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FACULTY OF MANAGEMENT, COMMERCE AND LAW

DEPARTMENT OF ACCOUNTANCY
Financial Reporting: ACC3141/3641

MODULE NOTES
CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

WARNING: Ignoring this module note may result in severe confusion, excessive head-scratching,
and the classic 'deer in headlights' look during class. This is SELF-STUDY—read it, know it, love it!"
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MODULE 1: CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING (SELF-STUDY)

CONTENT
1. PURPOSE
2. OBJECTIVES / OUTCOMES FOR THE MODULE
3. PRE-LECTURE PREP: LEARN BEFORE LECTURE (LBL) ASSIGNMENT
4. CHAPTER SUMMARY

1. PURPOSE OF THE FRAMEWORK

The Conceptual Framework for Financial Reporting (Conceptual Framework) deals with:
− The objective of financial reporting;
− The qualitative characteristics of useful financial information;
− The definition, recognition and measurement of the elements from which financial statements are
constructed; and
− Concepts of capital and capital maintenance.

2. OBJECTIVES / OUTCOMES FOR THE MODULE

After you have studied this module, you should be able to do the following:
− Understand the objective of financial reporting/financial statements.
− Explain and apply the underlying assumptions used to prepare financial statements.
− Explain the qualitative characteristics of financial statements.
− Explain and apply the elements of financial statements and their recognition criteria in respect of
the preparation of financial statements.
− Understand and apply the appropriate measurement bases that may be used when measuring
the elements.

3. PRE-LECTURE PREP:

WHAT?
Prescribed textbook: IFRS Textbook (actual standard)
Relevant chapter in prescribed textbook: Conceptual Framework

Any additional notes relevant

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4. SUMMARY – THE CONCEPTUAL FRAMEWORK

THE OBJECTIVE OF FINANCIAL REPORTING

OBJECTIVE OF FINANCIAL REPORTING:

To provide financial information that is useful to users in making decisions relating to providing
resources to the entity
Existing and potential
investors, lenders USERS DECISIONS INVOLVE DECISIONS ABOUT:
and other creditors

Buying, selling or Providing or settling Voting, or otherwise

holding equity or debt loans and other forms influencing
instruments of credit management’s actions

TO MAKE THESE DECISIONS, USERS ASSESS:

Prospects for future net cash inflows to the Management’s stewardship of the entity’s
entity economic resources.

TO MAKE BOTH THESE ASSESSMENTS, USERS NEED INFORMATION ABOUT BOTH:

The entity’s economic resources, claims How efficient and effectively management
against the entity and changes in those has discharged its responsibilities to use
resources and claims. the entity’s economic resources

QUALITATIVE CHARACTERISTICS

Components: Other considerations:

Predictive value Nature

Relevance
Confirmation value Materiality

Completeness
Prudence
Faithful
Neutrality
representation
Measurement uncertainty
Free from error
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ENHANCING QUALITATIVE CHARACTERISTICS

Over time
Comparability Consistency
Similar events or
transactions
Verifiability
These four qualitative characteristics enhance
Timeliness the usefulness of information but they cannot
make non-useful information useful.
Understandability

COST CONSTRAINT

The benefit of providing the information needs to justify the cost of providing and using the
information.

FINANCIAL STATEMENTS AND THE REPORTING ENTITY

REPORTING ENTITY:
• An entity that is required, or chooses, to prepare financial statements
• Not necessarily a legal entity – could be a portion of an entity or comprise more than one
entity

FINANCIAL STATEMENTS:
A particular form of financial reports that provide information about the reporting entity’s assets,
liabilities, equity, income and expenses.

Consolidated financial Unconsolidated Combined financial

statements financial statements statements
Provide information Provide information Provide information
about assets, liabilities, about the assets, about assets, liabilities,
equity, income and liabilities, equity, equity, income and
expenses of both the income and expenses expenses of two or more
parent and its of the parent only entities that are not all
subsidiaries as a single linked by a parent-
reporting entity subsidiary relationship

Information generally included in financial statements:

Statement of financial position Assets, liabilities and equity
Statement of profit or loss and other Income and expenses, gains and losses
comprehensive income
Statement of changes in equity Contributions from holders of equity claims and
distributions to them
Statement of cash flows Cash inflows and outflows
Notes to the financial statements Additional information about the information in
the financial statements.
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ELEMENTS OF FINANCIAL STATEMENTS

OLD DEFINITIONS NEW DEFINITIONS

• Assets • Assets
An asset of an entity is: An asset of an entity is:
o A resource; o A present economic resource;
o That is under the control of the o That is controlled by the entity;
entity; o As a result of past events
o That is expected to result in future
economic benefits flowing to the
entity; and An economic resource is a
o That originated as a result of a right that has the potential to
past event. provide economic benefits

