CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

All the concepts, principles, conventions, laws, rules and regulations that are used to prepare and present financial statements are
known as Generally Accepted Accounting Principles or GAAP.
‘Generally accepted accounting principles’ vary from country to country, because each country has its own legal and regulatory system.
The way in which businesses operate also differs from country to country. (For example, there is US GAAP, UK GAAP and Nigerian GAAP).
Many countries have now adopted International Financial Reporting Standards or IFRSs, sometimes called international accounting
standards. It is now fairly common to refer to the totality of the rules as IFRS or IAS.
The meaning of a conceptual framework
A conceptual framework is a system of generally accepted theoretical principles which form the frame of reference for financial
reporting.
A conceptual framework is a system of concepts and principles that form the basis (i.e underpin) for the development of new reporting
practices and evaluation of existing ones. These concepts and principles should be consistent with one another.
The International Accounting Standards Committee (the predecessor of the IASB) issued a conceptual framework document in 1989.
This was called the Framework for the Preparation and Presentation of Financial Statements and was adopted by the IASB.
The new conceptual framework was developed on a chapter-by-chapter basis. The complete new conceptual framework was published
in March 2018 and is called” The conceptual framework for financial reporting”
IMPORTANCE OR PURPOSE OF THE CONCEPTUAL FRAMEWORK
1. It assists the IASB in the development of quality accounting standards and in the review of the existing accounting standards.
2. It strengthens the credibility of financial reporting and accounting profession.
3. It assists the IASB in promoting harmonization of financial reporting standards.
4. It prevents contradictions and inconsistency between basic concepts, which helps to reduce ambiguity.
5. It assists the preparers of financial statements in applying IFRS and dealing with issues not yet covered by IFRS.
CONTENTS AND SCOPE OF CONCEPTUAL FRAMEWORK
In March 2018, the revised conceptual framework was developed on a chapter-by-chapter basis and the include:
Chapter 1: The objectives of general purpose financial statements.
Chapter 2: Qualitative characteristics of useful financial information.
Chapter 3: Financial statements and the reporting entity.
Chapter 4: The elements of financial statements.
Chapter 5: Recognition and derecognition.
Chapter 6: Measurement
Chapter 7: Presentation and disclosure
Chapter 8: Concepts of capital and capital maintenance.

Chapter 1: Objective of general purpose financial statements

The objective of general-purpose financial reporting forms the foundation of the Conceptual Framework. Other aspects of the
Conceptual Framework flow logically from the objective.
The objective
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.
‰ In order to make these decisions the users need information to help them assess the prospects for future net cash inflows to
an entity.
‰ In order to assess an entity’s prospects for future net cash inflows, users need information about the resources of the entity;
claims against the entity; and how efficiently and effectively the entity’s management have discharged their responsibilities to use
the entity’s resources. (This information is also useful for decisions by those who have the right to vote on or otherwise influence
management performance).
CHAPTER 2: QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION
Information must have certain characteristics in order for it to be useful for decision making.
The IASB Conceptual Framework describes:
 fundamental qualitative characteristics.
 enhancing qualitative characteristics.
Fundamental qualitative characteristics:
‰ Relevance
‰ Faithful representation.
The enhancing characteristics that enhance the usefulness of information that is relevant and a faithful representation are:
‰ Comparability.
‰ Verifiability
‰ Timeliness;
‰ Understandability
1. Relevance
Information must be relevant to the decision-making needs of users. Information is relevant if it can be used for predictive and/or
confirmatory purposes.
‰ It has predictive value if it helps users to predict what might happen in the future.
‰ It has confirmatory value if it helps users to confirm the assessments and predictions they have made in the past.
2. Faithful representation
The relevance of information is affected by its materiality. Information is material if omitting it or misstating it could influence
decisions that users make on the basis of financial information about a specific reporting entity.
‰ Materiality is an entity-specific aspect of relevance based on the nature or magnitude (or both) of the items to which the
information relates in the context of an individual entity’s financial report.
A perfectly faithful representation would have three characteristics. It would be:
‰Complete – the depiction includes all information necessary for a user to understand the phenomenon being depicted,
including all necessary descriptions and explanations.
‰ Neutral – the depiction is without bias in the selection or presentation of financial information.
‰ Free from error – where 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.

