Page 1 of 11 | FAR Handouts No.

02

CONCEPTUAL FRAMEWORK FOR

FINANCIAL REPORTING
KARIM G. ABITAGO, CPA

CONCEPTUAL FRAMEWORK FOR FINANCIAL

REPORTING
KARIM G. ABITAGO, CPA

Basic Concepts
Definition and Background
The Conceptual Framework is a summary of the terms and concepts that underlie the preparation and presentation
of financial statements.
The Conceptual Framework is concerned with general purpose financial statements, including consolidated
financial statements. Special purpose reports are outside the scope of the framework.
Underlying Theme
The underlying theme of the framework is decision usefulness or Usefulness of information in making economic
decision.
Purposes
Basic Purpose: To serve as a guide in developing future PFRSs and as a guide in resolving accounting issues not
directly addressed by existing PFRS.
Specific Purposes:
1. To assist
(a) in developing future PFRSs and reviewing existing
PFRSs.
FRSC (b) in promoting harmonization of regulations, accounting
standards and procedures relating to the presentation of
FS.
Preparers of FS in applying PFRSs.
Users of FS in interpreting the information in FS.
in forming an opinion as to whether the FS conforms with
Auditors PFRS.
2. To provide information to those who are interested with the work of FRSC.
Authoritative Status of the Conceptual Framework
(a) The Conceptual Framework is not a Philippine Financial Reporting Standard (PFRS) and hence does not define
standard for any particular measurement or disclosure issue. Thus, nothing in the Conceptual Framework overrides
any specific Philippine Financial Reporting Standard.
(b) In case where there is a conflict, the requirements of the Philippine Financial Reporting Standards shall prevail over
the Conceptual Framework.
(c) In the absence of a standard or an interpretation 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 information that is relevant and reliable.
Underlying Assumptions
Accounting assumptions or accounting postulates are the basic notions or fundamental premises on which the
accounting process is based.
Stated Underlying Assumption?
List of Underlying Assumptions
Under the Old CF Under the New CF
Going Concern Principle ✔ ✔
Accrual Principle ✔ x
Accounting / Economic Entity Concept x x
Time Period Principle x x
Monetary Unit Principle x x
a) Going Concern (Continuity Assumption)
Going concern assumption means that the accounting entity is viewed as continuing in operation indefinitely in the
absence of evidence to the contrary. Going concern is the foundation of cost principle.
Examples of application of going concern principle:
• The current and non-current classification of assets and liabilities
• The accrual of income and expenses and prepayments and unearned income.
• Depreciation of PPE, amortization of intangible assets and etc.

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KARIM G. ABITAGO, CPA

CONCEPTUAL FRAMEWORK FOR
FINANCIAL REPORTING

b) Accrual Principle
Accrual principle addresses the recognition of income and expenses as against the cash basis principle. Under this
principle, income is recognized when earned rather than when received and expense is recognized when incurred
rather than when paid.
c) Accounting Entity Concept
Under this concept, the entity is viewed separately from its owners. Accordingly, the personal transactions of the
owners among themselves or with other entities are not recorded in the entity’s accounting records.
d) Time Period Principle
According to the going concern principle, the operation of the business is viewed indefinitely. That was the
foundation of the time period principle. Under this principle, the life of the entity is divided into series of reporting
periods. An accounting period is usually 12 months and may either be a calendar year or a fiscal year.
e) Monetary Unit Principle
Under this principle, accounting information should be stated in a common measurement basis to be useful, which
is in the Philippines it is peso. Also, this concept assumes that the purchasing power of the peso is regarded as
constant.
Scope of the Conceptual Framework
Chapter 1: Objective of Financial Reporting (The Foundation of the CF)
Users of financial information
Users of financial information is classified into primary and other users. Primary users include potential and existing
investors, lenders and other creditors. They are considered as primary users since they are the primary providers of
resources to the entity. Other users include employees, customers, government and their agencies and public.
Summary of users and their needs or concerns on the financial statements
User Concern(s)
(a) Risk and return of investment
Investors
(b) Ability to pay dividends
Lenders and other creditors Liquidity and solvency
Employees Stability and profitability
Customers Continuity
Government Regulatory
Public Various

Objectives of Financial Reporting

Overall objective: 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".
Specific objectives
A. To provide information useful in making decisions about providing resources to the entity.
B. To provide information useful in assessing the prospects of future net cash flows to the entity.
C. To provide information about entity resources, claims and changes in resources and claims.
Limitations of financial reporting
(a) General purpose financial reports do not and cannot provide all of the information that existing and potential
investors, lenders and other creditors need.
(b) General purpose financial reports are not designed to show the value of an entity but they provide
information to help the primary users estimate the value of the entity.
(c) General purpose financial reports are intended to provide common information to users and cannot
accommodate every request for information.
(d) To a large extent, general purpose financial reports are based on estimate and judgment rather than exact
depiction.

