION PRINCIPLE is the application of

the matching principle. Under the matching principle, the costs and
expenses incurred in earning a revenue shall be reported in the same
period the latter is earned.

APPLICATION OF THE MATCHING PRINCIPLE

Cause and effect association;

Expense is recognized when the related revenue is recognized. The

reason is the presumed direct association of the expense with the specific
items of income. This is an application of the strict matching concept.

Illustration 5

Rickrolled, Inc. sold merchandise for ₱400,000 on account. Said

merchandise cost the company ₱95,000 to manufacture.

Journal Entry:
Accounts receivable ₱ 400,000
Sales P 400,000

Cost of Sales ₱ 95,000

Merchandise Inventory ₱ 95,000

When a merchandise inventory is sold, the cost of sale is

simultaneously recognized with the revenue (sales).

Systematic and rational allocation;

Costs are expensed by allocating them over the periods benefited by

such costs. The reason is that the cost incurred will directly benefit future
periods and that there is an absence of a direct or clear association of the
expense with specific revenue.

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Illustration 6

Rickrolled, Inc. erected a new building with a total cost of

₱10,000,000. The company estimates that the total economic life of the
building is 10 years. Under the straight-line method of depreciation, the
company must recognize ₱100,000 annually as depreciation expense.

Journal Entry:

Depreciation Expense ₱ 100,000

Accumulated Depreciation ₱ 100,000

The depreciation expense represents the allocated expense, from the

total cost of ₱10,000,000, to each year the building is expected to be used.

Immediate recognition

The cost incurred is expensed outright because of the uncertainty of

future economic benefits or the difficulty of reliably associating certain
costs with future revenue. The expenditure is expensed outright when no
future economic benefits are expected from the expenditure.

Illustration 7

Rickrolled Inc. paid its minimum-wage employees ₱8,125 each for

the month of February. The company employs ten employees.

Journal Entry:

Salaries Expense ₱ 81,250

Cash ₱ 81,250

The entire salaries paid to the employees are immediately recognized

as an expense as there are no expected future benefits that will arise from
the said transaction. It may be said that the benefits were already reaped
from the time the employees worked for the company, and the payment of
salaries they already earned is the result of such an event.

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CHAPTER 5: RECOGNITION AND DERECOGNITION

This chapter discusses criteria for including assets and liabilities in

financial statements (recognition) and guidance on when to remove them
(derecognition).

RECOGNITION
Summary of changes: The previous recognition criteria were that an
entity should recognise an item that met the definition of an element if it
was probable that economic benefits would flow to the entity and if the
item had a cost or value that could be determined reliably.

The revised recognition criteria refer explicitly to the qualitative

characteristics of useful information.

The Board’s aim was to develop a more coherent set of concepts, not to
increase or decrease the range of assets and liabilities recognised.

Why recognition is important- Recognising assets, liabilities, equity,

income and expenses depicts an entity’s financial position and financial
performance in structured summaries (the statements of financial position
and financial performance). The amounts recognised in a statement are
included in the totals and, if applicable, subtotals, in the statement. The
statements are linked because income and expenses are linked to changes
in assets and liabilities.

RECOGNITION
This is the process of capturing for inclusion in the statement of
financial position or the statement(s) of financial performance an item that
meets the definition of an asset, a liability, equity, income or expenses.

Recognition is appropriate if it results in both relevant information

about assets, liabilities, equity, income and expenses and a faithful
representation of those items, because the aim is to provide information
that is useful to investors, lenders and other creditors.

Recognition criteria:
1. Relevance - whether recognition of an item results in relevant
information may be affected by, for example:
a. low probability of a flow of economic benefits; and
b. existence uncertainty

2. Faithful Representation - whether recognition of an item results

in a faithful representation may be affected by, for example:
a. measurement uncertainty; and
b. recognition inconsistency (accounting mismatch)
c. presentation and disclosure
Cost constraint
Cost constrains recognition decisions, just as it constrains other
financial reporting decisions.

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 DERECOGNITION
Summary of changes: The guidance on derecognition is new.

Derecognition resulting from a transfer- Normally, a faithful

representation of a transfer of an asset or liability is achieved by
derecognition of the asset or liability with appropriate presentation and
disclosure.

However, in limited cases, it may be necessary to continue to recognise a

transferred component of an asset or liability together with a liability or
asset for the proceeds received or paid, with appropriate presentation and
disclosure.

DERECOGNITION
The removal of all or part of a recognised asset or liability from an
entity’s statement of financial position.
Derecognition aims to faithfully represent both:
 any assets and liabilities retained after the transaction that
led to the derecognition
 the change in the entity’s assets and liabilities as a result of
that transaction

Derecognition normally occurs:

1. For an asset- when the entity loses control of all or part of the
recognised asset
2. For a liability - when the entity no longer has a present obligation
for all or part of the recognised liability

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CHAPTER 6: MEASUREMENT

This chapter describes various measurement bases and discusses

factors to be considered when selecting a measurement basis.

Summary of changes: The previous version of the Conceptual Framework

included little guidance on measurement.

The revised Conceptual Framework describes what information

measurement bases provide and explain the factors to consider when
selecting a measurement basis.

Selecting a measurement basis: In selecting a measurement basis, it is

necessary to consider the nature of the information in both the statement
of financial position and the statement(s) of financial performance.