Enhancing qualitative characteristics:

Comparability: it is the qualitative characteristic that enables users to identify and understand similarities in, and differences among,
items Information about a reporting entity is more useful if it can be compared with similar information about other entities and with
similar information about the same entity for another period or another date.
Consistency is related to comparability but is not the same. Consistency refers to the use of the same methods for the same items, either
from period to period within a reporting entity or in a single period across entities. Consistency helps to achieve the goal of
comparability.
Verifiability
This quality helps assure users that information faithfully represents the economic phenomena it purports to represent. Verifiability
means that different knowledgeable and independent observers could reach consensus that a particular depiction is a faithful
representation.
Timeliness
This means having information available to decision-makers in time to be capable
of influencing their decisions.
Understandability
Information is made understandable by classifying, characterizing and presenting it in a clear and concise manner.
Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and
analyses the information diligently.

Chapter 3: Financial statements and the reporting entity

The objective of financial statements is to provide financial information about the reporting entity’s assets, liabilities, equity, income and
expenses that is useful to users of financial statements in assessing the prospects for future net cash inflows to the reporting entity and
in assessing management’s stewardship of the entity’s economic resources.
That information is provided:
‰ In the statement of financial position, by recognizing assets, liabilities and equity;
‰ In the statement(s) of financial performance, by recognizing income and expenses.
‰ In other statements and notes, by presenting and disclosing information about cashflows; recognized and unrecognized assets and
liabilities, equity, income and expenses; contributions from holders of equity claims and distributions to them; and the methods,
assumptions and judgements used in estimating the amounts presented or disclosed, and changes in those methods, assumptions and
judgements.
Reporting period
Financial statements are prepared for a specified period of time (reporting period) and provide information about:
‰ Assets and liabilities (including unrecognized assets and liabilities) and equity that existed at the end of the reporting period, or
during the reporting period.
‰ income and expenses for the reporting period.
Going concern assumption
Financial statements are normally prepared on the assumption that the reporting entity is a going concern and will continue in
operation for the foreseeable future.
It is assumed that the entity does not intend or need to enter liquidation or to cease trading. If that is not the case, the financial
statements may have to be prepared on a different basis and the basis used must be described.
The reporting entity
A reporting entity is one that prepares financial statements.
A reporting entity can be a single entity or a portion of an entity or can comprise
more than one entity (e.g., a group).
A reporting entity is not necessarily a legal entity.
It can be difficult to determine the boundary of a reporting entity that is not a legal entity. In this case the boundary is determined by
taking into account the information needs of the primary users.
CHAPTER 4: ELEMENTS OF FINANCIAL STATEMENTS:
This is covered by chapter 4 of The IASB Conceptual Framework.
The IASB Framework discusses the five elements of financial statements:
‰ For reporting financial position: assets, liabilities and equity; and
‰ For reporting financial performance: income and expenses.
ASSETS
An 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.
  Rights can take many forms including the right to receive cash, exchange resources on favourable terms, rights over physical
objects and rights to use intellectual property.
In order to be an asset, rights must both have the potential to produce economic benefits for the entity beyond those available to all
other parties and be controlled by the entity. Therefore, not all rights are assets (e.g., right to use public infrastructure is not an asset)
Control
Control links an economic resource to an entity
Control is the ability to obtain economic benefits from the asset, and to restrict
the ability of others to obtain the same benefits from the same item.
LIABILITIES
A liability is a present obligation of the entity to transfer an economic resource as a result of past events.
For a liability to exist, three criteria must all be satisfied:
‰ 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.
Obligation
An obligation is a duty or responsibility that an entity has no practical ability to avoid.
An obligation is always owed to another party (or parties) but it is not necessary to know the identity of the party (or parties) to whom
the obligation is owed.
Obligations might be established by contract or other action of law or they might be constructive. A constructive obligation arises from
an entity’s customary Transfer of economic resource practices, published policies or specific statements when the entity has no practical
ability to act in a manner inconsistent with those practices, policies or
statements.
An obligation must have the potential to require the entity to transfer an economic resource to another party (or parties).
An obligation can meet the definition of a liability even if the probability of a transfer
Equity
Equity is the residual interest in an entity after the value of all its liabilities has been deducted from the value of all its assets.
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.
The concept of income includes both revenue and gains.
‰ Revenue is income arising in the course of the ordinary activities of the entity. It includes sales revenue, fee income, royalties income,
income and income from investments (interest and dividends). Revenue is recognized in the statement of profit or loss.
‰ Gains represent other items that meet the definition of income.
Income includes gains on the disposal of non-current assets.
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.
Expenses include:
‰ Expenses arising in the normal course of activities, such as the cost of sales and other operating costs, including depreciation of non-
current assets.
Expenses result in the outflow of assets (such as cash or finished goods inventory) or the depletion of assets (for example, the
depreciation of noncurrent assets).
‰ Losses include for example, the loss on disposal of a non-current asset, and losses arising from damage due to fire or flooding. Losses
are usually reported as net of related income.
Financial performance is measured by profit or loss and gains or losses recognized in other comprehensive income. Profit is measured
as income less expenses.

