FINANCIAL ACCOUNTING & REPORTING 3

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Financial statements and conceptual framework for financial reporting

Module 002 Week001- FinAcct3 Financial

statements and conceptual framework for
financial reporting
Financial statements are prepared and presented for external users by
many entities around the world. Although such financial statements may
appear similar from country to country, there are differences which have
probably been caused by a variety of social, economic and legal
circumstances and by different countries having in mind the needs of
different users of financial statements when setting national requirements.
These different circumstances have led to the use of a variety of definitions of
the elements of financial statements. They have also resulted in the use of
different criteria for the recognition of items in the financial statements and
in a preference for different bases of measurement. The scope of the financial
statements and the disclosures made in them have also been affected.
The International Accounting Standards Board is committed to narrowing
these differences by seeking to harmonize regulations, accounting standards
and procedures relating to the preparation and presentation of financial
statements. It believes that further harmonization can best be pursued by
focusing on financial statements that are prepared for the purpose of
providing information that is useful in making economic decisions.
In general terms, a conceptual framework is a statement of generally
accepted theoretical principles which form the frame of reference for a
particular field of enquiry. In terms of financial reporting, these theoretical
principles provide the basis for both the development of new reporting
practices and the evaluation of existing ones. Since the financial reporting
process is concerned with the provision of information that is useful in
making business and economic decisions, a conceptual framework will form
the theoretical basis for determining which events should be accounted for,
how they should be measured and how they should be communicated.
Therefore, although it is theoretical in nature, a conceptual framework for
financial reporting has a highly practical end in view.

At the end of this module, you will be able to:

1. Describe the usefulness and scope of conceptual framework
2. Understand the objective of conceptual framework
3. Identify the qualitative characteristics of useful accounting information
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Financial statements and conceptual framework for financial reporting

4. Identify the fundamental and enhancing qualitative characteristics

Conceptual framework for financial reporting and its purposes

In general terms, a conceptual framework is a statement of generally accepted theoretical
principles which form the frame of reference for a particular field of enquiry. In terms of
financial reporting, these theoretical principles provide the basis for both the development
of new reporting practices and the evaluation of existing ones. Since the financial reporting
process is concerned with the provision of information that is useful in making business
and economic decisions, a conceptual framework will form the theoretical basis for
determining which events should be accounted for, how they should be measured and how
they should be communicated. Therefore, although it is theoretical in nature, a conceptual
framework for financial reporting has a highly practical end in view.
The purpose of the Conceptual Framework is:
 to assist the Board in the development of future PFRSs and in its review of existing
IFRSs;
 to assist the Board in promoting harmonization of regulations, accounting standards
and procedures relating to the presentation of financial statements by providing a
basis for reducing the number of alternative accounting treatments permitted by
PFRSs;
 to assist national standard-setting bodies in developing national standards;
 to assist preparers of financial statements in applying PFRSs and in dealing with
topics that have yet to form the subject of an PFRS;
 to assist auditors in forming an opinion on whether financial statements comply
with PFRSs; and
 to provide those who are interested in the work of the IASB with information about
its approach to the formulation of PFRSs.
This Conceptual Framework is not a standard and hence does not define standards for any
particular measurement or disclosure issue.
Nothing in this Conceptual Framework overrides any specific standard.
The Board recognizes that in a limited number of cases there may be a conflict between the
Conceptual Framework and a PFRS. In those cases where there is a conflict, the
requirements of the PFRS prevail over those of the Conceptual Framework. As, however,
the Board will be guided by the Conceptual Framework in the development of future PFRSs
and in its review of existing PFRSs, the number of cases of conflict between the Conceptual
Framework and PFRSs will diminish through time.

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Financial statements and conceptual framework for financial reporting

Scope of the framework

The Conceptual Framework deals with:
 the objective of financial reporting;
 the qualitative characteristics of useful financial information;
 the definition, recognition and measurement of the elements from which financial
statements are constructed; and
 concepts of capital and capital maintenance.

Main objective of conceptual framework

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. Those decisions
involve buying, selling or holding equity and debt instruments, and providing or settling
loans and other forms of credit.
Target users
Financial reporting is directed primarily to the existing and potential investors, lenders and
other creditors which compose the primary user group.
The reason is that existing and potential investors, lenders and other creditors have the most
critical and immediate need for information in financial reports.
As a matter of fact, the primary users of financial information are the parties that provide
resources to the entity.
Specific objectives of financial reporting
Specifically, the Conceptual Framework for Financial Reporting states the following
objectives of financial reporting:
 To provide information useful in making decisions about providing resources to the
entity
 To provide information useful in assessing the prospects of future net cash flows to
the entity
 To provide information about entity resources, claims and changes in resources and
claims.
Economic decisions
Existing and potential investors need general purpose financial reports in order to enable
them in making decisions whether to buy, sell or hold equity instruments.