Chapter 2: Qualitative Characteristics of Useful Information

Definition
Qualitative characteristics are the qualities or attributes that make financial accounting information useful to the
users.
Under the Conceptual Framework for Financial Reporting, qualitative characteristics are classified into fundamental
qualitative characteristics and enhancing qualitative characteristics.

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CONCEPTUAL FRAMEWORK FOR
FINANCIAL REPORTING

Fundamental Qualitative Characteristics

- are the qualities that make the information useful to the users in making economic decisions. These
characteristics address the content or substance of information. The fundamental qualitative characteristics are
relevance and faithful representation
Relevance means the capacity of information to make a difference in a decision made by users. Relevant
information has the following ingredients:
a) Predictive Value – the information can help users increase the likelihood of correctly predicting or
forecasting outcome of events.
b) Confirmatory Value – the information enables users confirm or correct earlier expectations.
TAKE NOTE:
1) Predictive and confirmatory values are interrelated, meaning, often, information has both predictive and
confirmatory values.
2) Materiality is NOT an ingredient of relevance but rather an specific aspect of relevance. Meaning, all
material items are relevant but not all relevant items are material.
3) What is materiality?
It is the omission or misstatement of information causing to influence the decision of the users.
Accordingly, the framework and PFRSs do not specify a uniform quantitative threshold for materiality, thus,
materiality is purely based on judgment. In the exercise of judgment in determining materiality, the following
factors may be considered: (a) Relative size of the item in relation to the total of the group to which the item
belongs; (b) Nature of the item.
Faithful representation means that the information provides a true, correct and complete depiction of the economic
phenomena that it purports to represent. Simply stated, faithful representation means that the descriptions and
figures match what really existed or happened. Also, faithful representation means that the actual effects of the
transactions shall be properly accounted for and reported in the financial statements. To be a perfectly faithful
representation, a depiction should have three ingredients, namely:
a) Completeness – all information necessary for users to understand the phenomena depicted is
provided, whether in words or in numbers.
b) Neutrality - means that the financial statements should not be prepared so as to favour one party to the
detriment of another party. A neutral depiction is "without bias" in the selection or presentation of financial
information.
c) Free from error - in this context, free from error does not mean perfectly accurate in all respects. Free
from error means there are no errors or omissions in the description of the phenomenon, and the process used to
produce the reported information has been selected and applied with no errors in the process.
TAKE NOTE:
1) Substance over form and conservatism are not ingredients of faithful representation and are specific aspect
only.
2) If there is a conflict between substance and form, the economic substance of the transaction shall prevail
over the legal form. Examples of situation where substance over form is applied: (a) accounting for non-interest
bearing notes receivable/payable; (b) finance lease accounting.
3) The Conceptual Framework did not include conservatism or prudence as an aspect of faithful
representation because to do so would be inconsistent with neutrality. Under conservatism, when
alternatives exist, the alternative which has the least effect on equity shall be chosen.
Enhancing Qualitative Characteristics
- are the qualities of information that enhances its usefulness. These characteristics address the form or
presentation of information. The enhancing qualitative characteristics are verifiability, comparability,
understandability and timeliness.
Verifiability means that different knowledgeable and independent observers could reach consensus, although not
necessarily complete agreement, that a particular depiction is a faithful representation.
Information is comparable if it helps users identify similarities and differences between different sets of information
that are provided by:
a) a single entity but different periods (intra-comparability); or
b) different entities in a single period (inter-comparability).
Although related, consistency and comparability are not the same. Comparability is the goal while consistency is
the means of achieving the goal.
Understandability requires that financial information must be comprehensible or intelligible if it is to be useful but
complex matters cannot be eliminated. Because of this, the framework requires the users to have a reasonable
knowledge of business and economic activities and must review and analyze the information diligently.
Timeliness means having information available to decision makers in time to influence their decisions. In other
words, timeliness requires that financial information must be available or communicated early enough when a
decision is to be made. Relevant information may lose its relevance if there is undue delay in its reporting.

