[ Learning Objectives Framework 37 Conceptual Framework for Financial Reporting eee State the purpose, status, and scope of the Conceptual Framework. State the objective of financial reporting. Identify the primary users of financial statements. Explain briefly the qualitative characteristics of useful information and how they are applied in financial reporting. Define the elements of financial statements and state their recognition criteria and their derecognition. State the measurement bases used in financial reporting. Purpose of the Conceptual Framework The Conceptual Framework prescribes the concepts for general purpose financial reporting. Its purpose is to: a. b. assist the International Accounting Standards Board (IASB) in developing Standards* that are based on consistent concepts; assist preparers in developing consistent accounting policies when no Standard applies to a particular transaction or when a Standard allows a choice of accounting policy; and assist all parties in understanding and interpreting the Standards. * In our succeeding discussions, we will use the term Standard(s) to refer to both the International Financial Reporting Standards (IFRS) and the Philippine Financia? Reporting Standards (PFRS). The Conceptual Framework provides the foundation for the development of Standards that: a b. promote transparency by enhancing the international comparability and quality of financial information. ; strengthen accountability by reducing the information gap between providers of capital and the entity's management, | | | |38 SS © contribute to economic efficiency by helping investors 4, identify opportunities and risks around the world, thy, improving capital allocation. The use of a single, trusted accounting language lowers the cost of capital and reduces international reporting costs. (Conceptual Framework SP15) Status of the Conceptual Framework The Conceptual Framework is not a Standard. If there is a conflict between a Standard and the Conceptual Framework, the requirement of the Standard will prevail. The authoritative status of the Conceptual Framework is depicted in the hierarchy of guidance shown below: 4 Hierarchy of reporting standards 1. PERSs i 2. Judgment When making the judgment: > Management shail consider the following: a. Requirements in other PFRSs dealing with similar transactions b. Conceptual Framework | >» Management may consider the following: | a. Pronouncements issued by other standard-setting bodies b. Other accounting literature and industry practices The hierarchy guidance above means that in the absence of a PERS that specifically applies to a transaction, management shall consider the applicability of the Conceptual Framework in developing and applying an accounting policy that results in useful information. To meet the objectives of general purpose financial reporting, a Standard sometimes contains requirements that depatt from the Conceptual Framework. In such cases, the departure is explained in the ‘Basis for Conclusions’ on that Standard. The Conceptual Framework may be revised from time '© time based on the IASB's experience of working with it. However revisions do not automatically result to changes in the Standards - estan3 ptual Framework not until after the [ASB goes through its due process of amending a Siandard. Scope of the Conceptual Framework The Conceptual Framework is concerned with general purpose financial reporting. General purpose financial reporting involves the preparation of general purpose financial statements. The Conceptual Framework provides the concepts that underlie general purpose financial reporting with regard to the following: 1. The objective of financial reporting Qualitative characteristics of useful finandal information Financial statements and the reporting entity The elements of financial statements Recognition and derecognition Measurement Presentation and disclosure Concepts of capital and capital maintenance SI eoRen The Objective of Financial Reporting “The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.” (Conceptual Framework.1.2) This objective is the foundation of the Conceptual Framework. All the other aspects of the Conceptual Framework revolve around this objective. Primary users The objective of financial rep called the primary users: 1. Existing and potential investors; 2. Lenders and other creditors orting refers to the following, so and e users cannot demand information directly from ties and must rely on general purpose financial much of _ their financial information needs. Thes reporting enti reports for40 Sect Ee Accordingly, they are the primary users to whom Beneral purpo, financial Teports are directed to. s Lenders refer to those who extend loans (e.g,, banky while other creditors refer to those who extend other forms of credit (e.g, supplier). The Conceptual Framework is concerne Purpose financial reporting. General (or simply ‘financial Teporting’) that caters to the common need: d with genera | purpose financial Teportin, deals with providing information Is of the primary users, Therefore, general purpose financial reports do not and cannot provide al] the information needs of primary users. These users will need tg consider other sources for their other information needs (for example, general economic conditions and expectations, Political events and political climate, and industry and company outlooks), The information needs of individual primary users may differ and possibly conflict. Accordingly, financial reporting aims to provide information that meets the needs of the maximum number of primary users. Focusing on common needs, however, does not prohibit the Provision of additional information that is most useful to a particular subset of primary users. Other users, such as the entity's management, regulators, and the public, may find general purpose financial reports useful. However, such reports are not primarily directed to these users. General purpose financial reports do not directly show the value of a reporting entity. However, they provide information that helps users in estimating the value of an entity. Providing useful information requires making estimates and judgments. The Conceptual Framework establishes the concepts that underlie those estimates and judgments, Decisions about providing resources to the entity The primary users’ decisions about providing resources to the entity involve decisions on: a, buying, selling or holding investments; b. providing or settling loans and other forms of credit; or ie41 c. exercising voting or similar tights that could influence management's actions relating to the use of the entity’s economic resources. These decisions depend on the investoi/lender/other creditor's expected returns (e.g., investment income or repayment of loan) ‘pectations about returns, in turn, depend on assessments of the entity’s (i) prospects ‘for future net cash inflows and (ii) management stewardship. To make these assessments, investors, lenders and other creditors need information on: a. the economic resources of the entity, claims against the entity and changes in those resources and daims; and b. how efficiently and effectively the entity's management has utilized the entity’s economic resources. Information on Economic resources, Claims, and Changes General purpose financial reports provide information on a reporting entity’s: a. Financial position — information on economic resources (assets) and claims against the reporting entity (liabilities and equity); and b. Changes in economic resources and claims - information on financial performance (income and expenses) and other transactions and events that lead to changes in financial position. Collectively, these are referred to under the Conceptual Framework as the economic phenomena. Economic resources and Claims : / Information about the nature and amounts of an entity’s economic resources (assets) and claims (liabilities and equity) can help users to identify the entity’s financial strengths and weaknesses, That information can help users in assessing the entity's: a. Liquidity and solvency; oy b. Needs for additional financing and how successful it is likely to be in obtaining that financing; andBn Management's stewardship on the use of economic TesoUurces Liquidity refers to an entity's ability to pay short-term obligations, while solvency refers to an entity's ability to mee its long-term obligations. . All of these contribute to the assessment of th ability to generate future cash flows. For example: ~ _ Information on currently maturing receivables and Obligations can help users assess the timing of future cash flows. Information about the nature of economic resources can heh users assess whether a resource can produce future cash flows independently or only in combination with other resources, Information on liquidity and solvency can help users assess the entity's ability to obtain additional financing Overleverage (use of too much debt) may cause difficulty in obtaining additional financing. - Information about priorities and payment requirements of claims can help users predict how future cash flows will likely to be distributed among the claims. e eNtity’s Changes in economic resources and claims Changes in economic resources and claims result from: a. financial performance (income and expenses); and b. other events and transactions. Information on financial performance helps users assess the entity’s ability to produce return from its economic resources Return provides an indication on how well management has efficiently and effectively used the entity’s resources. | Information on the variability of the return helps users it assessing the uncertainty of future cash flows. For example, significant fluctuations in reported profits may indicate faanet instability and uncertainty on the entity's ability to generate © flows from its operations.43 Information based on accrual accounting provides a better basis for assessing an entity's financial performance than information based solely on cash receipts and payments during the period. Information on past cash flows helps users assess the entity's ability to generate future cash flows by providing users a basis in understanding the entity's operating, investing and financing activities, assessing its liquidity or solvency, and interpreting other information about its financial performance. Economic resources and claims may also change for reasons aside from financial performance, such as issuing debt or equity instruments. Information on these types of changes is necessary for a complete understanding of the entity's changes in economic resources and claims and the possible impact of those changes on the entity’s future financial performance. Information about use of the entity's economic resources Information on how efficiently and effectively the entity's management has discharged its responsibilities to use the entity's economic resources helps users assess the entity's management's stewardship. This information also helps in predicting how efficiently and effectively the entity's resources will be used in future periods; thus, helping in the assessment of the entity's prospects for future net cash inflows. Examples of management's responsibilities to use the entity’s economic resources include safeguarding those resources and ensuring the entity’s compliance with laws, regulations and contractual provisions. | Summary: | The decisions of primary users are based on assessments of an | | entity’s prospects for future net cash inflows and management stewardship. | To make these