Session 2: The Conceptual

framework for Financial Accounting

References:
Deegan (2014) Chapter 6
Deegan (2019) Chapter 2
IFRS Foundation (2018) Conceptual Framework for Financial Reporting April
2018
IFRS (2018) IFRS Conceptual Framework Project Summary
International Financial Reporting Standards (2014) Technical Summary: The
Conceptual Framework for Financial Reporting
 Learning objectives

• Understand the role that a conceptual framework can play in the practice of financial
reporting.
• Be able to identify some of the perceived advantages and disadvantages that arise from the
establishment and development of a conceptual framework.
• Be able to identify, explain and critically evaluate the components that have been developed
within International Accounting Standard Board (IASB) and Australia Accounting Standard
Board (AASB) .
• Understand why the IASB revised the Conceptual Framework
• Understand the effects of the revised Conceptual Framework
• Understand the different measurement basis under the Framework
• Be able to apply current IASB and AASB conceptual frameworks in accounting practice
What is a conceptual framework?

• A “Conceptual Framework sets out the concepts that underlie the preparation and
presentation of financial statements for external users”. It 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. ”

Source: IASB the Conceptual Framework for Financial Reporting 2010

Overview of the contents of CF
Rationale for conceptual frameworks

• To develop the practice of financial reporting logically and consistently we need to

address and agree upon such issues as:
• what we mean by 'financial reporting' and what should be its scope;
• which organisational characteristics indicate that an entity should produce
financial reports;
• the 'objective' of financial reporting;
• qualitative characteristics financial information should possess for it to be
‘useful’;
• what are the elements of financial reporting; and
• what measurement rule(s) should be employed.
Rationale for conceptual frameworks
(cont.)

• Proponents argue that without agreement on these issues accounting standards will be
developed in an ad hoc manner

• There will be limited consistency between accounting standards in the absence of a

conceptual framework
 History of the development of CFs

• CFs were developed in a number of jurisdictions including

• US, UK, Canada, Australia, New Zealand, International Accounting Standards
Committee
• In recent years many countries have adopted the IASB Conceptual Framework given that
they have decided to adopt the accounting standards released by the IASB
• No standard-setters had developed a complete CF; measurement issues typically
remained unaddressed
• Since 2012 the IASB increased its work towards completing a revised conceptual
framework
IASB initiatives since 2010

• The IASB restarted the Conceptual Framework Project in 2012

• FASB withdrew its involvement at that time
• The IASB discontinued the ‘phased approach’ and decided to develop a complete set of
proposals
• Released a Discussion Paper entitled A Review of the Conceptual Framework for
Financial Reporting in July 2013
• IASB issued a revised Conceptual Framework in March 2018, effective immediately for
the Board and the IFRS interpretation committee
IASB revised Conceptual Framework

• Effective for preparers who develop accounting policies based upon the Conceptual
Framework for annual periods beginning on or after 1 January 2020
• Why was the CF revised:
• Priority
• identified as a priority by stakeholders in the 2011 Agenda Consultation
• Filling gaps
• for example, guidance on measurement, presentation and disclosure
• Updating
• for example, the definitions of an asset and a liability
• Clarifying
• for example, the role of measurement uncertainty
IASB revised Conceptual Framework

• Main improvements to the CF according to the IASB:

• New
• Measurement – new concepts on measurement, including factors to be
considered when selecting a measurement basis
• Presentation and disclosure – new concepts on presentation and disclosure,
including when to classify income and expenses in other comprehensive
income
• Derecognition – new guidance on when assets and liabilities are removed from
financial statements
• Updated
• Definitions – updated definitions of an asset and a liability
• Recognition – updated criteria for including assets and liabilities in financial
statements
IASB revised Conceptual Framework

• Main improvements to the CF according to the IASB (cont.):

• Clarified:
• Prudence
• Stewardship
• Measurement uncertainty
• Substance over form
AASB Amendments to the
Australian Conceptual Framework
• As an interim step, in anticipation of further revisions to the IASB conceptual
framework, the AASB is retaining its existing Framework, amended to the extent
necessary to incorporate the IASB’s Chapters 1 and 3 as an Appendix to the
Framework.
• The AASB revised guidance includes a restatement of the objective of general
purpose financial reporting, and reconsideration of the qualitative characteristics
that identify useful financial information.
• The AASB has also added not-for-profit specific paragraphs, where necessary, to
help clarify the concepts from the perspective of not-for-profit entities in the private
and public sectors

Source: AASB Amendments to the Australian Conceptual Framework 2013 (hereafter

AASB-CF2013)
AASB Amendments to the Australian
Conceptual Framework (Cont.)

