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ISM 502 Accounting Standards Application

Notes for Week 2

Conceptual Framework for Financial Reporting

The reasons for this preliminary information:

 The Conceptual Framework assists companies in developing accounting policies when no

IFRS Standard applies to a particular transaction.
 The Conceptual Framework sets out the fundamental concepts for financial reporting that
guide the Board in developing IFRS Standards.

Important issues to note:

 The Conceptual Framework is not a Standard. Nothing in the Conceptual Framework

overrides any Standard or any requirement in a Standard (SP1.2)
 The Conceptual Framework provides the foundation for Standards that (SP1.5):

(a) contribute to transparency by enhancing the international comparability and

quality of financial information, enabling investors and other market participants to
make informed economic decisions.

(b) strengthen accountability by reducing the information gap between the providers
of capital and the people to whom they have entrusted their money. Standards
based on the Conceptual Framework provide information needed to hold
management to account. As a source of globally comparable information, those
Standards are also of vital importance to regulators around the world.

(c) contribute to economic efficiency by helping investors to identify opportunities

and risks across the world, thus improving capital allocation. For businesses, the use
of a single, trusted accounting language derived from Standards based on the
Conceptual Framework lowers the cost of capital and reduces international reporting
costs.

The Conceptual Framework sets out:

1. the objective of general purpose financial reporting;

2. the qualitative characteristics of useful financial information;
3. a description of the reporting entity and its boundary;
4. definitions of an asset, a liability, equity, income and expenses and guidance supporting
these definitions;
5. criteria for including assets and liabilities in financial statements (recognition) and guidance
on when to remove them (derecognition);
6. measurement bases and guidance on when to use them;
7. concepts and guidance on presentation and disclosure; and
8. concepts relating to capital and capital maintenance.

1. The objective of general purpose financial reporting:

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(1.2) 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 relating to providing resources to the entity.
Those decisions involve decisions about:
(a) buying, selling or holding equity and debt instruments;
(b) providing or settling loans and other forms of credit; or
(c) exercising rights to vote on, or otherwise influence, management’s actions that
affect the use of the entity’s economic resources.

Economic resources and claims:

(1.13) Information about the nature and amounts of a reporting entity’s economic resources and
claims can help users to identify the reporting entity’s financial strengths and weaknesses. That
information can help users to assess the reporting entity’s liquidity and solvency, its needs for
additional financing and how successful it is likely to be in obtaining that financing. That information
can also help users to assess management’s stewardship of the entity’s economic resources.
Information about priorities and payment requirements of existing claims helps users to predict how
future cash flows will be distributed among those with a claim against the reporting entity.

Financial performance reflected by accrual accounting:

(1.17) 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. This is important because
information about a reporting entity’s economic resources and claims and changes in its economic
resources and claims during a period provides a better basis for assessing the entity’s past and future
performance than information solely about cash receipts and payments during that period.

2. The qualitative characteristics of useful financial information:

Fundamental qualitative characteristics:

 Relevance: (2.6) Relevant financial information is capable of making a difference in the

decisions made by users. (2.7) Financial information is capable of making a difference in
decisions if it has predictive value, confirmatory value or both.
 Materiality: (2.11) Information is material if omitting, misstating or obscuring it could
reasonably be expected to influence decisions that the primary users of general purpose
financial reports make on the basis of those reports, which provide financial information
about a specific reporting entity.
 Faithful representation: (2.12) 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 substance of the phenomena that it
purports to represent. In many circumstances, the substance of an economic phenomenon
and its legal form are the same.

Enhancing qualitative characteristics:

 Comparability: (2.24) Users’ decisions involve choosing between alternatives, for example,
selling or holding an investment, or investing in one reporting entity or another.
Consequently, information about a reporting entity is more useful if it can be compared with
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similar information about other entities and with similar information about the same entity
for another period or another date.
 Verifiability: (2.30) Verifiability helps assure users that information faithfully represents the
economic phenomena it purports to represent. Verifiability means that different
knowledgeable and independent observers could reach consensus, although not necessarily
complete agreement, that a particular depiction is a faithful representation.
 Timeliness: (2.33) 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.
 Understandability: (2.34) Classifying, characterizing and presenting information clearly and
concisely makes it understandable.

3. A description of the reporting entity and its boundary:

(3.2) The objective of financial statements is to provide financial information about the reporting
entity’s assets, liabilities, equity, income and expenses that is useful to users of financial statements
in assessing the prospects for future net cash inflows to the reporting entity and in assessing
management’s stewardship of the entity’s economic resources.

Reporting period:

(3.4) Financial statements are prepared for a specified period of time (reporting period) and provide
information about:
(a) assets and liabilities—including unrecognised assets and liabilities— and equity
that existed at the end of the reporting period, or during the reporting period; and
(b) income and expenses for the reporting period.