assessments, users need information on the entity’s | financial position, financial performance and other changes in | financial position, and utilization of economic resources. _OO Qualitative Characteristics ne ., The qualitative characteristics of useful financial informatio, identify the types of information that are likely to be most usefy) to the primary users in making decisions using an entity, financial report. Qualitative characteristics apply to information in the financial statements as well as to financial information provided in other ways. The Conceptual Framework classifies the qualitative characteristics into the following: 1. Fundamental qualitative characteristics — these are the characteristics that make information useful to users. They consist of the following: a. Relevance b. Faithful representation 2. Enhancing qualitative characteristics - these are the characteristics that enhance the usefulness of information. They consist of the following: a. Comparability b. Verifiability c. Timeliness d. Understandability Fundamental qualitative characteristics Relevance Information is relevant if it can make a difference in the decisions of users. Relevant information has the following: a. Predictive value — the information can help users in making predictions about future outcomes. b. Confirmatory value (feedback value) - the information can help users in confirming their Previous predictions. Predictive value and confirmatory value are interrelated. Information that has, predictive value= is likely” "46" "also" have confirmatory value. For example, revenue in the current peri“onceptual Pramewor See = can be used to predict revenue in a future period and at the same time can also be used in confirming a past prediction Materiality “Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of a specific reporting entity’s general purpose financial statements make on the basis of those financial statements.” (€0/2017/6 Definition of Material) The Conceptual Framework states that materiality is an ‘entity-specific’ aspect of relevance, meaning materiality depends on the facts and circumstances surrounding a specific entity. Accordingly, the Conceptual Framework and the Standards do not specify a uniform quantitative threshold for materiality. Materiality is a matter of judgment. IFRS? Practice Statement 2 Making Materiality Judgments provides a non-mandatory guidance that entities may follow in making materiality judgments. The guidance consists of a four- step process called the “materiality process.” Step 1 — Identify information that has the potential to be material. The starting point in making the identification is the requirements of the Standards. This is because, when developing Standards, the IASB identifies the information needs of a wide range of primary users and considers the balance between the benefits to be derived from the information and the cost of producing it. However, cost is not a factor when making materiality judgments. The entity also considers the common information needs of its primary users, in addition to those specified in the PFRSs. Step 2 — Assess whether the information identified in Step 1 is, in fact, material.46 SS ——————————n— — OOOnrT[—™— In making this assessment, the entity considers the following: , a. Whether the information could influence the users decisions, on the basis of the financial statements as a whole. The item’s nature or size, or both. c. Quantitative and qualitative factors. > Quantitative factors include the size of the impact of the item. The size of an item can be assessed in relation to q percentage of another amount (e.g., percentage of total assets or total revenues) or a threshold amount (eg, a capitalization threshold) >» Qualitative factors are characteristics of the item or its context. These are: i. Entity-specific qualitative factors, e.g., involvement of a related party or rarity of the item. ii. External qualitative factors, e.g., the entity’s industry sector or the state of the economy. Although there is no hierarchy among materiality factors, an entity normally first assesses an item on the basis of quantitative factors. If an item is quantitatively material, the entity need not reassess it on the basis of qualitative factors. However, if an item is quantitatively not material, the entity needs to reassess it on the basis of qualitative factors. For example, an item that has a zero amount (i.e., not quantitatively material) may nevertheless be considered material in light of qualitative factors. Step 3 — Organize the information within the draft financial statements in a way that communicates the information clearly and concisely to ) primary users. The entity exercises information in a manner that primary users, judgment on how to present maximizes understandability to thetual Framework 47 [ Step 4 — Review the draft financial statements to delerm ine | whether all material information has been identified and | materiality considered from a wide perspective and in aggregate, | on the basis of the complete set of financial statements. The review allows the entity to ‘step-back’ and get a wider perspective of the information provided, This is necessary because an item might not be material on its own, but it might be material if used in conjunction with the other information in the complete set of financial statements. The four-step Materiality Process (IFRS? Practice Statement 2) Step 1 Requirements Knowledge about primary users’ Identity Of IFRS Standards commen information needs il if“ ae Faithful representation . Faithful representation means the information provides a ire correct and complete depiction of the economic phenomena that it urports to represent. rep Wher an economic phenomenon’s substance differs from, its legal form, faithful representation requires the depiction of the substance (i.e., substance over form). Depicting only the legal form would not faithfully represent the economic phenomenon. Faithfully represented information has the following characteristics: a. Completeness — all information (in words and numbers) necessary for users to understand the phenomenon being depicted is provided. These include description of the nature of the item, numerical depiction (e.g., monetary amount), description of the numerical depiction (e.g,, historical cost or fair value) and explanations of significant facts surrounding the item. b. Neutrality — information is selected or presented without bias. Information is not manipulated to increase the probability that users will receive it favorably or unfavorably. Neutrality is supported by prudence, which is the use of caution when making judgments under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. Equally, the exercise of prudence does not allow the understatement of assets or overstatement of liabilities because the financial statements would not be faithfully represented. c. Free from error — this does not mean that the information is perfectly accurate in all respects. Free from error means there are no errors in the description and in the Process by which the information is selected and applied. If the information is an estimate, that fact should be described clearly, including an explanation of the Process used in making that estimate.ea Faithful esentation . Faithful represen means the information provides a tne correct and complete depiction of the economic phenomena that it urports to represent. rep Whee economic phenomenon’s substance differs from its legal form, faithful representation requires the depiction of the substance (i.e., substance over form). Depicting only the legal form would not faithfully represent the economic phenomenon, Faithfully represented information has the following characteristics: a. Completeness — all information (in words and numbers) necessary for users to understand the phenomenon being depicted is provided. These include description of the nature of the item, numerical depiction (e.g., monetary amount), description of the numerical depiction (e.g., historical cost or fair value) and explanations of significant facts surrounding the item. b. Neutrality — information is selected or presented without bias. Information is not manipulated to increase the probability that users will receive it favorably or unfavorably. Neutrality is supported by prudence, which is the use of caution when making judgments under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. Equally, the exercise of prudence does not allow the understatement of assets or overstatement of liabilities because the financial statements would not be faithfully represented. c. Free from error — this does not mean that the information is perfectly accurate in all respects. Free from error means there are no errors in the description and in the Process by which the information is selected and applied. If the information i§ an estimate, that fact should be described clearly, including an explanation of the process used in making that estimate.Canceptual Framework 49 Enhancing qualitative characteristics Comparability Information is comparable if it helps users identify similarities and differences between different sets of information that are provided by: a. a single enti ty but in different Periods (intra-comparability); or b. different entities in a single period (inter-comparability). Unlike the other qualitative characteristics, comparability does not relate to only one item because a comparison requires at least two items, Comparison is not uniformity, meaning like things must look alike and different things must look differently. It would be inappropriate to make different things look alike, or vice versa. Although related, consistency and comparability are not the same. Consistency refers to the use of the same methods for the same items. Comparability is the goal while consistency is the means of achieving that goal. Verifiabi Information is verifiable if different users could reach a general agreement as to what the information purports to represent. Verification can be direct or indirect. Direct verification involves direct observation (eg., counting of cash). Indirect verification involves checking the inputs to a model or formula and recalculating the outputs using the same methodology (e.g., checking the debits and credits in the cash ledger and recalculating the ending balance). Timeliness Information is timely if it is available to users in time to be able to influence their decisions. Understandability Information is understandable if it is presented in a clear and concise manner.50 Understandability does not mean that complex Matters should be excluded to make information understandable to Users because this would make information incomplete and Potentially misleading. Accordingly, financial reports are intended for users. a. who have reasonable knowledge of business activities, and b. who are willing to analyze the information diligently. i Summary: Qualitative Characteristics 1. Fundamental qualitative characteristics a. Relevance (predictive value & confirmatory value) » Materiality (entity-specific aspect of relevance) b. Faithful representation (completeness, neutrality, & free from error) | 2. Enhancing qualitative characteristics | a. Comparability i b. Verifiability |G Timeliness | |___d._Understandability. Applying the qualitative characteristics The fundamental qualitative characteristics are essential to the usefulness of information; meaning, information must be both relevant and faithfully represented for it to be useful. For example, neither a relevant information that