The Conceptual Framework for Financial

Reporting

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The Conceptual Framework (conceptual framework) for

financial reporting
The conceptual framework for financial reporting is an
overarching statement of principles that should be
applied when reporting under IFRS. It is not a standard in
itself. Development of the new conceptual framework
was a joint project between IASB and FASB until 2011
when they decided to develop separate frameworks.

8
Learning objectives
• Identify the principles and
concepts that underlie IFRS®.
• Identify how the Conceptual
Framework is reflected in
IFRS® Standards.

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Learning objectives
 Identify the principles and concepts that underlie
IFRS .
 Identify how the conceptual framework is reflected
in IFRS standards

9
Background
• Different jurisdictions have different requirements for those who need to apply
IFRS Standards.

• In Europe, any listed company needs to apply IFRS Standards in their group
accounts.

• Others can choose to apply IFRS Standards or local GAAP.

• IFRS Standards are developed from an underlying framework of accounting

concepts and principles.

• The revised Conceptual Framework was issued in March 2018.

• Adopted immediately by IASB.

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Background
Whether entities are required, or choose, to apply IFRS Standards, varies
by jurisdiction. In Europe, any company that is listed on any EU exchange
must prepare group accounts under IFRS. The individual parent accounts
and the accounts of subsidiaries can be prepared under any generally
accepted accounting framework (GAAP).

The conceptual framework we are looking at today is the new framework

issued in March 2018 and adopted immediately by the IASB. This body of
concepts acts as the “guiding light” that is referred to when developing
new standards, and offers guidance where no standard exists and a
framework for appraising existing standards. The new framework was
issued because it was thought that the existing framework did not cover
all areas fully and did not reflect the principles applied in more current
standards, such as IFRS 9, Financial Instruments.

Conceptual framework: Background

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Conceptual framework
Conceptual
Framework issued by
IASB in 8 chapters

Consistent Assistance for Understandin

concepts for preparers when g and
development of no IFRS interpretation
accounting Standard of IFRS
standards applies or there Standards
is a choice provided

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Conceptual framework
The new framework consists of eight chapters, which we
will look at in turn. Applying consistent concepts when
developing accounting standards is a key benefit of the
framework. This consistency helps preparers understand
underlying principles when an entity has the option of
implementing one standard over another. A clear outline
of principles and concepts helps decision makers
understand the key facets of accounting under IFRS
Standards.

We’ll review each chapter of the framework in detail.

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Chapter 1 ― Objective of general purpose financial reporting

To provide financial information

about the reporting entity that is
useful to existing and potential
investors, lenders, and other
creditors

Economic Changes in
resources and resources and Use of resources
claims claims

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Chapter 1—Objective of general purpose financial

reporting
The overriding objective of general purpose financial
reporting is to provide information that is useful to
users, particularly investors, lenders, and other creditors.
Information on assets and liabilities helps users assess
liquidity, solvency, and financing requirements. Changes
in resources and claims occur due to financial
performance (i.e., how an entity has traded), as well as
issues of debt or equity. Users need to know how well
management has used the resources of the entity. Why
would they want to invest more if the current resources
have been not been utilized effectively? In other words,
users want to assess the stewardship of management
(i.e., how efficient they are).

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Chapter 2 ― Qualitative characteristics of useful financial
information

Fundamental: Must Enhancing

be present

• Relevance ― • Comparability
Predictive or
confirmatory value, • Verifiability
material
• Timeliness
• Faithful
presentation ― • Understandability
Complete, neutral,
and free from error
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Chapter 2—Qualitative characteristics of useful financial information

The conceptual framework outlines fundamental and enhancing characteristics of financial information. Fundamental characteristics must be
present and enhancing characteristics must be maximized.
Information is relevant if it can make a difference to decisions made by users. For this to be the case, the information either has predictive value
to help predict future outcomes, or confirmatory value, as in it confirms or changes previous evaluations.

Materiality is also related to relevance; the definition of materiality tells us that information is material if omitting, misstating, or obscuring it
could be expected to influence the decisions of primary users.

Financial information must faithfully represent the substance of the phenomena it purports to represent. Faithful representation has three
characteristics, as follows:
 Complete — All information necessary for an understanding is included, including narrative.
 Neutral — Financial information is free from bias. Interestingly, the new conceptual framework reintroduces the concept of prudence to
support a position of neutrality versus conservative accounting.
 Free from error — There are no errors in processes used or descriptions given.