CHAPTER 5: RECOGNITION AND DERECOGNITION

Recognition
This is covered by chapter 5 of The IASB Conceptual Framework.
Recognition is the process of capturing for inclusion in the statement of financial position or the statement(s) of financial performance
an item that meets the definition of one of the elements of financial statements.
Recognition involves depicting the item in words and by a monetary amount.
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.
Recognition links the elements as the recognition of one item (or a change in its carrying amount) requires the recognition or
derecognition of another item. For example, revenue is recognized at the same time as the corresponding receivable.
Recognition criteria
Only items that:
‰ Meet the definition of an asset, a liability or equity are recognized in the statement of financial position.
‰ Meet the definition of income or expenses are recognized in the statement(s) of financial performance.
However, not all items that meet the definition of one of those elements are recognized.
An asset or liability is recognized only if recognition of that asset or liability and of any resulting income, expenses or changes in equity
provides users of financial statements with information that is useful, i.e. with:
‰ Relevant information about the asset or liability and about any resulting income, expenses or changes in equity; and
‰ a faithful representation of the asset or liability and of any resulting income, expenses or changes in equity.
Information about an asset or liability may not be relevant when there is uncertainty about its existence or when there is only a low
probability of an inflow or outflow of economic benefits in respect of that asset or liability.
Commentary on the new recognition criteria
Under the previous framework, an asset or liability would be recognized when:
‰ it meets the definition of an element: and
‰ satisfies the following two criteria:
1. It must be probable that the future economic benefit associated with the item will flow either into or out of the entity.
2. The item should have a cost or value that can be measured reliably.
The IASB’s deliberations on this and other projects have led them to the conclusion that the probability of an inflow or outflow is not a
recognition attribute but a measurement attribute.
The practical impact of the change in focus of the criteria will be negligible but is believed to provide a stronger conceptual foundation to
the recognition process.
Derecognition
Derecognition is the removal of all or part of a recognized asset or liability from an entity’s statement of financial position.
 This normally occurs when that item no longer meets the definition of an asset or of a liability:
 for an asset, derecognition normally occurs when the entity loses control of all or part of the recognized asset; and
 for a liability, derecognition normally occurs when the entity no longer has a present obligation for all or part of the recognized
liability.