is erroneous nor a correct information that is irrelevant helps users make good decisions. The enhancing qualitative characteristics only enhance the usefulness of information that is both relevant and faithfully represented but cannot make information that is irrelevant or erroneous to be useful. Accordingly, the enhancing qualitative characteristics should be maximized to the extent possible. There is no prescribed order in applying the enhancing qualitative characteristics, Sometimes one enhancing qualitative characteristic May have to be sacrificed to maximize another, The Cost Constraint Cost is a pervasive constraint on the entity's ability to provide useful financial information.Conceptual Frametoork Ks Providing information entails cost and this can only be justified by the benefits expected to be derived from using the information. Accordingly, an optimum balance between costs and benefits is desirable such that costs do not outweigh the benefits. Financial statements and the Reporting entity Objective and scope of financial statements The objective of general purpose financial statements is to provide financial information about the reporting entity's assets, liabilities, equity, income and expenses that is useful in assessing: a. the entity’s prospects for future net cash inflows; and b. management's stewardship over economic resources. That information is provided in the: a,_statement of financial position (for recognized assets, liabilities and equity; b. statement(s) of financial performance (for income and expenses); c other statements and notes (for additional information on recognized assets and liabilities, information on unrecognized assets and liabilities, information on cash flows, information on contributions from/distributions to owners, and other relevant information). Reporting period Financial statements are prepared for a specified period of time and provide information on assets, liabilities and equity that existed at the end of the reporting period, or during the reporting period, and income and expenses for the reporting period, (Conceptual Framework 3.4) Comparative information To help users of financial statements in evaluating changes and trends, financial statements also provide comparative information for at least one preceding reporting period. For example, an entity's 2019 current-year financial statements include the 201852. SS preceding year-financial statements as comparative information, This allows users to assess the information’s intra-comparability, Forward-looking information . ; Financial statements are designed to provide information about past events (i.e., historical data). Information about possible future transactions and other events is included in the financia) Statements only if it relates to the past information presented in the financial statements and is deemed useful to users of financial] statements. Financial statements, however, do not typically provide forwardooking information about management's expectations and strategies for the reporting entity. Financial statements include information about events after the end of the reporting period if it is necessary to meet the objective of financial statements. Perspective adopted in financial statements Information in financial statements is prepared from the Perspective of the reporting entity, not from the perspective of any particular group of financial statement user. Going concern assumption Financial statements are normally prepared on the assumption that the reporting entity is a going concern, Meaning the entity has neither the intention nor the need to end its operations in the foreseeable future. If this is not the case, the entity’s financial statements are prepared on another basis (e.g., measurement at realizable values rather than mixture of costs and values), “Going concern is referred to as the ‘underlyi Conceptual Framework, ng assumption’ in the previous version of the The reporting entity A reporting entity is one that is re quired, or chooses, to prepare financial statements, and is not necessarily a legal entity, It can be a single entity or a group or combination of two or more entities.Conceptual Framer By Sometimes an entity controls another entity. The controlling entity is called the parent, while the controlled entity is called the subsidiary. “If a reporting entity comprises both the parent and its subsidiaries, the reporting entity’s financial statements are referred to as ‘consolidated financial statements’. If a reporting entity is the parent alone, the reporting entity’s financial statements are referred to as ‘unconsolidated financial statements’. (Conceptual Framework 3.11) “If a reporting entity comprises two or more entities that are not all linked by a parent-subsidiary relationship, the reporting entity’s financial statements are referred to as ‘combined financial statements’.” (Conceptual Framework 312) For example, Jollibee Foods Corporation controls Chowking, Greenwich, Mang Inasal, Dunkin’ Donuts and many other companies. Jollibee is the parent, while the controlled companies are the subsidiaries. The financial statements of Jollibee, including its subsidiaries, are called consolidated financial statements. The financial statements of Jollibee alone, excluding its subsidiaries, are called unconsolidated financial statements. (The financial statements of each subsidiary alone are referred to as ‘individual financial statertents.") oa If financial statements are prepared to include only Chowking and Greenwich (two subsidiaries only without the parent), the financial statements would be referred to as combined financial statements. Consolidated and unconsolidated financial statements Consolidated financial statements provide information on a parent and its subsidiaries viewed as a single reporting entity. Consolidated financial statements are not designed to provide information on any particular subsidiary; that information is provided in the subsidiary‘s own financial statements. Consolidated information enables users to better assess the parent’s prospects for future cash flows because the parent’s cash flows are affected by the cash flows of its subsidiaries. Accordingly, when consolidation is required, unconsolidated54. _ ane ee financial statements cannot be used as substitute for Consolidateg financial statements. However, a parent may nonetheless }, Tequired or choose to prepare unconsolidated financial statementy in addition to consolidated financial statements. The Elements of Financial Statements The elements of financial statements are: Assets Liabilities f These relate to the entity’s financial position, Equity ; _ Eipenees ‘+ These relate to the entity’s financial performance gewne Asset 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.” (Conceptual Framework 43 & 44) The definition of asset has the following three aspects: a, Right b. Potential to produce economic benefits c. Control Right Asset is an economic resource and an economic resource is a right that has the potential to produce economic benefits, Rights that have the potential to Produce economic benefits include: a. Rights that correspond to an obligation of another party: i, right to receive cash, goods or services, ii. right to exchange economic Tesourc on favorable terms. iii. right to benefit from an obligation of another party to transfer an economic resource if a specified uncertain future event occurs. es with another partyConceptual Framewo . Conceptual Framework 5 b. Rights that do not correspond to an obligation of another party: i. right over physical objects (e.g,, right to use a property or right to sell an inventory), ° ii. right to use intellectual Property. (Conceptual Framework 46) Rights normally arise from law, contract or similar means. For example, the right to use a property may arise from owning it or leasing it. However, rights could also arise from other means, for example, by creating a know-how (e.g,, trade secret) that is not in the public domain or through a constructive obligation created by another party. For goods or services that are received and immediately consumed (e.g., supplies and employee services), the entity’s right to obtain the related economic benefits exists momentarily until the entity consumes the goods or services. Not all rights are assets. To be an asset, the right must have the potential to produce for the entity economic benefits that are beyond the benefits available to all other parties and those economic benefits must be controlled by the entity. For example, a public road which anybody can access without significant cost and a know-how that is in the public domain are not assets of the entity. An entity cannot have a right to obtain economic benefits from itself. Thus, treasury shares are not an entity’s assets, Similarly, debt and equity instruments issued by a parent and held by its subsidiary (or vice versa) are not assets (or liabilities) in the consolidated financial statements. Theoretically, each right is a separate asset. However, for accounting purposes, related rights are often treated as a single asset. For example, ownership of a physical object typically gives Tise to several rights, such as the tight to use the object, the right to sell it, the right to pledge it, and other similar rights. The asset is the set of rights and not the physical object. For example, a lessee (someone who rents a property) may recognize an asset for its right to use the property {ie,, ‘right-of-use asset’ or, in layman’s terms, leasehold rights) but not for the56 ree Property itself (because the lessee does not legally own the leaseg Property — the lessor does). Nonetheless, describing the set of rights as the physical object will often provide a faithful Tepresentation of those rights. There can be instances where the existence of a Tight is uncertain, for example, when the entity's right is disputed by another party. Until that uncertainty is resolved (for example, by 3 court ruling). itis uncertain whether an asset exists. Potential to Produce economic benefits The asset is the present right that has the potential to produce economic benefits and not the future economic benefits that the right may produce. Thus, the right’s potential to produce economic benefits need not be certain, or even likely — what is important is that the right already exists and that, in at least one circumstance, it would produce economic benefits for the entity. Consequently, an asset can exist even if the probability that it will produce benefits is low, although that low probability affects decisions on whether the asset is to be recognized, how it is measured, what information is to be provided about the asset, and how that information is PFOVided. (Concepiual Framework 4.14. 