There are four enhancing characteristics:

Comparability — Information is more useful if it can be compared with other entities or past periods. Consistent use of accounting policies helps
to support comparability.

Verifiability — Various knowledgeable and independent observers are able to conclude that given information is a faithful representation, i.e.,
counting cash.

Timeliness — Generally, the older the information is, the less useful it is.

Understandability — Information is presented clearly and concisely. Users are assumed to have a reasonable knowledge of business, and
information on complex transactions cannot be omitted on the grounds that financial information would be easier to understand without it.

Case study: Conceptual framework

Ask participants to do the related case study

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Chapter 3 ― Financial statements and the reporting entity

• Statement of financial position • Going concern assumption

• Statement of financial performance • Reporting entity
• Other statements and notes — Single entity
— Part of an entity
— More than one entity
— Not necessarily a legal entity

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Chapter 3—Financial statements and the reporting entity

The statement of financial position (SOFP) tells users about assets, liabilities, and equity
recognized by the entity. The statement of financial performance is also useful, as it reports
income and expenses. Other statements and notes provide useful information about risks,
cash flows, assumptions, judgments, and unrecognized assets and liabilities.

Financial statements are presented for the current reporting period and at least one
preceding period.

The going concern assumption is applied if the business is expected to be in operation for the
foreseeable future, at least a year from the reporting date. If not, this must be disclosed and
the accounts must be prepared on the break-up basis, which involves different valuation and
presentation methods.

A reporting entity could be

 a single entity,
 a part of an entity, or
 more than one entity.

It does not necessarily have to be a legal entity.

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Chapter 3 ― Financial
statements and the reporting
entity
Financial statements may be
• unconsolidated financial
statements,
• combined financial
statements, or
• consolidated financial
statements.

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Chapter 3—Financial statements and the reporting

entity
A reporting entity could be a single entity, a proportion
of an entity, or more than one entity. It does not
necessarily have to be a legal entity. If the reporting
entity is a single entity, it will prepare unconsolidated
financial statements. If the reporting entity is two or
more entities with no parent-subsidiary relationship,
they will prepare combined financial statements. If a
reporting entity is a parent with subsidiaries, it will
prepare consolidated financial statements.

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Chapter 4 ― The elements of financial statements
Assets
• Present economic resource controlled by the entity as a result of
past events.
• Economic resource ― Right with the potential to produce
economic benefits.
• Not all rights are assets ― Need to be controlled and have
potential to produce economic benefit.
• Potential doesn’t have to be probable.
• Substance over form must be applied.
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Chapter 4—The elements of financial statements

The new conceptual framework has changed the definitions of the elements of financial statements.

Assets:
• Present economic resource controlled by the entity as a result of past events.
• Economic resource — Right with the potential to produce economic benefits.
• Not all rights are assets — The rights need to be controlled and have potential to produce
economic benefit.
• There must be potential to produce economic benefits, but this doesn’t have to be probable.
• An asset may not be recognized if economic benefits are not probable, as we shall see, or their
measurement may be affected.
• Substance over form must be applied.

Rights could originate from the obligations of another party. As an example, a customer may owe us
money or we may enter into a forward exchange contract that gives us a right to exchange economic
resources on favorable terms. Another example of a right that may arise from obligations of another
party could be the right to use/sell a property.

Having a right isn’t enough on its own to recognize an asset. There are further criteria to meet. A right
must have the potential to produce economic benefit and must be controlled by the entity. For
example, staff skills would not be capitalized on the SOFP, as an entity does not control those skills—
staff can leave roles and take those skills elsewhere.
Note that under the previous conceptual framework, in order to be recognized as an asset, the
economic benefit had to be considered “probable” versus “potential.” Under the new framework,
probability may affect the measurement of the asset that is recognized.

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Conceptual framework: Assets

16
Chapter 4 ― The elements of financial statements, continued
Liabilities
• A present obligation to transfer an economic resource as a result of
past events.
Obligation ― A duty or responsibility that entity has no practical
ability to avoid.
• Could be legal or constructive.
• Potential to transfer economic benefit does not have to be
probable.
• Economic benefits received or actions taken must create the
obligation.
• Substance over form must be applied.
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Chapter 4—The elements of financial statements, continued

Liabilities:
• Liabilities represent a present obligation to transfer an economic resource as a result of past
events.
• An obligation can be legal or constructive, and is a duty or responsibility that an entity has no
practical ability to avoid.
• There must be potential to transfer economic benefits, but it does not have to be probable. A
liability may not be recognized if a transfer of economic benefits is not probable, as we shall
see, or its measurement may be affected.
• Economic benefits received or actions taken must create the obligation.
• Substance over form must be applied.