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CONCEPTUAL FRAMEWORK FOR
FINANCIAL REPORTING

The cost constraint

Cost is a pervasive constraint on the information that can be provided by financial reporting. In other words, the cost
constraint is a consideration of the cost incurred in generating financial information against the benefit to be
obtained from having the information. The benefit derived from the information should exceed the cost incurred in
obtaining the information.
Chapter 3: The 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:
1) Statement of Financial Position (for recognized assets, liabilities and equity)
2) Statement(s) of Financial Performance (for income and expenses)
3) Other Statements and Notes
Reporting Period of Financial Statements
Financial statements are prepared for a specified period of time or the reporting period. Financial statements also
provide comparative information for at least ONE PRECEDING REPORTING PERIOD.
Reporting Entity
Reporting entity is an entity who must or chooses to prepare the financial statements and is NOT necessarily a
legal entity.
As a result, we have a few types of financial statements:
a) Consolidated – a parent and subsidiaries report as a single reporting entity.
b) Unconsolidated or Individual – a parent alone provides reports.
c) Combined – reporting entity comprises two or more entities not linked by parent-subsidiary relationship
Chapter 4: Elements of Financial Statements
The elements of financial statements refer to the quantitative information shown in the statement of financial
position and statement of comprehensive income, namely: Assets, Liabilities, Equity, Income and Expense. These
elements are classified into:
Elements directly related to Entity's
Financial Position Financial Performance
Asset Income
Liability Expense
Equity
Assets – a present economic resource controlled by the entity as a result of a past event. An economic resource is
a right that has the potential to produce economic benefits.
The essential characteristics of an asset are:
a) The asset is controlled by the entity.
b) The asset is the result of a past transaction or event.
c) The asset provides future economic benefits.
d) The cost of the asset can be measured reliably.
NOTE: Tangibility and ownership are not essential characteristics of assets. Also, the presence or absence of
expenditure is not necessary in determining the existence of assets.
Liability – is a present obligation of an entity arising from past transaction or event, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits.
The essential characteristics of a liability are:
a) The liability is the present obligation of a particular entity.
b) The liability arises from past transaction or event.
c) The settlement of the liability requires an outflow of resources embodying economic benefits.
NOTE: Identification of payee and certainty of timing of settlement and amount of liability are not essential
characteristics of liabilities.
Equity - is the residual interest in the assets of the entity after deducting all of its liabilities.
Income – is the increase in economic benefit during the accounting period in the form of an inflow or increase of
asset or decrease of liability that results in increase in equity, other than contribution from equity participants.
Simply stated, income is an inflow of future economic benefit that increases equity, other than contribution by
owners.
NOTE: Income encompasses both revenue and gains

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CONCEPTUAL FRAMEWORK FOR
FINANCIAL REPORTING

REVENUE VS. GAIN

Revenue Gain
(a) Arises from Ordinary course of business Incidental or peripheral operations
(b) Presentation in the FS At gross amount At net amount (net of direct cost)
Comprehensive income is classified into two: Profit or Loss (P/L) or Other Comprehensive Income (OCI).
General rule is, an income is part of profit or loss unless it will be classified as OCI which are as follows:
1. Unrealized gain or loss on financial asset measured at fair value through other comprehensive income
2. Gain or loss from translating the financial statements of a foreign operation
3. Revaluation surplus during the year
4. Unrealized gain or loss from derivative contracts designated as cash flow hedge
5. Remeasurements of defined benefit plan including actuarial gain or loss on defined benefit obligation
Expense – is the decrease in economic benefit during the accounting period in the form of outflow or decrease in
asset and increase in liability that results in decrease in equity, other than distribution to equity participants.
Chapter 5: Recognition and Derecognition
Recognition is a term which means the process of reporting an asset, liability, income or expense on the face of the
financial statements of an entity
Recognition criteria:
a) It meets the definition of an asset, liability, equity or expense and
b) Recognizing it would provide useful information