4.15 64, 17) An economic resource can produce economic benefits for an entity in many ways. For example, the asset may be: a. Sold, leased, transferred or exchanged for other assets; b. Used singly or in combination with other assets to produce goods or provide services; Used to enhance the value of other assets; . Used to promote efficiency and cost savings; or e. Used to settle a liability. ao The presence or absence of expenditure is not necessary in determining the existence of an asset, For example, expenditure on penalty for violation of law does not Tesult to an asset, On the other hand, an asset can be obtained for free from donation. Moreover, acquiring an asset and incurring expenditure do not_Concepteal Framework _ necessarily need to coincide, For example, inventory purchased on account is recognized as asset before the purchase price is paid. Control Control means the entity has the exclusive right over the benefits of an asset and the ability to prevent others from accessing those benefits. Accordingly, if one party controls an asset, no other party controls that asset, Control does not mean that the entity can ensure that the resource will produce economic benefits in all circumstances. It only means that if the resource produces benefits, it is the entity who will obtain those benefits and not another party. Control links an economic resource to an entity and indicates the extent to which an entity should account for that economic resource. For example, an economic resource that an entity does not control is not an asset of the entity. If an entity controls only a portion of an economic resource, the entity accounts only that portion and not the entire resource. Control normally stems from legally enforceable rights (e.g., ownership or legal title). However, ownership is not always necessary for control to exist because control can arise from other rights. For example, Entity A acquires a car through bank financing. Although the bank retains legal title over the car until full payment, the car is nonetheless an asset of Entity A because Entity A has the exclusive right to use the car and therefore controls the benefits from it. Physical possession is also not always necessary for control to exist. For example, goods transferred by a principal to an agent on consignment remain as assets of the principal until the goods are sold to third parties. This is because the principal retains control over the goods despite the fact that physical possession is transferred to the agent. Similarly, the agent does not recognize the goods as his assets because he does not control the economic benefits from the goods ~ the principal does.—— 58 2. Liability ; Liability is “a present obligation of the ‘entity to transfer 4, economic resource as a result of past events.” (Conceptual Framework 429, The definition of liability has the following three aspects: a. Obligation b. Transfer of an economic resource ¢. Present obligation as a result of past events Obligation . . An obligation is “a duty or responsibility that an entity has no | practical ability to avoid.” (Conceptual Framework 4.29) An obligation is either: a. Legal obligation - an obligation that results from a contract, legislation, or other operation of law; or b. Constructive obligation - an obligation that results from an entity's actions (e.g., past practice or published policies) that create a valid expectation on others that the entity will accept and discharge certain responsibilities. An obligation is always owed to another party. However, it is not necessary that the identity of that party is known, for example, an obligation for environmental damages may be owed to the society at large. One party's obligation normally corresponds to another Party's right. For example, a buyer's obligation to pay an accounts payable of #100 normally corresponds to the seller's Tight to collect an accounts receivable of #100, However, this accounting symmetry is not maintained at all times because the Standards sometimes contain different recognition and measurement requirements for the liability of one Party and the corresponding asset of the other party. For example, direct origination costs result to different measurements of the lender’s loan receivable and the borrower's loan Payable, Similarly, a seller may beConceptual Framework 59 required to recognize a Warranty obligation but the buyer would not recognize a corresponding asset for that warranty , There can be instances where the existence of an obligation is uncertain. Until that uncertainty is resolved (for example, by a court ruling), it is uncertain whether a liability exists. Transfer of an economic resource The liability is the obligation that has the potential to require the transfer of an economic resource to another party and not the future economic benefits that the obligation may cause to be transferred. Thus, the obligation’s potential to cause a transfer of economic benefits need not be certain, or even likely, for example, the transfer may be required only if a specified uncertain future event occurs. What is important is that the obligation already exists and that, in at least one circumstance, it would require the entity to transfer an economic resource. Consequently, a liability can exist even if the probability of a transfer of an economic resource is low, although that low probability affects decisions on whether the liability is to be recognized, how it is measured, what information is to be provided about the liability, and how that information is provided. (Conceptual Framework $.37 & 4.38) ‘An obligation to transfer an economic resource may be an obligation to: a. pay cash, deliver goods, or render services; b. exchange assets with another party on unfavorable terms; c. transfer assets if a specified uncertain future event occurs; or d. issue a financial instrument that obliges the entity to transfer an economic resource. Present obligation as a result of past events / The obligation must be a present obligation that exists as a result of past events. A present obligation exists as a result of past events ifs a. the entity has already obtained economic benefits or taken an action; andOe the entity will or may have to transfer ay By Baia consequelst Jd not otherwise have had to economic resource that it wou transfer. (Conceptual Framework 443) _ Examples: ee a | Entity A intends to acquire goods in the future, _ Analysis: a Entity A has no present obligation. A present obligation arises only when Entity A: a. has already purchased and received the goods; and / b. asaconsequence, Entity A will have to pay the purchase price. | Entity B operates a nuclear power plant. In the current year, anew | | law was enacted penalizing the improper disposal of toxic waste. | | Nei sitnila law excsted inprior years J Analysis: The enactment of legislation is not in itself sufficient to result in an entity’s present obligation, except when the entity: a, has already taken an action contrary to the provisions of that law; and b. asa consequence, the entity will have to pay a penalty. Accordingly; - Entity B has no present obligation if its existing method of waste disposal does not violate the new law. Similarly, Entity B has no present obligation if it can avoid penalty by changing its future method of waste disposal. - On the other hand, Entity B has a present obligation if its previous waste disposal has already caused damages, and as consequence, Entity B has to pay for those damages. Entity C enters into an irrevocable commi party to acquire goods i itment with another he future, on credit, SeConceptual Framework ee 61 Analysis: A non-cancellable future commitment gives rise to a present obligation only when it becomes onerous (.e., burdensome), for example, if the goods become obsolete before the delivery but Entity C cannot cancel the contract without Paying a substantial penalty Unless it becomes burdensome, no present obligation normally arises from a future commitment, ‘Although not stated in the sales contract, Entity D has a publicly- known policy of providing free repair services for the goods it sells. Entity D has consistently honored this implied policy in the | Base Analysis: Entity D has a present constructive obligation to provide free tepair services for the goods it has already sold because: a. Entity D has already taken an action by creating valid expectations on the customers that it will provide free repair services; and b. as a consequence, Entity D will have to provide those free services. Entity E obtained a loan from a bank. Repayment of the loan is [vein 10 yeaes Oe A Analysis: ; Entity E has a present obligation because it has already received the loan proceeds, and as a consequence, has to make the repayment, even though the bank cannot enforce the repayment until a future date. [Entity Femployed Me.Juan Analysis:62 FE Entity F has no present obligation until aft ter Mr. Juan hag rendered services. Before then, the contract is executory ~ Entity ‘ has a combined right and obligation to exchange future Salary foe Mr. Juan’s future services. Executory contracts An executory contract “is a contract that is equally unperformeq _ Neither party has fulfilled any of its obligations, or both Parties have partially fulfilled their obligations to an equal extent” (Conceptial Framework 4.56) An executory contract establishes a combined right and obligation to exchange economic resources, which are interdependent and inseparable. Thus, the two constitute a single asset or liability. The entity has an asset if the terms of the contract are favorable; a liability if the terms are unfavourable, However, whether such an asset or liability is included in the financial statements depends on the recognition criteria and the selected measurement basis, including any assessment of whether the contract is onerous. The contract ceases to be executory when one party performs its obligation. If the entity performs first, the entity's combined right and obligation changes to an asset. If the other party performs first, the entity’s combined right and obligation changes to a liability. Continuing the previous example: Entity F neither recognizes an asset nor a liability upon entering the employment contract with Mr. Juan because, at that point, the contract is executory, dé Mr. Juan renders services, the contract ceases to be executory, and Entity F’s combined right and obligation changes to a liability - an obligation to pay Mr. Juan’s salary (e.g., salaries payable). - If Entity F pays Mr, Juan's salary in advance, Entity F's combined right and obligation changes to an asset — a right to receive the services or a right to be reimbursed if the services are not received (e.g., advances to employees).63 Equity “Equity is the residual intere: deducting all its liabilities.” The definition of e ‘St in the assets of the entity after (Conceptual Framework 463) ‘quity applies to all entities regardless of form (ie, sole Proprietorship, Partnership, cooperative, corporation, non-profit entity, or government entity). : Although, equity is defined as a residual, it may be sub- dassified in the statement of financial Position. FOE example, the equity of a corporation may be sub-classified into share capital, retained earnings, reserves and other components of equity. Reserves may refer to amounts set aside for the protection of the entity's creditors or stakeholders from losses, For some entities (e.g, cooperatives), the creation of reserves is required by law. Transfers to such reserves are appropriations of retained earnings rather than expenses. Income 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.” (Conceptual Framework 4.68) Expenses 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.” (Conceptual Framework 4.69) The definitions of income and expenses are opposites. Income Expenses > Increases in assets or > Decreases in assets or Decreases in liabilities Increases in liabilities > Results in increase inequity _| » Results in decrease in equity > Excludes contributions from | > Excludes distributions to the the entity's owners entity’s owners Contributions from, and distributions to, the entity’s owners are nof income, and expenses, but rather direct adjustments to equity.thy Although income and expenses are defined in terms of changes in assets and liabilities, information on income ang expenses is just as important