UNIT 1: Lecture 1:

Conceptual Framework for Financial

Reporting
BASIC CONCEPTS IN ACCOUNTING
 Learning unit outcomes

• Identify, name and discuss the users of financial statements.

• Explain the Conceptual Framework
• Discuss the objective of financial statements
• Write down the definitions of the elements of financial statements (assets,
liabilities, equity, income and expenses)
• Apply the definitions of elements of financial statements in discussion
questions and identify and classify given items as assets, liabilities, income or
expenses.
• Write down and discuss the accounting equation.
The role of Accounting
INTRODUCTION
Accounting is a process of collecting, processing and presenting financial information in a specific
format to assist various decision makers in making financial decisions…Read textbook, p3
THE HISTORY OF ACCOUNTING
The relationship between different accounts (previously the journal was seen as the most
important accounting record)... Read textbook, p4
DEVELOPMENTS IN THE FIELD OF ACCOUNTING
Previously, entities account for the same transaction differently according to their own sets of
accounting standards/own set of Generally Accepted Accounting Principles (GAAP).
The need for a common set of international accounting standards – led to establishment of the
IASC.
The IASC became later the International Accounting Standards Board (IASB).
IASB- develops standards called International Financial Reporting Standards (IFRS & IAS
standards).
IFRS- Users must be confident that the financial statements of the entity are reliable and
comparable with other entities.
Conceptual Framework- The IFRSs /accounting standards should be base on sound principles. This
framework was adopted by IASB for the Preparation and Presentation of Financial Statements.
The role of Accounting cont.
Financial Statements
Prepared and presented at least annually. Directed at the information needs of the
users.

Set of financial statements:

• Statement of profit or loss and other comprehensive income (SPLOCI or SPL)
• Statement of changes in equity (SCE)
• Statement of financial position (SFP)
• Statement of cash flows (SCF)
• Notes on accounting policies and other explanatory notes and
• comparative information in respect of preceding period.

Primary users
• The business owners, management, employees, government, the public, existing and
potential investors, lenders and other creditors.
 The Conceptual Framework for Financial
Reporting
Conceptual Framework (Textbook, p6):
• This framework (issued by IASB during September 2010) describes the basic concepts that underlie the
preparations and presentation of financial statements for external users.
• Different circumstances have led to the use of various definitions and different recognition criteria.
• The IASB decided to narrow the differences by preparing the Conceptual framework for financial reporting.
• The IASB uses the Conceptual Framework to develop future IFRSs and review existing IFRSs.
• Fundamental theoretical principles and interrelated objectives that serves as a frame of reference for financial
accounting.
Main purpose:
• To assist IASB in developing International Financial reporting standards based on consistent concepts.
• To assist preparers to prepare consistent accounting policies .
• To assist all parties to understand and interpret the Standards.
The Conceptual framework deals with:
a) The objective of financial reporting; b) The qualitative characteristics that determine the usefulness of
information in financial statements; c) Financial Statements and the reporting entity (see p6 and p20 – p22); d)
Elements of financial statements; e) Recognition and de-recognition; f) Measurement;
g) Presentation and disclosure & h) Concepts of capital and capital maintenance. (outside the scope for EFIN1)
 Objective of general purpose financial
reporting
The objective is:
• to provide financial information
• about the reporting entity,
• that is useful to existing and potential investors, lenders and other creditors,
• in making decisions relating to providing resources to the entity.

However, these reports do not and cannot provide all the information
needed. Users need to consider pertinent information from other sources
e.g. Economic conditions, political events, industry and company outlooks.

(Prescribed Textbook, page 8 & the Conceptual Framework, Ch.1, par 1.2 )
 Underlying assumption
Going concern assumption
• The financial statements are normally prepared on the assumption basis that an entity will
continue in operation for the foreseeable future.