• Previous guidance on the objective and the qualitative characteristics of

financial statements, as well as the guidance previously available in Statement
of Accounting Concepts SAC2 Objective of General Purpose Financial
Reporting, are now superseded.
• Major amendments to the Australian CF comprises two chapters

• Chapter 1: The objective of general purpose financial reporting

• Chapter 3: Qualitative characteristics of useful financial information

• Current components of Australian conceptual framework include
• SAC1 Reporting entity
• AASB Conceptual Framework 2013-1
Definition of the reporting entity

• In 2010 the IASB released an exposure draft entitled Conceptual Framework for
Financial Reporting: The Reporting Entity in which it defined a reporting entity as:
a circumscribed area of economic activities whose financial information has the
potential to be useful to existing and potential equity investors, lenders and other
creditors who cannot directly obtain the information they need in making decisions
about providing resources to the entity and in assessing whether management
and the governing board of that entity have made efficient and effective use of the
resources provided.

• A similar definition can be found in Australian conceptual framework SAC1

Reporting Entity
Indicative factors of identifying
a reporting entity
• Separation of management from those with an economic interest in the
entity

• The economic or political importance/influence of the entity to/on other

parties

• The financial characteristics of the entity

See SAC1 Reporting Entity

Determining whether an entity is a reporting entity and therefore
required to produce general purpose financial statements
The objective of general purpose
financial reporting

• The objective of general purpose financial reporting forms the foundation of the
Framework.
• Other aspects of the Framework—a reporting entity concept, the qualitative
characteristics of, and the constraint on, useful financial information, elements of
financial statements, recognition, measurement, presentation and disclosure—flow
logically from the objective.
The objective of general purpose
financial reporting: For-profit entities

• IASB/AASB Framework
• 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.

Source: OB2, AASB-CF2013

• In the newly revised CF, the objective of GPFR has been expanded
to include stewardship
The objective of general purpose
financial reporting: Not-for-profit
entities

• In the context of Australia, AusOB2.1 AASB CF 2013 outlines users of financial

information about a not-for-profit reporting entity are
• existing and potential resource providers (such as investors, lenders and other
creditors, donors and taxpayers),
• recipients of goods and services (such as beneficiaries, for example, members
of the community),
• and parties performing a review or oversight function on behalf of other users
(such as advisers and members of parliament).
Useful financial information - General
purpose financial reports

• OB12 states general purpose financial reports provide information about

• the financial position of a reporting entity, which is information about the entity’s
economic resources and the claims against the reporting entity.
• the effects of transactions and other events that change a reporting entity’s
economic resources and claims.
• Both types of information provide useful input for decisions about providing
resources to an entity.
Underlying assumptions of general
purpose financial reporting

• In order to be useful to the users, financial statements are prepared on the accrual
basis of accounting
• Accrual accounting depicts the effects of transactions and other events and
circumstances on a reporting entity’s economic resources and claims in the
periods in which those effects occur, even if the resulting cash receipts and
payments occur in a different period (see IFRS 2014 Technical Summary)
• Also assumes an entity is a going concern and will continue in operation for the
foreseeable future
Qualitative characteristics of useful
financial information

• IASB2010/AASB CF 2013 prescribe that if financial information is to be useful, it

must be
• relevant and faithfully represent what it purports to represent (i.e. fundamental
qualitative characteristics)

• The usefulness of financial information is enhanced if it is

• comparable, verifiable, timely and understandable (i.e. enhancing qualitative
characteristics)
Qualitative characteristics of useful
financial information: Fundamental QC

• Fundamental qualitative characteristics are

• Relevance: capable of making a difference in users’ decisions (see IASB/AASB
CF2013 QC6-10)
– predictive value
– confirmatory value
– materiality (see IASB/AASB CF2013 QC11)

• Faithful representation (IASB/AASB CF2013 QC12-16)

– Completeness (depiction including numbers and words)
– Neutrality (unbiased)
– free from error (ideally)
• The newly revised CF identifies three clarifying aspects of faithful representation:
prudence, measurement uncertainty, substance over form
Applying the fundamental qualitative
characteristics

Process for applying the fundamental qualitative characteristics (IASB/AASB CF 2013

QC17-18)
• First, identify an economic phenomenon (i.e. transactions and events) that has
the potential to be useful to users of the reporting entity’s financial information.

• Second, identify the type of information about that phenomenon that would be
most relevant if it is available and can be faithfully represented.