Obligations could be contractual, through legislation, or established through past practice or published
policy. For example, a retailer may always accept returns, regardless of the length of time since the
sale, based on policy.

Crucially, there must have been a “past event” to create an obligation. The entity must have already
obtained economic benefits or taken an action to create the obligation. For example, a lawyer may
give incorrect advice to a client in the reporting period. The obligation must have the potential for
transfer of economic benefit. Again, this is a change from the previous conceptual framework, which
required the transfer to be probable. However, the probability may affect the measurement of any
recognized liability. In order to represent assets and liabilities faithfully, their substance must be
reflected in the financial statements, which may be different from the underlying legal contract.

Conceptual framework: Liability

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Chapter 4 ― The elements of financial statements, continued
Equity

• Residual interest in the assets of an entity after deducting all of its

liabilities.

• Includes ordinary shares and preference shares if they don’t meet

the definition of a liability.

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Chapter 4—The elements of financial statements,

continued
Equity:
• Residual interest in the assets of an entity after
deducting all of its liabilities
• Includes ordinary shares and preference shares as
long as they don’t meet the definition of a liability

Conceptual framework: Equity

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Chapter 4 ― The elements of financial statements, continued
Income

Increases in assets, or decreases in liabilities, that result in increase

in equity, other than those relating to contributions from holders of
equity claims.

Expenses

Decreases in assets, or increases in liabilities, that result in

decreases in equity, other than those relating to distributions to
holders of equity claims.

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Chapter 4—The elements of financial statements

Different transactions result in income and expenses with
different characteristics. Providing information about these
separately helps users to understand financial performance.

Income—Increases in assets, or decreases in liabilities, that

result in increase in equity, other than those relating to
contributions from holders of equity claims

Expenses—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: Income and expenses

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Discussion exercise – Conceptual Framework
CycleKids Inc. is a children’s bike retailer that has a policy of offering
a full refund to dissatisfied customers, even though it has no legal
obligation to do so. This is advertised on all marketing material.

Based on concepts of the conceptual framework, would the refund

meet the definition of a liability?

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Discussion exercise
CycleKids Inc. is a children’s bike retailer that has a policy
of offering a full refund to dissatisfied customers, even
though it has no legal obligation to do so. This is
advertised on all marketing material.

Based on concepts of the conceptual framework, would

the refund meet the definition of a liability?

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Discussion exercise solution – Conceptual Framework
Liability ― A present obligation to transfer an economic resource as
a result of past events.

• CycleKids, Inc. has a constructive obligation.

• The obligation has the potential to require CycleKids, Inc. to

transfer an economic resource in the form of a refund.

• A past event has occurred because CycleKids, Inc. has taken an

action in selling bikes to customers.

• A liability should be recognised for the best estimate of costs of

refunds on bikes sold to customers prior to the year-end.
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Discussion exercise solution

A liability is a present obligation to transfer an economic
resource as a result of past events. The following facts
apply:
• CycleKids Inc. has a constructive obligation.
• The obligation has the potential to require CycleKids
Inc. to transfer an economic resource in the form of a
refund.
A past event has occurred because CycleKids Inc. has
taken an action in selling bikes to customers. Based on
these facts, a liability should be recognized for the best
estimate of costs of refunds on bikes sold to customers
prior to the year-end.

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Chapter 5 ― Recognition and derecognition
Recognition

• Item meets the definition of an element of the financial statements,

AND it provides users with information that is relevant and a
faithful representation of the item.

• Recognition may not lead to relevant information if it’s uncertain

that an item exists (“existence uncertainty”) or the probability of
transfer of economic benefits is low.

• If the level of uncertainty involved in measuring an item is high

(“measurement uncertainty”), a faithful representation may not be
achieved.
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Chapter 5—Recognition and derecognition

“Recognition” refers to recording a double entry and capturing an item that meets the
definition of an element in the financial statements. An item that meets the definition of an
element is recognized only if recognition results in relevant information and a faithful
representation.

For example, if a company is being sued for unfair dismissal but lawyers advise that the
chance of the claim being successful is low, then including this claim will not provide relevant
information to the users.