as information on assets ana liabilities because financial statement users need information o, both the financial position and financial performance ofan entity, Recognition and Derecognition The recognition process Recognition is the process of including in the statement of financial position or the statement(s) of financial performance an item that meets the definition of one of the financial statement elements {ie., asset, liability, equity, income or expense). This involves recording the item in words and in monetary amount and including that amount in the totals of either of those statements, “The amount at which an asset, a liability or equity is recognized in the statement of financial position is referred to as its ‘carrying amount’.” (Conceptual Framework 3.1) Recognition links the elements, the statement of financial position and the statement(s) of financial performance as follows: ‘Statement of financial position at beginning of reporting period + (Conceptual Framework Diagram 3.1)Conceptual Framework As The statements are inked because the recognition of one element (or 7 a change in its carrying amount) requires the recognition or derecognition of another element(s). “Examples: >» Recognition of income nit ~ Recording a sale increases both resulting in an increase in ‘cash’ /‘receivable’ (asset) and ‘sales’ (income). asset | > Recognition of income ~ Earning an unearned income resulting in a decrease in decreases ‘uneamed income’ liability. (liability) and increases income. > Recognition of expense ~ Accruing unpaid salaries resulting in an increase in __increases both ‘salaries expense’ liability. and ‘salaries payable’ (liability). resulting in a decrease in increases ‘supplies expense’ and > Recognition of expense - Payment for supplies expense assets. |__ decreases ‘cash’. Sometimes the recognition of income results in the simultaneous recognition of a related expense. This simultaneous recognition of income and expense is also called “matching of costs and income” (matching concept). For example, the sale of goods results in the simultaneous recognition of ‘sales’ (income) and ‘cost of sales’ (expense). Recognition criteria An item is recognized if: a. it meets the definition of an asset, liability, equity, income or expense; and , ; b. recognizing it would provide useful information, ie., relevant and faithfully represented information. Both the criteria above must be met before an item is Tecognized. Accordingly, items that meet the definition of a financial statement element but do not provide useful information are not recognized, and vice versa.& OT mation, as well as using that information, entails cost. For example, the reporting entity may incur costs in j surement PUTPOSES; USers spen, d appraising its property for measure 2 ‘ < tie and effort in analyzing and interpreting the information Thus, an entity should consider the cost constraint ‘cost-benefit principle) when making recognition decisions such that the usefulness of the information justifies its cost. It is not Possible, however, to establish a uniform threshold for determining a optimum balance between costs and benefits. This would depend on the item and the facts and circumstances. Accordingly, judgment is required when deciding whether to recognize an item, and thus the recognition requirements in the Standards may need to vary. Even if an item that meets the definition of an asset or liability is not recognized, information about that item may still need to be disclosed in the notes. In such cases, the item is referred to as unrecognized asset or unrecognized liability. Providing infor! Relevance The recognition of an item may not provide relevant information if, for example: a. itis uncertain whether an asset or liability exists; or b. an asset or liability exists, but the probability of an inflow or outflow of economic benefits is oz. (Conceptual Framework 5.12) Existence uncertainty & Low probability of inflows/outflows Existence uncertainty or low probability of an inflow or outflow of economic benefits may result in, but does not automatically lead to, the non-recognition of an asset or liability, Other factors should be considered. If one or both of the foregoing factors result to nor recognition, information about the unrecognized asset or liability may still need to be provided in the notes (e.g,, information about the existence uncertainty or the possible inflows or outflows). Despite the presence of one or both of the foregoing factors, an asset or liability may nonetheless be recognized if this Provides relevant information. For example, the cost of an assetConceptual 67 | | (ability) arising from an exchange transaction on market terms generally reflects the probability of an inflow (outflow) of economic benefits. Thus, the asset (liability) may be recognized because not recognizing it would result to the recognition of income (expense), which may not faithfully represent the transaction. Faithful representation The recognition of an item is appropriate if it provides both relevant and faithfully represented information. The level of measurement uncertainty and other factors (i.e, presentation and disclosure) affect an item’s faithful representation. Measurement uncertainty An asset or liability must be measured: for it to be recognized. Often, measurement requires estimation and thus subject to measurement uncertainty. The use of reasonable estimates is an essential part of financial reporting and does not necessarily undermine the usefulness of information. Even a high level of Measurement uncertainty does not necessarily preclude an estimate from providing useful information if the estimate is clearly and accurately described and explained. However, an exceptionally high measurement uncertainty can affect the faithful representation of an item, such as when the asset or liability can only be measured using cash-flow based measurement techniques and, in addition, one or more of the following circumstances exists: a, there is an exceptionally wide range of possible outcomes and each outcome is exceptionally difficult to estimate. b. the measure is-highly sensitive to small changes in estimates of the probability of different outcomes. c the measurement requires exceptionally difficult or exceptionally subjective allocations of cash flows that do not relate solely to the asset or liability being measured. (Conceptual Framework 5.20)ee, Derecognition - : Derene ton is the opposite of recognition. , is me eae Of a previously recognized asset or liability from the entity's statement of financial position. Derecognition occu: definition of an asset or liability, such as control of all or part of the asset, or no longer has a present obligation for all or part of the liability. 1s when the item no longer meet the when the entity loses On derecognition, the entity: , a. derecognizes the assets or liabilities that have expired or have been consumed, collected, fulfilled or transferred (i.e, ‘transferred component’), and recognizes any resulting income and expenses. b. continues to recognize any assets or liabilities retained after the derecognition (i.e., ‘retained component). No income or expense is normally recognized on the retained component unless there is a change in its measurement basis. After derecognition, the retained component becomes a unit of account separate from the transferred component. Unit of account Unit of account is “the right or the group of rights, the obligation or the group of obligations, or the group of rights and obligations, to which recognition criteria and measurement concepts are applied.” (conceptual Framework 448) A unit of account can be an account title (e.g., Cash or Accounts receivable), a group of similar assets (e.g., Property, plant and equipment), or a group of assets and liabilities (eg. Cash-generating unit). A unit of account is selected for an asset or liability when determining how that asset or liability, and the related income or expense, will be recognized and measured, For example, ‘Cash’ is recognized when it is either on hand or deposited in the bank and is measured at face amount, while “Accounts receivable’ isual Framework - 69 recognized when a sale occurred and is measured at the adjusted for any uncollectable amount. eum a0 entity transfers part of an asset or part of a liability, the unit of account may change at that time, so that the transferred eimponent and the retained component become separate units of account.” (Conceptual Framework 4.50) transaction price, adj “if Transfers Derecognition is not appropriate if the entity retains substantial control of a transferred asset. In such case, the entity continues to recognize the transferred asset and recognizes any proceeds received from the transfer as a liability. If there is only a partial transfer, the entity derecognizes only that transferred component and continues to recognize the retained component. Commentary on the changes in the Conceptual Framework ASSET Previous version New version % Definition Asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected Definition Asset is a present economic resource controlled by the entity as a result of past events. An economic resource is a to flow to the entity. tight that has the potential to produce economic benefits. % Essential elements % Essential elements a. Control a. Right b. Past events b. Potential to produce c. Future economic benefits economic benefits c._ Control Commentary: The new Conceptual Framework deleted the notion of an ‘expected’ flow of future economic benefits and clarifies that the asset is the70 Sc ‘right’ and not the ultimate inflow of conte nen from that right. Moreover, it stresses that the right is wl fy ity controls and not the future economic benefits. Accor ing an Asset can exist even if its potential to produce ecoreint > ms is not certain or even likely {although this could affect the asset's recognition and measurement). New version * Recognition criteria a. The item mects the definition of a financial definition of a financial statement element; statement element; and b. It is probable that any |b. Recognizing it — would future economic benefit} provide useful information, associated with the item | ie, relevant and faithfully will flow to or from the represented information, entity; and c. The item has a cost or value that can be measured with reliability. Previous version *s Recognition criteria a. The item meets the Commentary: @ The new Conceptual Framework deleted the notion of a ‘probability’ threshold and states that an asset can exist even if its probability to produce economic benefits is low (although this can affect recognition decisions on the asset’s ability to provide useful information). It further states that what is important is that in at least one circumstance the economic resource will produce economic benefits. @ The new Conceptual Framework also deleted the ‘reliable measurement’ criterion and states that even a high level of Measurement uncertainty does not necessarily preclude an asset from being recognized if the estimate is clearly and accurately described and explained. The main effect of the Changes is a shift of focus to the principle of providing useful information, rather than onConceptual Framework rules. Accordingly, necessarily preclude an 71 the non-recognition of an asset does not ntity from providing information about that unrecognized asset in the notes. Previous version “ Derecognition (asset) Not specifically addressed % Derecognition (asset) New An asset is derecognized when it has expired or has been | consumed, collected, or | transferred. | | | LIABILITY ; | Previous version New version | fe Definition Liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of tesources embodying economic benefits. % Definition | Liability is a present obligation | of the entity to transfer an | economic resource as a result of past events. Essential elements % Essential elements a. Present obligation arising | a. Obligation from past events b. Transfer of an economic b. Outflow of economic resource benefits c. Present obligation as a result of past events Commentary: © The notion of an ‘expected’ flow of future economic benefits is deleted, similar to the change in the definition of an asset. The new Conceptual Framework emphasizes that the liability is the ‘obligation’ an from that obligation. .d not the ultimate outflow of economic benefits72 SS @ The new Conceptual Framework also introduced the Concept of ‘no practical ability to avoid’ to the definition of an obligation, Recognition and Derecognition The changes in the recognition and derecognition of a liability parallel those for an asset EQUITY, INCOME & EXPENSES Commentary: The new Conceptual Framework retained the definitions of equity, income and expenses. However, the emphases that income includes both revenues and gains, and expenses include both expenses and losses, were deleted. The IASB, however, do not expect that these deletions would cause any changes in practice. (Conceptual Framework BC1.96) = Also, the new Conceptual Framework states that income and expenses are classified as recognized either in profit or loss or other comprehensive income. (This will be discussed momentarily.) @ The new Conceptual Framework also removed the explicit references to the expense recognition principles of ‘systematic and rational allocation’ and ‘immediate recognition’, but not ‘matching’. This, however, does not mean that the former two are no longer relevant as they are still implied in the new Conceptual Framework (Conceptual Framework, Chapter 5, €.g.,5.10) Other relevant changes: The new Conceptual Framework also introduced the concepts of ‘unit of account’ and ‘executory contracts’. Summary: The changes align the Conceptual Framework to the LASB’s current | thinking in formulating Standards. For example: > Focusing the definition of an asset to a right, rather than @ physical object, parallels the requirement of PFRS 16 Leases 0° | the recognition of a ‘right-of-use asset’ by a lessee. | > Focusing on providing useful information when making | recognition decisions, rather than on probability threshold and |> Including the concept that 73 reliable measurement, parallels the requirements of PERS 3 | Business Combination for goodwill, PERS 9 Financial Instruments for certain derivative instruments and PERS 13 Fair Value Measurement on the ‘hierarchy of fair value measurement.’ income and expenses are recognized either in profit or loss or other comprehensive | income parallels the requirements of PAS 1 Presentation of | Financial Statements and other relevant standards. » Introducing the Concepts of ‘unit of account’ and ‘executory contracts’ aligns the Conceptual Framework to the provisions of PFRS 9 on the accounting for investment portfolios and PFRS 15 Revenue from Contracts with Customers on the recognition of | ‘contract asset’, ‘contract liability’ or ‘receivable’. The Conceptual Framework is not a Standard, hence it does | not provide requirements for specific transactions or other events ~ these are addressed by the Standards. The Conceptual Framework’s main purpose is to provide the foundation for the development of | globally acceptable Standards. : | Measurement Recognition requires quantifying an item in monetary terms, thus necessitating the selection of an appropriate measurement basis. The application of the qualitative characteristics, including the cost constraint, is likely to result in the selection of different measurement bases for different assets, liabilities, income and expenses. Accordingly, the Standards prescribe specific measurement bases for different types of assets, liabilities, income and expenses. Measurement bases The Conceptual Framework describes the following measurement bases: 1. Historical cost 2. Current value a. Fair value74 b. Value in use and fulfilment value c. Current cost Historical cost The historical cost of an asset is the consideration Paid to acquire the asset plus transaction costs. The historical cost of a liability is the conside, received to incur the liability minus transaction costs. In cases where it is not possible to identify the cost, Such as On transactions that are not on market terms, the resulting asset o liability is initially recognized at current value. That value becomes the asset's (liability’s) deemed cost for subsequent Measurement at historical cost. Unlike current value, historical cost does not Teflect changes in value, but is updated overtime to depict the following: ation Historical cost of an asset Historical cost of a liabilit a. impairment, depreciation or | a. increase in the Obligation amortization resulting from the liability becoming onerous b. collections that extinguish |b. payments or fulfilments part or all of the asset made that extinguish part or all of the liability _ ¢. discount or premium c. discount or premium amortization when the asset amortization when the is measured at amortized liability is measured at cost amortized cost Current value Current value measures reflect changes in values at the measurement date. Unlike historical cost, current value is mot derived from the price of the transaction or other event that gave tise to the asset or liability. Current value measurement bases include the following? a. Fair value b. Value in use for assets and Fulfilment value for liabilities c. Current costConceptual Framework ee TS 75 Fair value Fair value is “the price that would be paid to transfer a liability, in market participants at the me; 613) teceived to sell an asset, or an orderly transaction between ‘asurement date.” (Conceptual Framework Fair value reflects the perspective of market participants (i.e. participants in a market to which the entity has access). Accordingly, it is not an entity-specific measurement. Fair value can be measured directly by observing prices in an active market or indirectly using measurement techniques, ¢.g., cash-flow-based measurement techniques. Fair value is not adjusted for transaction costs, Value in use and fulfilment value 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.” (Conceptual Framework 617) 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.” (Conceptual Framework 6.17) “Value in use and fulfilment value reflect entity-specific assumptions rather than assumptions by market participants.” (Conceptual Framework 6.19) Value in use and fulfilment value are measured indirectly using cash-flow-based measurement techniques, similar to those used in measuring fair value but from an entity-specific perspective rather than from a market-participant perspective. Value in use and fulfilment value do not include transaction costs in acquiring an asset or incurring a liability but include transaction costs expected to be incurred on the ultimate disposal of the asset or fulfilment of the liability. Current cost : 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.” (Concepmel Framework 6.21)76 ee Sa Current cost of a liabil ity is “the consideration that Woy received for an equivalent liability at the measurement date the transaction costs that would be incurred at that date.” Miny, Framework 621) Once Current cost and historical cost are entry values (ie, y Teflect prices in acquiring an asset or incurring a liability), where, fair value, value in use and fulfilment value are exit Values ( . they reflect Prices in selling or using an asset or transferring e fulfilling a liability). Unlike historical cost, however, Current eos, teflects conditions at the measurement date. In some cases, current cost can only be measureg indirectly, for example, by adjusting the current price of a Tew asset to reflect the current age and condition of the asset held by the entity. Considerations when selecting a measurement basis When selecting a measurement basis, it is important to consider the following: a, the nature of information provided by a particular measurement basis; and b. the qualitative characteristics, the cost constraint, and other factors. Information provided by particular measurement bases Different measurement bases result in different information to be Provided in the financial statements. For example: > Measuring an asset at historical cost may result in the subsequent recognition of depreciation or impairment, whereas measuring that asset at fair value would result in the subsequent recognition of gain or loss from changes in fait value; measuring an asset at current cost may result to the recognition of holding gains and losses from price changes. » Measuring an asset (liability) at historical cost or current cost does not result to gain or loss on initial recognition, unless the asset is impaired (or the liability is onerous), whereas measuring an asset at fair value or value in use may result t° gain or loss on initial recognition if the market in which theConceptual Framework cues eee, 77 eC asset is acquired is different from the market that is the source of the prices used in measuring the asset's fair value; the initial gain or loss is the difference between the consideration paid and the fair value of the asset acquired. v Historical cost and current cost measurements include transaction costs in acquiring an asset, whereas fair value measurement excludes transaction costs; value in use measurement considers only the transaction costs on the asset's disposal. » The computation of gain or loss on the derecognition of an asset depends on its measurement basis, For example, the gain or loss on the derecognition of an asset measured at historical cost is computed as the difference between the net disposal proceeds, if any, and the asset’s historical cost adjusted for depreciation and impairment, whereas, if the asset is measured at fair value, the gain or loss is the difference between the net disposal proceeds, if any, and the asset's fair value. The qualitative characteristics and the cost constraint An entity also considers whether the information provided by a particular measurement basis is useful. Information is useful if it is relevant and faithfully represented and, as far as possible, comparable, verifiable, timely and understandable. Relevance The relevance of information is affected by: a. the characteristics of the asset or liability; and b. how that asset or liability contributes to future cash flows. The characteristics of the asset or liability affect the relevance of the information provided by a measurement basis. For example, an asset or liability whose value is sensitive to market factors is more appropriately measured at fair value rather than at historical cost. Fair value measurement results in reporting the changes in market factors as they occur, rather than only when the asset orwo liability is derecognized. On the other pe: Aes Steg financial liability that is held solely for co ng © "paying contractual cash flows, rather than for trading activites, is More appropriately measured at amortized cost (historical ae How the asset or liability contributes to future cas flows also affects the relevance of the information provided by a For example, an asset that is used in measurement basis. produce cash flows (eg, combination