Going concern assumption:

(3.9) Financial statements are normally prepared on the assumption that the reporting entity is a
going concern and will continue in operation for the foreseeable future.

Consolidated financial statements:

(3.15) Consolidated financial statements provide information about the assets, liabilities, equity,
income and expenses of both the parent and its subsidiaries as a single reporting entity. That
information is useful for existing and potential investors, lenders and other creditors of the parent in
their assessment of the prospects for future net cash inflows to the parent. This is because net cash
inflows to the parent include distributions to the parent from its subsidiaries, and those distributions
depend on net cash inflows to the subsidiaries.

4. Definitions of an asset, a liability, equity, income and expenses and guidance supporting these
definitions:

Asset:

(4.3) An asset is a present economic resource controlled by the entity as a result of past events.

(4.4) An economic resource is a right that has the potential to produce economic benefits.
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Liability:

(4.26) A liability is a present obligation of the entity to transfer an economic resource as a result of
past events.

Equity:

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

Income and Expenses:

(4.68) Income is increases in assets, or decreases in liabilities, that result in increases in equity, other
than those relating to contributions from holders of equity claims.

(4.69) Expenses are decreases in assets, or increases in liabilities, that result in decreases in equity,
other than those relating to distributions to holders of equity claims.

5. Criteria for including assets and liabilities in financial statements (recognition) and guidance on
when to remove them (derecognition):

(5.1) Recognition 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 one of the elements of
financial statements—an asset, a liability, equity, income or expenses. Recognition involves depicting
the item in one of those statements—either alone or in aggregation with other items— in words and
by a monetary amount, and including that amount in one or more totals in that statement.

(5.26) Derecognition is the removal of all or part of a recognised asset or liability from an entity’s
statement of financial position. Derecognition normally occurs when that item no longer meets the
definition of an asset or of a liability:
(a) for an asset, derecognition normally occurs when the entity loses control of all or
part of the recognised asset; and
(b) for a liability, derecognition normally occurs when the entity no longer has a
present obligation for all or part of the recognized liability

6. Measurement bases and guidance on when to use them:

(6.1) Elements recognised in financial statements are quantified in monetary terms. This requires the
selection of a measurement basis. A measurement basis is an identified feature—for example,
historical cost, fair value or fulfilment value —of an item being measured. Applying a measurement
basis to an asset or liability creates a measure for that asset or liability and for related income and
expenses.

Historical cost:

(6.4) Historical cost measures provide monetary information about assets, liabilities and related
income and expenses, using information derived, at least in part, from the price of the transaction or
other event that gave rise to them.

Current value:
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(6.10) Current value measures provide monetary information about assets, liabilities and related
income and expenses, using information updated to reflect conditions at the measurement date.

(6.11) Current value measurement bases include:

(a) fair value: (6.12) Fair value 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.
(b) value in use for assets and fulfilment value for liabilities: (6.17) 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. Fulfilment value is the
present value of the cash, or other economic resources, that an entity expects to be
obliged to transfer as it fulfils a liability. Those amounts of cash or other economic
resources include not only the amounts to be transferred to the liability
counterparty, but also the amounts that the entity expects to be obliged to transfer
to other parties to enable it to fulfil the liability.
(c) current cost: (6.21) The current cost of an asset is the cost of an equivalent asset
at the measurement date, comprising the consideration that would be paid at the
measurement date plus the transaction costs that would be incurred at that date.
The current cost of a liability is the consideration that would be received for an
equivalent liability at the measurement date minus the transaction costs that would
be incurred at that date. Current cost, like historical cost, is an entry value: it reflects
prices in the market in which the entity would acquire the asset or would incur the
liability. Hence, it is different from fair value, value in use and fulfilment value, which
are exit values. However, unlike historical cost, current cost reflects conditions at the
measurement date.

7. Concepts and guidance on presentation and disclosure:

(7.4) To facilitate effective communication of information in financial statements, when developing

presentation and disclosure requirements in Standards a balance is needed between:
(a) giving entities the flexibility to provide relevant information that faithfully
represents the entity’s assets, liabilities, equity, income and expenses; and
(b) requiring information that is comparable, both from period to period for a
reporting entity and in a single reporting period across entities.

8. Concepts relating to capital and capital maintenance:

(8.1) 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.

(8.4) The concept of capital maintenance is concerned with how an entity defines the capital that it
seeks to maintain. It provides the linkage between the concepts of capital and the concepts of profit
because it provides the point of reference by which profit is measured; it is a prerequisite for
distinguishing between an entity’s return on capital and its return of capital; only inflows of assets in
excess of amounts needed to maintain capital may be regarded as profit and therefore as a return on
capital. Hence, profit is the residual amount that remains after expenses (including capital
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maintenance adjustments, where appropriate) have been deducted from income. If expenses exceed
income the residual amount is a loss.