Accrual Basis of Accounting

• Although par 3.9 of the Conceptual Framework does not specifically mention the accrual
basis of accounting as an assumption.
• However, as per par 1.17, financial performance is reflected by accrual accounting which
should depicts the effects of transactions and other events on a reporting entity’s resources
in the periods in which those effects occur. This is so, even if the cash receipts and payments
of those occur in a different period. Accrual basis is therefore also applicable.

(Prescribed Textbook, page 8 & the Conceptual Framework, Ch1, par 1.17; Ch.3, par 3.9 )
 Qualitative characteristics of financial
reports
Qualitative characteristics:
• The attributes that make the information provided in financial reports useful to users.
• If financial information is to be useful, it must be based on the following
fundamental characteristics:
a) relevance; and
b) faithful representation of what it purports to represent.
• The usefulness of financial information is enhanced if it is;
a) comparable,
b) verifiable,
c) timely; and
d) understandable.

(Prescribed Textbook, page 8 & the Conceptual Framework, Ch.2, par 2.4/2.20 )
 Relevance
• Information is capable of making a difference in the decisions made by users.
• Information is relevant, if based on the above decisions, some users choose not to
take advantage of it or are already aware of it from other sources.
• The nature and materiality of information has an effect on the relevance of
information.
• Information is material if the omission or misstatement could influence the economic
decisions of users.

The next slide explains ‘materiality’ in the context of relevance.

(Prescribed Textbook, page 8 & the Conceptual Framework, Ch.2, par 2.6 )
 Materiality (part of relevance)
• Information is material if omitting it or misstating it could influence decisions made
by primary users of general purpose financial reports (of a specific entity).

• Materiality is an entity-specific aspect of relevance based on the nature of the items

to which the information relates, in the context of an individual entity’s financial
report.

(Prescribed Textbook, page 8 & the Conceptual Framework, Ch.2, par 2.11 )
 Faithful representation
• Financial reports represent economic phenomena (exists or can be seen) in words and
numbers.
• To be a perfectly faithful representation (financial statements): it would be complete, neutral
and free from error.
“Complete” all information necessary for a user to understand the phenomenon being
presented. E.g. full description of assets (nature, value, quality and significant fact about each
item)
“Neutral” is without bias in the selection or presentation of financial information. No
manipulation to increase, for example, the probability that financial information will be
received favorably by users.
“Free from error” no errors or omissions during the process used to produce the reported
information. (This does not always mean perfect, but reasonable estimates that are clearly and
accurately described).

(Prescribed Textbook, page 9 & the Conceptual Framework, Ch.2, par 2.12 )
 Enhancing qualitative characteristics
Comparability, par 2.24
Information in the financial statements is more useful if it can be compared with corresponding
information of similar entities and comparable with similar information of the same entity but for
another period or date/consecutive periods should be the same.
• Enables users to identify and understand similarities in, and differences among, items.
Verifiability, par 2.30
• Helps assure users that information faithfully represents the economic phenomena it purports to
represent.
• Means that different knowledgeable and independent observers could reach consensus, although not
necessarily complete agreement, that a particular depiction is a faithful representation.
Timeliness, par 2.33
• Means having information available to decision- makers in time to be capable of influencing their
decisions.
Understandability, par 2.34
Classifying, characterizing and presenting information clearly and concisely makes it understandable.
(Textbook, page 9 & the Conceptual Framework, Ch.2, par 2.23 )
 Cost constraint of useful financial reporting
• In applying the cost constraint, the Board assesses whether the benefits of reporting
particular information are likely to justify the costs incurred to provide and use that
information.
• Benefits derived from financial information must exceed the cost of providing it.

(Prescribed Textbook, page 10 & the Conceptual Framework, Ch.2, par 2.42 )
 Financial statements and the reporting entity
Object and scope of financial statements
• Provide financial information about the reporting entities assets, liabilities, equity,
income and expenses (elements of financial statements) that is useful to users of
financial statements; and
• in assessing the prospects for future net cash inflows to the reporting entity as well as;
• assessing management’s stewardship of the entity’s economic resources.