with other assets to ! property, plant and equipment) is likely to be measured a historical cost. On the other hand, an asset that can be sold independently (e.g., investment in stocks) is likely to be measured at fair value. Faithful representation The level of measurement uncertainty may affect the faithful representation of information. Measurement uncertainty arises when a measure cannot be determined directly by observing prices in an active market and must instead be estimated. “A high level of measurement uncertainty does not necessarily prevent the use of a measurement basis that provides relevant information.” (Conceptual Framework 6.50) Thus, in cases where the measurement uncertainty associated with a particular measurement basis is so high that it cannot provide sufficiently faithfully represented information, it is appropriate to consider selecting a different measurement basis that would also result in relevant information. “Measurement uncertainty is different from both outcome uncertainty and existence uncertainty: a. outcome uncertainty arises when there is uncertainty about the amount or timing of any inflow or outflow of economic benefits that will result from an asset or liability. b. existence uncertainty arises when it is uncertain whether a asset or a liability exists.” (Conceptual Framework 6.61) Outcome uncertainty or existe: i mce uncertainty ma) sometimes contribute;/ but does pot 7: hes Necessarily lead, '€Conceptual Framework 79 measurement uncertainty. For example, there is no measurement uncertainty if an asset’s fair value can be determined directly by observing prices in an active market, even if it is uncertain how much cash that asset will ultimately produce and hence there is outcome uncertainty, Existence uncertainty may affect decisions on whether an asset or a liability is to be recognized, Enhancing qualitative characteristics and the Cost constraint Comparability Consistently using same measurement bases for same items, either from period to period within a single entity (intra-comparability) or within a single period across different entities (inter-comparability), makes the financial statements more comparable. This does not mean, however, that a selected measurement basis should never be changed. A change is appropriate if it results in more relevant information. Because a change in measurement basis can make financial statements less understandable, explanatory information should be disclosed to enable users of financial statements to understand the effect of the change. Understandability Generally, the more different measurement bases are used, the more complex the resulting information become, and hence less understandable. Using more different measurement bases is appropriate only if it is necessary to provide useful information. Verifiability Using measurement bases that result in measures that can be independently corroborated either directly (e.g., by observing prices) or indirectly (e.g. by checking inputs to a model) enhances verifiability, If a measure cannot be verified, explanatory information should be disclosed to enable users of financial statements to understand how-the-measure.was determined, In80 aaah Some cases, it may be more appropriate to indicate the Use of different measurement basis. ‘ Depending on the facts and circumstances, the use either historical cost or current value has its own me to verifiability. For example: > ste of erits in Telation In many situations, using historical cost is sim Benerally well understood, and hence verifiable, measuring depreciation, impairment or onerous be subjective, and hence lessens verifiability. Fair value is determined from the Perspective of market Participants, not from the entity’s perspective, ang is independent of when the asset was acquired or the liabili was incurred. Thus, in principle, different entities that have access to the same markets would come up with essentially the same amount of fair value for a particular asset of a liability, and hence verifiable. This could also enhance comparability because, unlike historical cost, fair value measurement results in the same amount of measure for identical assets (liabilities) with different (incurrence) dates. Value in use and fulfilment value are costly to implement and requires subjective assumptions. Accordingly, these may result in different measures for identical assets or liabilities by different entities. This reduces verifiability and comparability. Nonetheless, value in use may provide useful information, for example, when determining the recoverable amount of a group of assets, ie., cash-generating unit. » Current cost results in the same amount of measure for identical assets (liabilities) acquired (incurred) at different dates. This enhances comparability, However, determining current cost can be costly, complex, and subjective, thus reducing verifiability and understandability, Nonetheless, current cost may provide useful information, for example, when revaluing a property whose fair value cannot be determined directly by observing prices in an active market. ipler and Howeve, Hiabilities car acquisitionceptual Framework 81 Selecting an appropriate measurement basis requires the consideration of all factors in combination, including the cost constraint and other factors, rather than only ‘a single factor in isolation. ’ Factors specific to initial measurement In transactions on market terms, an asset’s (liability’s) cost is normally similar to its fair value on initial recognition. Even so, it is still necessary to describe the measurement basis used at initial recognition because this determines whether any income or expense arises on that date. For example, measuring an asset or liability at cost does not result to any income or expenses on initial recognition, except when the asset is impaired or the liability is onerous, or when income or expense arises from the derecognition of a transferred asset or liability. Moreover, the initial and subsequent measurement bases usually parallel each other. For example, if historical cost is to be used subsequently, that measurement basis is also normally appropriate at initial recognition. In transactions not on market terms, measurement at historical cost may not provide faithfully represented information. Examples of transactions not on market terms include: a. transactions in which the transaction price is affected by related party relationships or by financial distress of one of the parties b. receipt of donation from another party or a grant from the government c incurrence of a liability that is imposed by law or a penalty for anact of wrongdoing In such cases, it may be appropriate to measure the resulting asset or liability at a “deemed cost’ (eg., fair value). More than one measurement basis Sometimes it may be necessary e ; measurement basis in order to provide useful information. to use more than one82 Ee In most cases, the use of different measurement ha, applied in such a way that: a. a single measurement basis is used in the statement of financial position and statement(s) of financial Performangs. and Sis ig b. additional information is disclosed in the notes for a different measurement basis. For example, an investment property may be Measured using the cost model. However, the investment Property's fair value is disclosed in the notes. In some cases, however, it may be more appropriate to a. use a current value measurement basis for the asset or liability in the statement of financial position; and b. a different measurement basis for the related income and expenses in the statement of profit or loss In such cases, the related total income or expense may need to be allocated to both profit or loss and other comprehensive income. For example, a debt instrament may be measured at fair value in the statement of financial Position. However, the interest income is measured in relation to the instrument's amortized cost, while the fair value changes are recognized in other comprehensive income. Measurement of equity Total equity is not measured directh ly. It is simply equal to the difference between the carrying amounts of Tecognized assets and tecognized liabilities. Financial statements are not designed to show an entity's value. Thus, total equity cannot be expected to be equal to the entity's market value nor the amount that can be raised from either selling or liquidating the entity.83 Conceptual Frai Although total equity is not measured directly, some of its components can be measured directly (eg, share capital). However, because equity is a residual amount, at least one of its components cannot be measured directly (e.g,, retained earnings). Equity is generally positive although some of its components may be negative (e.g, retained earnings can be negative if the entity has accumulated losses). In some cases, even total equity can be negative such as when total liabilities exceed total assets. Cash-flow-based measurement techniques A measure that cannot be observed directly needs to be estimated. One way to make the estimate is by using cash-flow-based measurement techniques. Such techniques are not measurement bases, but rather used in applying a measurement basis. Accordingly, when using such a technique, it is necessary to identify which measurement basis is used and the extent to which the technique reflects the factors applicable to that measurement basis. When making an estimate from a range of possible outcomes, the single amount that provides the most relevant information is usually one from within the central part of the range (a central estimate). However, different central estimates provide different information. For example: a. Statistical mean (Expected value or Probability-weighted average) — reflects the average amount within the entire range, giving more weight to the outcomes that are more likely. Expected value is not intended to predict the ultimate cash inflow (outflow) from an asset (liability). Statistical median (Maximum amount that is more likely than not to occur) - is the middle amount within the range and reflects the probability of an inflow or outflow to be no more than that amount. b. Statistical mode (Most likely outcome) — reflects the single most likely ultimate inflow (outflow) from the asset (liability),84 and which is the amount that occurs the highest number of times within the range. Example: ; A range of possible outcomes consists of the following: 13, 18, 13, 14, 13, 16, 14, 21, and 13. a. Statistical mean is the average, so we simply add the Values then divide the sum by the number of the values in the Tange. (13 +18 +13+14+13+16+ 14 +21+13)=9= 15 b. Statistical median is the middle value, so we simply rearrange the values in numerical order then get the middle value. 