The relative importance of each factor to be considered depends upon the

facts and circumstances of individual cases. Consideration of the factors
and the cost constraint is likely to result in the selection of different
measurement bases for different assets, liabilities, income, and expenses.

1. Historical Cost
 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.

 Historical cost of assets is reduced if they become impaired

and historical cost of liabilities is increased if they become
onerous.

 One way to apply a historical cost measurement basis to

financial assets and financial liabilities is to measure them
at amortised cost.

2. Current Value
Current value provides information updated to reflect conditions
at the measurement date. It includes:
a. Fair Value
 This is 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.

 This reflects market participants’ current expectations

about the amount, timing and uncertainty of future cash
flows.

b. Value in Use (for assets)

Fulfilment Value (for liabilities)
 This reflects entity-specific current expectations about the
amount, timing and uncertainty of future cash flows.
c. Current Cost
 This reflects the current amount that would be:
 paid to acquire an equivalent asset
 received to take on an equivalent liability

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 The factors to be considered when selecting a measurement basis
are relevance and faithful representation, because the aim is to provide
information that is useful to investors, lenders and other creditors.

Relevance of information provided by a measurement basis is affected by:

a. characteristics of the asset or liability
 the variability of cash flows
 sensitivity of the value to market factors or other risks
 for example, amortised cost cannot provide relevant
information about a deriviative

b. contribution to future cash flows

 whether cash flows are produced directly or indirectly in
combination with other economic resources
 the nature of the entity’s business activities
 for example, if assets are used in combination to produce
goods or services, historical cost can provide relevant
information about margins achieved in a period

Faithful representation - Whether a measurement basis can provide a

faithful representation is affected by:
a. measurement inconsistency
 If financial statements contain measurement
inconsistencies (accounting mismatch), those financial
statements may not faithfully represent some aspects of the
entity’s financial position and financial performance.
b. measurement uncertainty
 does not necessarily prevent the use of a measurement
basis that provides relevant information
 but if too high might make it necessary to consider
selecting a different measurement basis

Cost constraint
Cost constrains the selection of a measurement basis, just as it
constrains other financial reporting decisions.

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CHAPTER 7: PRESENTATION AND DISCLOSURE

This chapter includes concepts on presentation and disclosure and

guidance on including income and expenses in the statement of profit or
loss and other comprehensive income.

Summary of changes: This chapter is new.

Better Communication: Information about assets, liabilities, equity,

income and expenses is 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.

The revised Conceptual Framework includes concepts that describe how

information should be presented and disclosed in financial statements.

The Board is also working on several projects on the theme of Better

Communication to make financial information more useful to investors,
lenders and other creditors and to improve the communication of that
information.

The Statement of Profit or Loss

 the primary source of information about an entity’s financial
performance for the reporting period
 could be a section of a single statement of financial performance
or a separate statement
 The statement(s) of financial performance include(s) a total
(subtotal) for profit or loss
 In principle, all income and expenses are classified and included in
the statement of profit or loss.

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
 The Board may make such a decision when doing so would result
in the statement of profit or loss providing more relevant
information or a more faithful representation.

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CHAPTER 8: CONCEPTS OF CAPITAL AND CAPITAL
MAINTENANCE

The Board decided that updating the discussion of capital and capital
maintenance was not feasible when it developed the 2018 Conceptual
Framework and could have delayed the completion of the 2018 Conceptual
Framework significantly.

The Board decided that it would be inappropriate for the 2018 Conceptual
Framework to exclude a discussion of capital and capital maintenance
altogether. Those concepts are important to financial reporting and
influence the definitions of income and expenses, the selection of
measurement bases, and presentation and disclosure decisions.

Therefore, the material in Chapter 8—Concepts of capital and capital

maintenance of the 2018 Conceptual Framework has been carried forward
unchanged from the 2010 Conceptual Framework. That material originally
appeared in the 1989 Framework.

The Board may decide to revisit the concepts of capital and capital
maintenance in the future if it considers such a revision necessary.

The financial performance of an entity is determined using two

approaches:

The transaction approach

The transaction approach is the traditional preparation of an

income statement wherein an entity recognizes each accountable
transaction as they occur and summarizes the ultimate result thereof by
comparing the total accumulated revenue and total accumulated expense
during a specific accounting period.

The capital maintenance approach

The capital maintenance approach is the process of determining the

income of an entity by simply comparing the capital at the beginning of the
accounting period and the end of the same period. If the latter exceeds the
former, then there is income. If otherwise, there is a loss.

Two concepts of capital maintenance approach:

Financial capital - the absolute monetary amount of the net assets
contributed by the shareholders and the amount of the increase in net
assets resulting from earning retained by the entity. This is based on
historical cost.

Physical capital - the quantitative measure of the physical

productive capacity to produce goods and services. This concept requires
that productive assets shall be measured at current costs rather than
historical costs.

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 Unit Summary

 The Conceptual Framework for Financial Reporting sets out the

basic concepts and postulates in financial reporting that will aid in
the creation of accounting standards, preparation, presentation,
audit, and general use of financial statements.

 It does not seek to replace or override any accounting standard as

its operation is merely suppletory to such accounting standards. Its
scope includes: the objective of a financial reporting; qualitative
characteristics of useful financial information; definition,
recognition, and measurement of the elements from which financial
statements are constructed; concepts of capital and capital
maintenance; and the reporting entity.

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