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Financial statements and conceptual framework for financial reporting

Existing and potential lenders and other creditors need general purpose financial reports in
order to enable them in making decisions whether to provide or settle loans and other forms
of credit.
Assessing future cash flows
Decisions by existing and potential investors about buying, selling or holding equity
instruments depend on the returns that they expect from an investment, for example,
dividends.
Similarly, decisions by existing and potential lenders and other creditors about providing or
settling loans and other forms of credit depend on the principal and interest payments or
other returns they expect.
Economic resources and claims
General purpose financial reports provide information about the financial position of a
reporting entity.
Information about the nature and amount of an entity’s economic resources and claims can
help users identify the entity’s financial strength and weakness.
Otherwise stated, information about financial position can help users to assess the entity’s
liquidity, solvency and the need for additional financing.
Liquidity is the availability of cash in the near future to cover currently maturing obligations.
Solvency is the availability of cash over a long term to meet financial commitments when
they fall due.
Changes in economic resources and claims
General purpose financial reports also provide information about the effects of transactions
and other events that change the entity’s economic resources and claims.
Changes in economic resources and claims result from the entity’s financial performance and
from other events or transactions.
Accrual accounting
The financial performance of an entity shall be measured in accordance with accrual
accounting.
Accrual accounting depicts the effects of transactions and other events and circumstances
on an entity’s economic resources and claims in the periods in which those effects occur even
if the resulting cash receipts and payments occur in a different period.

Qualitative characteristics of useful financial information

The qualitative characteristics of useful financial information identify the types of
information that are likely to be most useful to the existing and potential investors, lenders
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Financial statements and conceptual framework for financial reporting

and other creditors for making decisions about the reporting entity on the basis of
information in its financial report.
The qualitative characteristics of useful financial information apply to financial information
provided in financial statements, as well as to financial information provided in other ways.
Cost, which is a pervasive constraint on the reporting entity’s ability to provide useful
financial information, applies similarly. However, the considerations in applying the
qualitative characteristics and the cost constraint may be different for different types of
information.
If financial information is to be useful, it must be relevant and faithfully represent what it
purports to represent. The usefulness of financial information is enhanced if it is
comparable, verifiable, timely and understandable.

Fundamental qualitative characteristics

The fundamental qualitative characteristics relate to the content or substance of financial
information.
The fundamental qualitative characteristics are:
a. Relevance
b. Faithful representation
Information must be both relevant and faithfully represented if it is to be useful.

a. Relevance
In the simplest terms, relevance is the capacity of the information to influence a decision.
To be relevant, the financial information must be capable of making a difference in the
decisions made by users.
Information that does not bear on an economic decision is useless.
For example, the statement of financial position is relevant in determining financial
position and the income statement is relevant in determining performance.
Ingredients of relevance
Financial information is capable of making a difference in a decision if it has predictive
value and confirmatory value.
Financial information has predictive value if it can be used as an input to processes
employed by users to predict future outcome.
In other words, financial information has predictive value when it can help users increase
the likelihood of correctly or accurately predicting or forecasting outcome of events.
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Financial statements and conceptual framework for financial reporting

Financial information has confirmatory value if it provides feedback about previous

evaluations.
In other words, financial information has confirmatory value when it enables users confirm
or correct earlier expectations.
Materiality
Materiality is a practical rule in accounting which dictates that strictly adherence to GAAP
is not required when the items are not significant enough to affect the evaluation, decision
and fairness of the financial statements. This concept is also known as doctrine of
convenience.
It is a company-specific aspect of relevance. Information is material if omitting it or
misstating it could influence decisions that users make on the basis of the reported
financial information. An individual company determines whether information is material
because both the nature and/or magnitude of the item(s) to which the information relates
must be considered in the context of an individual company’s financial report.

b. Faithful representation
Under the New Conceptual Framework for Financial Reporting, the term ‘faithful
representation” is used instead of the term “reliability”.
Faithful representation means that financial reports represent economic phenomena or
transactions in words and numbers.
Simply worded, faithful representation means that the actual effects of the transactions shall
be properly accounted for and reporting in the financial statements.
Ingredients of faithful representation
Completeness
Completeness requires that relevant information should be presented in a way that
facilitates understanding and avoids erroneous implication.
Completeness is the result of the adequate disclosure standard or the principle of full
disclosure.
The standard of adequate disclosure means that all significant and relevant information
leading to the preparation of financial statements shall be clearly reported.
The rule is that the accountant shall disclose a material fact known to him which is not
disclosed in the financial statements but disclosure of which is necessary in order that the
statements would not be misleading.