(Prescribed Textbook, page 20, par 1.10 & the Conceptual Framework, Ch.3, par 3.2 )
Let us have a look in detail at the elements of financial statements on the next slide
 Elements of Financial Statements
The elements directly related to the financial position in the statement of financial
position are assets, liabilities and equity.

The elements directly related to the measurement of performance in the

statement of profit or loss and comprehensive income are income and expenses.

(Prescribed Textbook, page 10, par 1.5 & the Conceptual Framework, Ch.4, par 4.1 )
 ASSETS

Definition:
An ASSET is a present economic resource controlled by the entity as a result of past events.
• An economic resource is defined as being a right that has potential to produce economic
benefits
• There are therefore three important aspects within the definition of an assets:
 right- entitled to the economic resource (legal right/contract agreement, etc.)
 potential to produce economic benefits- potential to produce cash inflows, etc.
 control
 links an economic resource to an entity. Par 4.19
 The present ability to direct the use of the economic resource and obtain the
economic benefits that may flow from it.
Note: All 3 above criteria/aspects must be met, including whether a past event did occur, to
conclude that an item meets the definition of an asset.
(Textbook, page 10, par 1.5.1 & the Conceptual Framework, Ch.4, par 4.3, 4.19-22 )
Work through Textbook Example 1.1 & Study Guide SG1.1- Question 1 to SG1.5-Question 5
 LIABILITIES

Definition: A liability is a present obligation of the entity to transfer an economic

resource as a result of past events.
The following criteria must all be met before a liability exists.
 the entity has an obligation
 the obligation is to transfer an economic resource
 the obligation is a present obligation that exists as a result of past events.
(Prescribed Textbook, page 12, par 1.5.2 & the Conceptual Framework, Ch.4, par 4.26 )
Work through Textbook Example 1.2 & Study Guide, SG1.3- Question 3)
 EQUITY

Definition:
Equity is the residual(remaining) interest in the assets of the entity after deducting
all its liabilities.
• Different classes of equity, such as ordinary and preference shares (different
rights to the equity holders).
• For example, in a corporate entity, funds distributed by shareholders, retained
earnings and other components of equity may be shown separately.
• Capital (owners contribution)…other components are profit and drawings.
• EQUITY = ASSETS – LIABILITIES
(Prescribed Textbook, page 14, par 1.5.3 & the Conceptual Framework, Ch.4, par 4.63 )
 INCOME

Definition:
Income is increases in assets, or decreases in liabilities, that results in increases in
equity, other than those relating to contributions from holders of equity claims.
• Income is all the amounts earned by the entity for goods sold, services rendered
and the use by others of entity assets. Goods and services may be sold for cash
or on credit. When goods or services are sold for cash, the cash asset increases.
If the sales transaction was on credit, the receivables asset increases.

(Prescribed Textbook, page 14, par 1.5.4 & the Conceptual Framework, Ch.4, par 4.68 )
Work through Study Guide, SG1.3- Question 3
 EXPENSES

Definition:
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.

• Examples of expenses are salaries, telephone and electricity, etc.

(Prescribed Textbook, page 15, par 1.5.5 & the Conceptual Framework, Ch.4, par 4.68 )
Work through Study Guide SG1.1- Question 1, SG1.4 & SG1.5
 INCOME & EXPENSES

Accounting for capital contributions: Income & Expenses

“other than those relating to distributions to holders of equity claims” as part of
the definition of income & expenses:
• A capital contribution should not be included in profit or loss for the period, nor
within other comprehensive income. Instead, it should be presented in the
statement of changes in equity (i.e. similar to the proceeds of a share
issue/dividends/donations). This is because the increase/decrease in
shareholders’ funds is not ‘income’ or 'expense as defined in the Conceptual
Framework.
• Therefore, income or expenses cannot result from ‘contributions from holders of
equity claims’. (Prescribed Textbook, page 15, par 1.5.4 & 1.5.5)
 Recognition of elements of financial statements
Recognition:
The process of incorporating an item in the statement of financial position or statement
of profit or loss.
• Must meet the definition of an element, i.e. Asset, Liability, Equity, Income & Expense.