CHAPTER 5: MEASUREMENT
Measurements of elements of financial statements
The Conceptual Framework allows two principal measurement bases that are used for the elements of financial statements.
These include:
 Historical cost. Historical cost provides monetary information about assets, liabilities and related income and expenses, using
information derived, from the price of the transaction or other event that gave rise to them. It does not reflect changes in values,
except to the extent that those changes relate to impairment of an asset or a liability becoming onerous.
The historical cost of an asset when it is acquired or created is the value of the costs incurred in acquiring or creating the asset,
comprising the consideration paid to acquire or create the asset plus transaction costs. The historical cost of a liability when
it is incurred or taken on is the value of the consideration received to incur or take on the liability minus transaction costs.
Current value: measures provide monetary information about assets, liabilities and related income and expenses, using information
updated to reflect conditions at the measurement date. Because of the updating, current values of assets and liabilities reflect changes,
since the previous measurement date, in estimates of cash flows and other factors reflected in those current values. The current value of
an asset or liability is not derived, even in part, from the price of the transaction or other event that gave rise to the asset or liability
Current value measurement bases include:
(a) fair value;
(b) value in use for assets and fulfilment value for liabilities
(c) current cost.
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 at the measurement date.
Fair value reflects the perspective of market participants - participants in a market Measurements of elements of financial statements.
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.
Those amounts of cash or other economic resources include not only the amounts to be transferred to the liability counterparty, but also
the amounts that the entity expects to be obliged to transfer to other parties, to enable it to fulfil the liability.
The 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. The current cost of a liability is the
consideration that would be received for an equivalent liability at the measurement date minus the transaction costs that would be
incurred at that date.

Factors to be considered when considering measurement basis:

1. Nature of the information
2. Usefulness of the information
3. Other factors, including the cost constraints and with reference to the enhancing qualitative characteristics.

CHAPTER 7: PRESNTATION AND DISCLOSURE

A reporting entity communicates information about its assets, liabilities, equity, income and expenses by presenting and disclosing
information in its financial statements.
Effective communication of information in financial statements makes that information more relevant and contributes to a faithful
representation of an entity’s assets, liabilities, equity, income and expenses. It also enhances the understandability and comparability of
information in financial statements.
Effective communication of information in financial statements requires:
(a) Focusing on presentation and disclosure objectives and principles rather than focusing on rules.
(b) Classifying information in a manner that groups similar items and separates dissimilar items.
(c) Aggregating information in such a way that it is not obscured either by unnecessary detail or by excessive aggregation.
Presentation and disclosure objectives and principles :
To facilitate effective communication of information in financial statements, when developing
presentation and disclosure requirements in Standards, a balance is needed between:
(a) giving an entity the flexibility to provide relevant information that faithfully represents the
entity’s assets, liabilities, equity, income and expenses; and
(b) requiring information that is comparable, both from period to period for a reporting entity
and in a single reporting period across entities.

CHAPTER 8 : CONCEPT OF CAPITAL AND CAPITAL MAINTENANCE

The Conceptual Framework states that there are two concepts of capital:
1. A financial concept of capital
2. A physical concept of capital.
Different systems of accounts used different capital maintenance concepts. The choice of capital maintenance has a profound effect on
the measurement of profit.
Financial capital maintenance
With the financial concept of capital maintenance, a profit is not earned during a period unless the financial value of equity at the end of
the period exceeds the financial value of equity at the beginning of the period (after adjusting for equity capital raised or distributed).
Historical cost accounting is based on the concept of money financial capital maintenance. Under this concept, an entity makes a profit
when its closing equity exceeds its opening equity measured as the number of units of currency at the start of the period. Note that this
is a separate issue from asset valuation.
Assets could be revalued during the period, but this would have no effect on the opening capital position.
An alternative view of financial capital maintenance is used in constant purchasing power accounting. This system is based on the
concept of real financial capital maintenance. Under this concept, an entity makes a profit when its closing equity exceeds opening
equity remeasured to maintain its purchasing power.
This requires the opening equity to be uplifted by the general inflation rate. This is achieved by a simple double entry.
Physical capital maintenance
A physical concept of capital is that the capital of an entity is represented by its productive capacity or operating capability. Where a
physical concept of capital is used, the main concern of users of the financial statements is with the maintenance of the operating
capability of the entity.
With a physical concept of capital maintenance, a profit is not earned during a period unless (excluding new equity capital raised during
the period and adding back any distribution of dividends to shareholders) the operating capability of the business is greater at the end
of the period than at the beginning of the period.