When considering whether recognition would result in relevant information, a preparer

should consider whether there is a low probability of a flow of economic resource and
whether there is uncertainty about the item’s existence.

When considering whether a faithful representation would result, a preparer should consider
the degree of measurement uncertainty.

Deciding whether an item provides users with information that is relevant and considered
faithful representation requires judgment. If an item meets the definition of a financial
statement element, but is not recognized, then the item may need to be disclosed.

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Chapter 5 ― Recognition and derecognition, continued
Derecognition

• For an asset ― Normally, when control is lost

• For a liability ― Normally, when there is no longer a present

obligation

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Chapter 5—Recognition and derecognition

The previous framework did not provide guidance on
derecognition, which involves removing some or all of an
item from the financial statements.

For an asset, derecognition normally occurs when

control is lost. For a liability, derecognition normally
occurs when there is no longer a present obligation.

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Chapter 6 ― Measurement

Historic cost Based on transaction price when asset was acquired or

liability was incurred.

Current value Fair value

Value in use or fulfillment value

Current cost

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Chapter 6— Measurement
The Conceptual Framework refers to two main
measurement bases: historic cost and current value.

Historic cost is based on the transaction price when the

asset was acquired or liability was incurred.

Current value may be measured as one of the following:

 Fair value—Price received to sell an asset or paid to
transfer a liability (IFRS 13)
 Value in use or fulfillment value—Present value of
cashflows from disposal of an asset or resources
transferred to fulfill liability
 Current cost—Cost of an equivalent asset or
consideration received for an equivalent liability at
measurement date

24
Chapter 6 ― Measurement, continued

• Relevant • Historic cost?

When selecting a
• Faithful • Related assets and
measurement basis, representation liabilities measured
remember that information differently?
must be useful to users:
• Enhancing qualitative • Change in
characteristics measurement
technique?

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Chapter 6—Measurement, continued

Once again, the Conceptual Framework asks preparers to think about what is
most useful to the users when deciding on a measurement basis. Information
must be relevant and represent faithfully what it purports to represent and, as
far as possible, reflect the enhancing characteristics.

 The relevance of information provided by a measurement basis is

affected by the characteristics of the asset or liability and its contribution
to future cash flows (e.g., whether an asset will be sold or used to
produce goods or services to sell).
 Faithful representation is affected by measurement inconsistency and
measurement uncertainty. If measurement uncertainty is too high, it may
be necessary to consider a different measurement basis.

This can raise conflict. Historic cost is generally verifiable and well understood,
but may not provide relevant information to users as it is less predictive. If
assets and liabilities that are linked (i.e., a leased asset and corresponding
liability) are not measured consistently, then it might not lead to a faithful
representation. Changing the measurement basis for the same items would
reduce comparability and understandability but could improve relevance.

25
Chapter 7 ― Presentation and disclosure

Effective presentation helps to achieve relevance, faithful representation,

understandability, and comparability:

Flexibility versus Statement of Other comprehensive

Grouping items
comparability profit or loss income (OCI)

• Balance required • On basis of shared • Theoretically all • Items included

characteristics income and expenses by exception
in the statement

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Chapter 7—Presentation and disclosure

Effective presentation and disclosure ensure relevance, supports
faithful representation, and increases understandability and
comparability. The framework asks entities to strike a balance
between having the flexibility to provide relevant information and
requiring information to be comparable. If dissimilar items are
grouped together, then the qualitative characteristics are not
reflected. The framework also asks for a balance to be struck
between aggregating large amounts of data and obscuring
important detail.

All income and expenses should be reported in profit or loss by

default; items are only reported in other comprehensive income
(OCI) as permitted or required by an IFRS where this presentation
provides more relevant information or a more faithful presentation.

In principle, OCI is reclassified to profit or loss in a future period;

however, OCI is not reclassified if country specific IFRSs require
otherwise.

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Chapter 8 ― Concepts of capital and capital maintenance

Financial concept of Physical concept of

capital maintenance capital maintenance

• Net assets or equity of the entity • Productive capacity of the

• More useful if users interested in entity
maintenance of capital invested • More useful if users interested
in operational capacity

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Chapter 8—Concepts of capital and capital maintenance

When looking at the financial concept of capital, an

increase in equity over the period would indicate profit
has been made.
When looking at a physical concept of capital, an
increase in the operating capacity of an entity over the

period would indicate profit has been made.

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