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Financial statements and conceptual framework for financial reporting

Neutrality
A neutral depiction is “without bias” in the preparation or presentation of financial
information.
A neutral depiction is not slanted, weighted, emphasized, de-emphasized or otherwise
manipulated to increase the probability that financial information will be received favorably
or unfavorably by users.
In other words, to be neutral, the information contained in the financial statements must be
free from bias.
To be neutral is to be fair.
Free from errors
Free from error means there are no errors or missions in the description of the phenomenon
or transaction, and the process used to produce the reported information has been selected
and applied with no errors in the process.
In this context, free from error does not mean perfectly accurate in all respects.
For example, an estimate of an unobservable price or value cannot be determined to be
accurate or inaccurate.
However, a representation of that estimate can be faithful if the amount is described clearly
and accurately as an estimate.
Moreover, the nature and limitations of the estimating process are explained, and no errors
have been made in selecting and applying an appropriate process for developing the
estimate.
Substance over form
If information is to represent faithfully the transactions and other events it purports to
represent, it is necessary that they are accounting in accordance with their substance and
reality and not merely their legal form.
The economic substance of transactions and events are usually emphasized when economic
substance differs from legal form.
Substance over form is not considered a separate component of faithful representation because
it would be redundant.
Faithful representation inherently represents the substance of an economic phenomenon or
transaction rather than merely representing its legal form.

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Financial statements and conceptual framework for financial reporting

Enhancing qualitative characteristics

The enhancing qualitative characteristics relate to the presentation or form of the financial
information. These are intended to increase the usefulness of the financial information that
is relevant and faithfully represented.
The enhancing qualitative characteristics are:
a. Comparability
b. Understandability
c. Verifiability
d. Timeliness
Information must be both relevant and faithfully represented if it is to be useful but to be
most useful it must be comparable, understandable, verifiable and timely.

a. Comparability
Comparability means the ability to bring together for the purpose of noting points of likeness
and difference.
Comparability is the enhancing qualitative characteristic that enables users to identify and
understand similarities and dissimilarities among items.
The economic substance of transactions and events are usually emphasized when economic
substance differs from legal form.
Comparability may be made within an entity or between and across entities.
Comparability within an entity is also known as horizontal comparability or
intracomparability.
Comparability across entities is also known as intercomparability or dimensional
comparability.
Consistency
Implicit in the qualitative characteristic of comparability is the principle of consistency.
The principle of consistency requires that “the accounting methods and practices should be
applied on a uniform basis from period to period”.
Consistency is not the same as comparability.

b. Understandability
Understandability requires that financial information must be comprehensible or intelligible
if it is to be most useful.

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Financial statements and conceptual framework for financial reporting

An essential quality of the information provided in financial statements is that it is readily

understandable by users.
Financial statements cannot realistically be understandable to everyone.
At times, even well-informed and diligent users may need to seek the aid of an adviser to
understand information about complex phenomena or transactions.
Understandability is very essential because a relevant and faithfully represented
information may prove useless if it is not understood by users.

c. Verifiability
Verifiability means that different knowledgeable and independent observers could reach
consensus, although not necessarily complete agreement, that a particular depiction is a
faithful representation. In other words, verifiability implies consensus.
The financial information is verifiable in the sense that it is supported by evidence so that an
accountant that would look into the same evidence would arrive at the same economic
decision or conclusion.
Verification can be direct or indirect.
Direct verification means verifying an amount or other representation through direct
observation, for example, by counting cash.
Indirect verification means checking the inputs to model, formula or other technique and
recalculating the inputs using the same methodology.

d. Timeliness
Timeliness means that financial information must be available or communicated early
enough when a decision is to be made.
Relevant information and faithfully represented financial information furnished after a
decision is made is useless or of no value.
Generally, the older the information, the less useful.
Timeliness enhances the truism that “without knowledge of the past, the basis for prediction
will usually be lacking and without interest in the future, knowledge of the past is sterile”.

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Financial statements and conceptual framework for financial reporting

References and Supplementary Materials

Books and Journals

Valix, C., Peralta, J. & Valix, C.A; 2016; Financial Accounting Volume 3; Metro Manila,
Philippines; GIC Enterprises & Co., Inc.

Valix, C., Peralta, J. & Valix, C.A; 2016; Financial Accounting Volume 1; Metro Manila,
Philippines; GIC Enterprises & Co., Inc.

Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield; 2013; Intermediate Accounting;

United States; John Wiley & Sons, Inc.

Barry Elliot, Jamie Elliot; 2011; Financial Accounting and Reporting; Essex CM20 2JE,
England; Pearson Education Limited

Online Supplementary Reading Materials

The Conceptual Framework;
http://www.fasb.org/jsp/FASB/Page/BridgePage&cid=1176168367774; October 29,
2017

The Conceptual Framework; http://www.ifrs.org/projects/work-plan/conceptual-

framework/; October 29, 2017

IASplus; https://www.iasplus.com/en/resources/ifrsf/iasb-ifrs-ic/iasb; October 29,

2017

IASplus; https://www.iasplus.com/en/standards/ias/ias; October 29, 2017

Online Instructional Videos

The Conceptual Framework Intermediate Accounting CPA Exam;
https://www.bing.com/videos/search?q=conceptual+framework&&view=detail&mid=222
050C98AACF518049E222050C98AACF518049E&FORM=VRDGARl; January 10, 2018

Financial Accounting Conceptual Framework (Financial Accounting Tutorial #12);

https://www.bing.com/videos/search?q=conceptual+framework&&view=detail&mid=8E
AF86DFB689D8DCF6278EAF86DFB689D8DCF627&FORM=VRDGAR; January 10, 2018

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