• Liabilities • Liabilities
A liability of an entity is: A liability of an entity is:
o A present obligation; o A present obligation;
o Arising from a past event; and o Of the entity
o That is expected to result in an o To transfer an economic resource
outflow from the entity of o As a result of a past event.
resources embodying economic
benefits. A duty or responsibility that
the entity has no practical
ability to avoid
• Equity • Equity
Equity is define as the residual Equity is define as the residual
interest in the assets after deducting interest in the assets after deducting
all its liabilities. all its liabilities.
• Income • Income
Income is described as: Income is described as:
o Increases in economic benefits o Increases of assets;
during the accounting period; o Or decreases in liabilities
o In the form of inflows or o That result in increases in equity;
enhancements of assets;
o Other than those relating to
o Or decreases of liabilities; and contributions from holders of
o That result in increases in equity equity claims.
other than those relating to
contributions from equity
participants

• Expense
• Expense
Expenses are defined as:
Expenses are defined as:
o Decreases in economic benefits
during the accounting period; o Decreases of assets;
o In the form of outflows or depletion o Or increases in liabilities
of assets; o That result in decreases in equity;
o Or incurrences of liabilities; and o Other than those relating to
o That result in decreases in equity distributions to holders of equity
other than those relating to claims.
distributions to equity participants.
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RECOGNITION AND DERECOGNITION

RECOGNITION:
The process of capturing for inclusion in the statement of financial position or the statement of
financial performance an item that meets the definition of an asset, a liability, equity, income or
expenses.

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.

RELEVANCE FAITHFUL REPRESENTATION

• Whether recognition of an item results • Whether recognition of an item results
in relevant information may be affected in a faithful representation may be
by, for example: affected by, for example:

Low probability of a flow of economic Measurement uncertainty

benefits
Recognition inconsistency
Existence uncertainty (accounting mismatch)
Presentation and disclosure

COST CONTRAINTS:
Cost constrains recognition decisions, just as it constrains other financial reporting decisions.

DERECOGNITION:
The removal of all or part of a recognised asset, or liability from an entity’s statement of financial
position.

ASSETS LIABILITIES
• When the entity loses control of all or • When the entity no longer has a
part of the recognised asset. present obligation for all or part of the
recognised liability.

DERECOGNITION AIMS TO FAITHFULLY REPRESENT BOTH:

• Any assets and liabilities retained after the transaction that led to the de-recognition.
• The change in the entity’s assets and liabilities as a result of that transaction.
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MEASUREMENT

HISTORICAL COST MEASUREMENT BASES

• Historical cost provides information derived, at least in part, from the price of the transaction
or other event that gives 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.

CURRENT VALUE MEASUREMENT BASES

• Current value provides information updated to reflect conditions at the measurement date.

Value in use (for assets) /

Fulfilment value (for
Fair value liabilities) Current cost
• The price that would be • Reflects entity-specific • Reflects the current
received to sell an current expectations amount that would be:
asset, or paid to transfer about the amount, o paid to acquire an
a liability, in an orderly timing and uncertainty equivalent asset
transaction between of future cash flows. o received to take on
market participants at an equivalent
the measurement date. liability.
• Reflects market
participants’ current
expectations about the
amount, timing and
uncertainty of future
cash flows.

FACTORS TO CONSIDER IN SELECTING A MEASUREMENT BASIS:

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

CHARACTERISTICS OF THE CONTRIBUTION TO FUTURE CASH

ASSET/LIABILITY FLOWS
• The variability of cash flows • Whether cash flows are produced
• Sensitivity of the value to market directly or indirectly in combination with
factors or other risks other economic resources
• The nature of the entity’s business
activities
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FAITHFUL REPRESENTATION
Whether a measurement basis can provide faithful representation is affected by:

MEASUREMENT INCONSISTENCY MEASUREMENT UNCERTAINTY

• If financial statements contain • Does not necessarily prevent the use of
measurement inconsistencies a measurement basis that provides
(accounting mismatch), those financial relevant information
statements may not faithfully represent • But if too high might make it necessary
some aspects of the entity’s financial to consider selecting a different
position and financial performance measurement basis

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

PRESENTATION AND DISCLOSURE

THE STATEMENT OF PROFIT OR LOSS:

• The statement of profit or loss is the primary source of information about an entity’s financial
performance for the reporting period.
• Profit or loss 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

RECYCLING:
• In principle, income and expenses included in other comprehensive income in one period are
recycled to the statement of profit or loss in a future period when doing so results in the
statement of profit or loss providing more relevant information or a more faithful
representation
• When recycling does not result in the statement of profit or loss providing more relevant
information or a more faithful representation, the Board may decide income and
expenses included in other comprehensive income are not be subsequently recycled.