13, 13, 13, 13, 14, 14, 16, 18, 21. The median is 14. In case the number of values is an even number, say 10 instead of 9 as in the illustration above, the two middle values are added and divided by two (e.g, if the number of values is 10, the 5" and 6" values are added and then divided by two to get the median). ¢. Statistical mode is the most frequent value. The mode is 13 (because it occurs four times). Note: The example above is just a simplification and is only intended to help reinforce your understanding of the concepts discussed. Hence, the example should not be construed to reflect all the factors needed when applying a cash- flow-based measurement technique. For example, expected value is computed by applying probabilities (4e., percentages) to the estimated cash flows, as well as @ tisk adjustment for possible variations in those est timates, and a consideration of the time value of money. This is illustrated in Intermediate Accounting. Presentation and Disclosure Presentation and disclosure as communication tools Information about assets, liabilities, equity, income and expenses is communicated through presentation and disclosure in the financial statements. Effective communication-makas information more useful. Effective communication requires;a, focusing on presentation and disclosure objectives and principles rather than on rules. b. classifying information by grouping similar items and separating dissimilar items. c. aggregating information in a manner that it is not obscured either by excessive detail or by excessive summarization. The cost constraint (cost-benefit principle) is a pervasive constraint — meaning it affects all aspects of financial reporting. Hence, it affects decisions about presentation and disclosure. Presentation and disclosure objectives and principles Presentation and disclosure objectives are specified in the Standards. Those requirements strive for a balance between: a. giving entities the flexibility to provide relevant and faithfully represented information; and b. requiring information that has both intra-comparability (comparability from period to period within a single entity) and. inter-comparability (comparability within a single period across different entities) Effective communication also requires the consideration of the following principles: a. entity-specific information is more useful than standardized descriptions, also known as ‘boilerplate’; and b. duplication of information is usually unnecessary as it can make financial statements less understandable. Classification a , Classification refers to the sorting of assets, liabilities, equity, income or expenses with similar nature, function, and measurement basis for presentation and disclosure purposes. Combining dissimilar items can reduce the usefulness of information.86 TTT Classification of assets andliabilities = Classification is applied to an asset's or liability fe selected unit of account. However, it is sometimes necessary to apply classification to a higher level of aggregation and then sub-classify the components separately. For example, assets or liabilities arg classified as current and noncurrent and then each component of those classifications are sub-classified separately. Offsetting Offsetting occurs when an asset and a liability with separate units ‘of account are combined and only the net amount is presented in the statement of financial position. Offsetting is generally not appropriate because it combines dissimilar items. Treating a set of rights and obligations as a single unit of account is not offsetting. Classification of equity Equity claims with differeii characteristics may be classified separately. For example, a corporation's equity may be classified into share capital, retained earnings, and other components. Similarly, equity components that are subject to legal or similar requirements may be classified separately, for example, statutory reserves, appropriated retained earnings, and unrestricted retained earnings. Classification of income and expenses Income and expenses are classified as recognized either in: a. profit or loss; or b. other comprehensive income. Profit or loss is customarily used as the main indicator of an entity’s ‘return’ or ‘earnings’, and hence the entity’s financial performance. However, a complete understanding of an entity's financial performance requires information on all recognized income and expenses, including those that are recognized in other comprehensive income, as well-as other information inekided i the financial statements,Conceptual Framewor The Standards specify whether an income or expense is to be recognized in profit or loss or in other comprehensive income Generally, income and expenses associated with assets and liabilities that are measured at historical cost are recognized in profit or loss. The Standards also specify whether an income or expense that was previously recognized in other comprehensive income is subsequently reclassified to profit or loss or transferred directly within equity. Aggregation Aggregation is “the adding together of assets, liabilities, equity, income or expenses that have shared characteristics and are included in the same classification.” (Conceptual Framework 720) Example: Classifying vs. Aggregation ‘All receivables arising from sales | All receivables (i.e., Accounts onaccount are classified as receivable, Notes receivable, “Accounts receivable.” Accounts | Advances, etc.) are aggregated receivable is a unit of account for | and presented in the statement of recognition and measurement financial position under a single purposes. line item called "Trade and other receivables.” © Offsetting Accounts receivable and accounts payable are netted and only the net amount is presented. This is usually prohibited. Aggregation summarizes a large volume of detail, thus ful. However, balance should be making information more use! gregation can conceal important strived for because excessive 2g} detail. Typically, summarized information is presented in the statement of financial position and the statement(s) of financial performance while detailed informations provided in the notes.88 a Concepts of Capital and Capital maintenance 6 ok wan The Conceptual Framework mentions two concepts of capital, namely: . a. Financial concept of capital ~ capital is regarded as the invested money or invested purchasing power. Capital is synonymous with equity, net assets, or net worth. b. Physical concept of capital - capital is regarded as the entity's productive capacity, €8. units of output per day. The choice of an appropriate concept is based on users’ needs. Thus, if users are primarily concerned with the maintenance of nominal invested capital or purchasing power of invested capital, the financial concept should be used; whereas, if their primary concern is the entity's operating capability, the physical concept should be used. Most entities adopt the financial concept of capital in preparing their financial statements. The concept chosen affects the determination of profit. In this regard, the concepts of capital give rise to the following concepts of capital maintenance: a. Financial capital maintenance — Under this concept, profit is earned if the net assets at the end of the period exceeds the 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 ~ Under this concept, profit is eamed only if the entity’s productive capacity at the end of the period exceeds the productive capacity at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period. rr oe concept of capital maintenance is essential it istinguishing between a return’ on ‘capital and a return of capitalConceptual Framework ee 89 Only inflows of assets in excess of the capital is regarded as return on cay The physic: amount needed to maintain pital or profit. al capital maintenance concept requires the use of current cost. On the contrary, the financial capital maintenance concept does not require any particular measurement basis. This would depend on the type of financial capital that the entity seeks to maintain. The main difference between the two concepts of capital maintenance is the treatment of the effects of changes in the prices of assets and liabilities. This is summarized below: L Financial capital Physical capital Nominal cost | Constant purchasing power Profit represents the i Profit represents the | All price changes are increase in nominal increase in invested _| treated as capital money capital over purchasing power maintenance the period | over the period. adjustments that are | part of equity and not | Increases in the prices | Only the portion of —_| as profit. of assets held over the | the increase in prices period, also called | inexcess of the increase holding gains, are, _|_ in the general level of conceptually, profits | prices is regarded as butare recognized as | profit. The remainder such only when the is treated as capital assets are disposed of. | maintenance adjustment (ie., part of equity) The Conceptual Framework has been designed to apply to a range of accounting models and concepts of capital and capital maintenance. Accordingly, the Conceptual Framework does not prescribe a particular model, except for financial reporting under hyperinflationary economy. Capital maintenance adjustments ae / The revaluation or restatement of assets and liabilities results in increases or decreases in equity, Although these increases or90 ——— decreases meet the definition of income or expenses, they are 1, recognized in profit or loss under certain concepts of Capital maintenance. Accordingly, these items are included in equity ag capital maintenance adjustments or revaluation reserves, Story + Manong Magbabalut sells balut. One morning, Manong had #109, Manong used that amount to buy balut, cook the balut, and sell them, ay the end of the day, Manong had 240. Question 1: If Manong uses the financial capital maintenance (measured in nominal monetary units) how much profit did Manong | earn? Assume Manong did not eat any of his baluts. | Answer: P140 (P240 net assets, end. - P10 net assets, beg.) Question 2: What if Manong ate one balut costing P10, how much is the profit? Answer: P150 (P240 net assets, end. + 810 distribution to owner - Pl00 | net assets, beg.) Question 3: If Manong uses the financial capital maintenance concept | (measured in units of constant purchasing Power). How much profit did Manong earn? | Answer: Coming soon! It is too early for us to discuss this. For now, just | ask Manong Magbabalut when you see him. ©¥“Summary: le Jonceptual Frammecoork 6 The Conceptual Framework’s Purpose is to serve as a guide in developing, understanding, and interpreting the Standards. The Conceptual Framework is not a Standard, In case of a conflict between these two, the Standard prevails. The Conceptual Framework is concerned with general purpose financial reporting. General purpose financial reporting involves the preparation of general purpose financial statements. The objective of general purpose financial reporting is to provide information that is useful to primary users in making decisions about providing resources to the entity. To make those decisions, primary users need information on the entity's: a, financial position and financial performance; and | b. management stewardship. The primary users are (a) existing and potential investors and (b) lenders and other creditors. Financial reports do ot and cannot provide all the information needs of the primary users. Only their common needs are catered by financial reports. The fundamental qualitative characteristics are (1) Relevance and (2) Faithful representation. The enhancing qualitative characteristics are (3) Comparability, (4) Verifiability, (5) Timeliness and (6) Understandability. Relevant information has (a) Predictive value and (b) Feedback value. Materiality is an entity-specific aspect of relevance. It is a matter of judgment. The overriding consideration when making materiality judgment is whether information could reasonably be expected to influence the.decisions of users. This is in keeping with the objective of financial reporting of providing useful information. ; The materiality process involves the following steps: (1) Identify, (2) Assess, (3) Organize, and (4) Review. The elements of faithful representation include (a) Completeness, (b) Neutrality, and (c) Free from error.