• Third, determine whether that information is available and can be faithfully

represented. If so, the process of satisfying the fundamental qualitative
characteristics ends at that point. If not, the process is repeated with the next
most relevant type of information.
Qualitative characteristics of useful
financial information: Enhancing QC
• Enhancing qualitative characteristics (see IASB/AASB CF2013 QC19-32)
• Comparability: like things look alike; different things look different

• Verifiability: knowledgeable and independent observers could reach

consensus, but not necessarily complete agreement, that a depiction is a
faithful representation

• Timeliness: having information available to decision-makers in time to be

capable of influencing their decisions

• Understandability: Classify, characterise, and present information clearly and

concisely
Applying the enhancing
qualitative characteristics

• Applying the enhancing qualitative characteristics is an iterative process that does

not follow a prescribed order (see IASB/AASB CF2013-1 QC33 – 34)
• Enhancing qualitative characteristics should be maximised to the extent possible.
• However, the enhancing qualitative characteristics, either individually or as a group,
cannot make information useful if that information is irrelevant or not faithfully
represented.
Cost versus benefits of useful financial
information

• The cost constraint on useful financial reporting

• Cost incurred by providers of financial information
• Cost incurred by users of financial information
• The benefits of useful financial information
• for providers
• for users
• In applying the cost constraint, the Board assesses whether the benefits of
reporting particular information are likely to justify the costs incurred to provide and
use that information.

See QC35-39, IASB/AASB CF2013-1

Elements in financial reporting

• The elements directly related to the measurement of financial position are

• assets,
• liabilities, and
• equity
• The elements directly related to the measurement of financial performance are
• Income, and
• Expenses

See IASB/AASB Framework 2010

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
• The newly revised CF emphasises that in
recognising an element of a GPFR, we must
consider both relevance and faithful representation
Concepts of Capital and Capital
Maintenance
Refer to IASB/AASB Framework, para.102-110
Concepts of capital
• Under a financial concept of capital (commonly used
approach), 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.
Concepts of Capital and Capital
Maintenance (Cont.)
Refer to IASB/AASB Framework, para.102-110
• Concepts of Capital Maintenance and the Determination of Profit (related to the
concepts of capital, para 102 IASB/AASB Framework)
(a) Financial capital maintenance
– 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.

(b) Physical capital maintenance

– 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.
Understanding IASB/AASB Frameworks:
Class quizzes

• The following four slides contain 8 quizzes sourced

from IFRS Foundation (2010)
Quiz: purpose of the Conceptual Framework for Financial Reporting

Question 1: The purpose of the Conceptual Framework for Financial Reporting is:

a. to assist the IASB in setting IFRSs?

b. to assist preparers of financial statements in applying IFRSs?
c. to assist auditors in forming an opinion on whether financial statements comply with IFRSs?
d. to assist users of financial statements in interpreting IFRS financial statements?
e. all of the above?

Quiz: objective of general purpose of financial reporting

Question 2: The objective of general purpose financial reporting is:

a. 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?
b. to inform government statistics?
c. to support the entity’s tax return?
d. to meet all the information needs of all the users of an entity’s financial statements?
e. to inform economic decision-making by a broad range of users (including managers, investors,
creditors and prudential regulators)?
Quiz: fundamental qualitative characteristics 35

Question 3: The fundamental qualitative characteristics are:

a. comparability and relevance?

b. relevance and reliability?
c. relevance, reliability and comparability?
d. relevance and faithful representation?
e. comparability, relevance and faithful representation?

Quiz: qualitative characteristics 36

Question 4: verifiability means knowledgeable and independent observers:

a. would reach complete agreement that a depiction is a faithful representation?
b. cannot reach consensus that a depiction is a faithful representation?
c. could reach consensus, but not necessarily complete agreement,
that a depiction is a faithful representation?
 Quiz: qualitative characteristics 37

Question 5: which statement/s are true?

a. Relevance is a fundamental qualitative characteristic.
b. Financial information without both relevance and faithful representation is not
useful.
c. Financial information without both relevance and faithful representation cannot
be made useful by being more comparable, verifiable, timely or understandable.
d. Financial information that is relevant and faithfully represented may still be
useful even if it does not have any of the enhancing qualitative characteristics
e. All of the above statements.
f. None of the above statements.

Quiz: recognition 39

Question 6: Expenses are recognised in comprehensive income

a. using the matching basis—on the basis of a direct association between the costs
incurred and the earning of specific items of income?
b. using the accrual basis—items are recognised as assets, liabilities,
equity, income or expenses when they satisfy the definitions and
recognition criteria for those items?
c. at the discretion of management?
Quiz: measurement 41

Question 7: How many measurement bases does IFRSs specify for the measurement of assets?
a. one—historical cost
b. one—fair value
c. two—historical cost and fair value
d. many—including historical cost, fair value, value in use, estimated selling
price less costs to complete and sell, etc

Quiz: status of Conceptual Framework 42

Question 8: the Conceptual Framework:

a. is an IFRS?
b. overrides all other IFRS requirements?
c. does not define standards for any particular measurement or disclosure issue?
d. is in the hierarchy that management must in the absence of a specific IFRS
requirement apply in developing an accounting policy that results in
information that is relevant and reliable?
Summary

Recap learning objectives of Topic 3

Answer to class quiz: e, a, d, c, e, b, d, d