(Textbook, page 15 &17, par 1.6 ; 1.7 & the Conceptual Framework, Ch.5, par 5.1-5.6 )
Work through Textbook Example 1.3
 Recognition of elements of financial statements
How to structure your answer on a discussion question when recognize and classifying an item/element in the
financial statements:
STEP 1 What, Why & How
Determine whether the element/item (eg. vehicles) you identified in the given questions should be discuss is either an
asset, income, expense or a liability according the Conceptual Framework.
STEP 2
Based on the item that you identified from the information, discuss ad provide the definition of the element/item you
have identified. (Refer also to the 2. “Analysis of transactions” sheet for type of accounts/items.)
STEP 3
Apply every part of the definition to the given information in order to establish whether the item meets all
parts/components of the definition. (You should usually discuss the SFP elements first (depending on number of marks
allocated), if they do not ask for a specific element.)
STEP 4
Conclusion- identify, recognise and classify the item as an asset, income, expense or liability if all criterias of the
definition were met. (Refer to the 3.How to Structure your answer on a discussion question” sheet )

Additional remarks:
• Recognise the item based on the accrual concept. It is irrelevant whether money was paid or received.
 Derecognition of elements of financial statements

De-recognition:
• is the removal of all or part of a recognised asset or liability from an entity’s
statement of financial position.
• occurs when that item no longer meets the definition of an asset or of a
liability, e.g. entity loses control of an asset or no longer has a present
obligation.
(Textbook, page 15 &17, par 1.6 ; 1.7 & the Conceptual Framework, Ch.5, par 5.1-5.6 )
Work through Textbook Example 1.3
 Measurement of elements of financial statements
Historical cost
• measures monetary information of assets, liabilities and related income and expenses based
upon the price of the transaction or other event that gave rise to them.
Current value
• provides monetary information about assets, liabilities and related income and expenses,
using information updated to reflect conditions at the measurement date.
Other current values;
• Fair value- the price that would be received to sell an asset, or paid to transfer a liability, in an
orderly transaction between market participants at the measurement date.
• Value in use- applies the time value of money principle to present value.
• Fulfilment value- the present amount/value that an entity expects to be obliged to transfer as
it fulfils a liability.
• Current cost- reflects current prices in the market in which the entity would acquire the asset
or would incur the liability
(Prescribed Textbook, page 17, par 1.8 & the Conceptual Framework, Ch.6, par 6.1-6.10 )
 Accounting equation

(Page 19 in the prescribed textbook)

ASSETS = LIABILITIES + EQUITY

OR

ASSETS = OWNER’S EQUITY + LIABILITIES

Work through example 1.4 & 1.5

26
Examples 1.4 & 1.5

27
Financial statements: Presentation & Disclosure
(Page 20-22)

• Statement of financial position

Example 1.6

• Statement of profit or loss

Example 1.7

• Statement of changes in equity

Example 1.8
Presentation of Financial Statements:
General features
• IASB issues IFRSs and IASs
• Amended IAS 1 – Presentation of financial statements-amended December 2014
• IAS 1 includes 8 general features
1. Fair presentation and compliance with IFRSs
2. Going concern
3. Accrual basis of accounting (except statement of cash flows) -items recognised when they satisfy
definitions of elements and recognition criteria.
4. Materiality and aggregation-each material class of similar items presented separately. Items of
dissimilar nature presented separately unless immaterial.
5. Offsetting – assets and liabilities, and income and expenses, shall not be set off against each other.
6. Frequency of reporting- at least annually.
7. Comparative information
8. Consistency of presentation – presentation and classification of items retained from one period to
next.

(Not tested in UNIT 1. Read through to get understanding)

 Homework

Refer to study guide Learning unit 1 :

Textbook Questions: 1.1, 1.2, 1,3, 1.4 a)

Study Guide Questions SG1.1 to SG1.5

Attempt questions without referring to the solutions

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