The recognition of an item may not provide useful information if:

a) It is uncertain whether an asset or liability exists
b) An asset or liability exists but the probability of an inflow or outflow of economic benefits is low.
NOTE:
a) The recognition criteria above apply to assets, liabilities, income and expense. There is no Equity
Recognition Principle / Criteria because it is a residual interest.
b) The expense recognition principle is the application of the matching principle. Accordingly, the
matching principle requires that those costs and expenses incurred in earning a revenue should be
reported in the same period.
c) Expenses are incurred in conformity with the three applications of the matching principle, namely:
c.1) Cause and effect association - the cause and effect association principle means that "the
expense is recognized when the revenue is already recognized" on the basis of a presumed direct
association of the expense with specific revenue. This is actually the "strict matching concept". Examples:
Cost of sales, warranty expense, sales commissions.
c.2) Systematic and rational allocation - Under the systematic and rational allocation principle, some
costs are expensed by simply allocating them over the periods benefited. Example: Depreciation of PPE,
amortization of intangible assets and depletion of wasting assets.
c.3) Immediate recognition - Under immediate recognition principle, the cost incurred is expensed
outright because of uncertainty of future economic benefits or difficulty of reliably associating certain
costs with future revenue. Examples: officers salaries and most administrative expenses, casualty
losses.
Derecognition is the OPPOSITE of recognition. It is the removal of a previously recognized asset or liability from the
entity’s statement of financial position.

Derecognition occurs when the item no longer meet the definition of an asset or liability, such as when the entity
control of all or part of the asset or no longer has a present obligation for all or part of the liability.

On derecognition, the entity:

(a) derecognizes the assets or liabilities that have expired or have been consumed, collected, fulfilled or
transferred and recognized any resulting income and expenses.
(b) continues to recognize any assets or liabilities retained after the derecognition.
NOTE: Derecognition is NOT appropriate if the entity retains substantial control of a transferred asset.

Chapter 6: Measurement
Measurement is the process of determining the monetary amounts at which the elements of the financial
statements are to be recognized and carried in the statement of financial position and income statement.
The Framework acknowledges that a variety of measurement bases are used today to different degrees and in
varying combinations in financial statements including:

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CONCEPTUAL FRAMEWORK FOR
FINANCIAL REPORTING

Historical cost – This measurement is based on the transaction price at the time of recognition of the element. 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 consideration received to incur the liability minus transaction costs.
Current value – It measures the element updated to reflect the conditions at the measurement date. Current value
measurement bases include the following:
(1) Fair Value – is the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants. Fair value is not an entity specific measurement.
(2) 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. 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.
NOTE: Value in use and fulfilment value DO NOT include transaction costs in acquiring an asset or incurring the
liability but include transactions costs expected to be incurred on the ultimate disposal of the asset or fulfilment of
the liability.
(3) 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 transaction costs that would be incurred on
that date. Current cost of liability is the consideration that would be received for an equivalent liability at the
measurement date minus transaction costs that would be incurred on that date.
NOTE: Current cost and historical cost are ENTRY VALUES while value in use, fulfilment value and fair value are
EXIT VALUES.
The framework points out that it can be appropriate to measure some components of equity directly but it is not
possible to measure total equity directly.
Chapter 7: Presentation and Disclosure
Information about assets, liabilities, equity, income and expenses is communicated through presentation and
disclosure in the financial statements.

Effective communication makes information more useful. Effective communication requires:

(1) Focusing on presentation and disclosure objectives and principles rather than on rules.
(2) Classifying information by grouping similar items and separating dissimilar items.
(3) Aggregating information in a manner that it is not obscured either by excessive detail or by excessive
summarization.
NOTE: Classification refers to the sorting of assets liabilities, equity, income or expenses with similar nature,
function and measurement basis for presentation and disclosure purposes. Aggregation is the adding together of
assets, liabilities, equity, income or expenses that have shared characteristics and are included in the same
classification.

Chapter 8: Concepts of Capital and Capital Maintenance

Financial Capital Physical Capital
Concept of capital Invested money or invested purchasing power Productive capacity of the entity
Adopted by most entities? ✔ x
Measurement Historical cost Current cost

The "capital maintenance approach" or net assets approach means that net income occurs only after the capital
used from the beginning of the period is maintained.

Under the financial capital concept, net income occurs "when the financial or nominal amount of the net assets at
the end of the year exceeds the financial or nominal amount of the net assets at the beginning of the period, after
excluding distributions to and contributions by owners during the period."

Under the physical capital concept, net income occurs "when the physical productive capital of the entity at the end
of the year exceeds the physical productive capital at the beginning of the period, also after excluding distributions
to and contributions from owners during the period."

Most of the problem solving questions regarding capital maintenance approach is based on financial capital. With
such, the template below might be of help in answering.
Net changes in equity xxx
Less: Additional investment by owners (xxx)
Add: Withdrawals and distributions to owners xxx
Comprehensive income xxx
Less: Other comprehensive income (xxx)
Add: Other comprehensive loss xxx
Profit or Loss / Net Income xxx

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