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FINANCIAL ACCOUNTING AND REPORTING

The Conceptual Framework for Financial Reporting

PURPOSE AND STATUS OF THE FRAMEWORK

The IASB Framework for the Preparation and Presentation of Financial Statements describes the
basic concepts by which financial statements are prepared. The Framework serves as a guide to
the FRSC in developing accounting standards and as a guide to resolving accounting issues that
are not addressed directly in Philippine Accounting Standards or Philippine Financial Reporting
Standards or Interpretations. The purpose of the framework as outlined is to:
a) To assist the Board in the development of future IFRSs and in its review of existing
IFRSs
b) To assist the Board in promoting harmonisation 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
IFRSs
c) To assist national standard-setting bodies in developing national standards;
d) To assist preparers of financial statements in applying IFRSs and in dealing with
topics that have yet to form the subject of an IFRS
e) To assist auditors in forming an opinion on whether financial statements comply with
IFRSs
f) To assist users of financial statements in interpreting the information contained in
financial statements prepared in compliance with IFRSs
g) To provide those who are interested in the work of the IASB with information about
its approach to the formulation of IFRSs.
This Conceptual Framework is not an IFRS and hence does not define standards for any particular
measurement or disclosure issue.

Scope of the Framework:

The Objective of general purpose financial reporting;
Qualitative characteristics of financial information
Underlying assumption
The definition, recognition and measurement of the elements of the financial
statements
Concepts of capital and capital maintenance.
The Objective of Financial Reporting
 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.

 General purpose financial reports provide information about the financial position of a
reporting entity, which is information about the entity’s economic resources and the claims
against the reporting entity. Financial reports also provide information about the effects of
transactions and other events that change reporting entity’s economic resources and
claims.

Financial performance reflected by accrual accounting

Accrual accounting depicts the effects of transactions and other events and circumstances on a
reporting 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

These characteristics are the attributes that make the information in financial statements
useful to investors, creditors, and others. The Framework identifies “fundamental” and
“enhancing” qualitative characteristics:

Fundamental Characteristics

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Relevance - Information in financial statements is relevant when it is capable of making a

difference in the decisions made by the users.

Ingredients of relevance:
 Predictive Value – Information can help users increase the likelihood of correctly
predicting or forecasting the outcome of certain events.
 Feedback Value – Information can help users confirm or correct earlier expectations.

Note that the predictive and confirmatory roles of information are interrelated.
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. In other words, 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.

Faithful Representation - Financial reports represent economic phenomena in words and

numbers. To be useful, financial information must not only represent relevant phenomena, but it
must also faithfully represent the phenomena that it purports to represent.

Ingredients of Faithful Representation

 Complete - A complete depiction includes all information necessary for a user to
understand the phenomenon being depicted, including all necessary descriptions and
explanations.
 Neutral - A neutral depiction is without bias in the selection or presentation of financial
information. A neutral depiction is not slanted, weighted, emphasised, de-emphasised or
otherwise manipulated to increase the probability that financial information will be received
favourably or unfavourably by users
 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.

Enhancing qualitative characteristics

Comparability, verifiability, timeliness and understandability are qualitative characteristics that

enhance the usefulness of information that is relevant and faithfully represented.

 Comparability is the qualitative characteristic that enables users to identify and understand
similarities in, and differences among, items.

 Verifiability - 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, although not necessarily complete
agreement, that a particular depiction is a faithful representation.

 Timeliness - means having information available to decision-makers in time to be capable

of influencing their decisions.

 Understandability - Classifying, characterising and presenting information clearly and

concisely makes it understandable.

The cost constraint on useful financial reporting

Cost is a pervasive constraint on the information that can be provided by financial reporting.
Reporting financial information imposes costs, and it is important that those costs are justified by
the benefits of reporting that information. There are several types of costs and benefits to consider.
Underlying Assumptions (Postulates)
The Framework sets Going Concern as the only underlying assumption meaning, financial
statements presume that an enterprise will continue in operation indefinitely or, if that presumption
is not valid, disclosure and a different basis of reporting are required.

The new FRSC conceptual framework mentions going concern as the only underlying assumption
(previously Accrual was included). However, it is widely believed that inherent traits of the
financial statements are the basic assumptions of:

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 Accounting Entity. The business is separate from the owners, managers, and employees
who constitute the business. Therefore transactions of the said individuals should not be
included as transactions of the business.
 Time Period. Financial reports are to be prepared for one year or a period of twelve
months.
 Monetary unit. There are two aspects under this assumption

a. Quantifiability of the peso, meaning that the elements of the financial statements
should be stated under one unit of measure which is the Philippine Peso.

b. Stability of the peso, means that there is still an assumption that the purchasing power
of the peso is stable or constant and that instability is insignificant and therefore
ignored.

The Elements of Financial Statements

Financial statements portray the financial effects of transactions and other events by grouping
them into broad classes according to their economic characteristics. These broad classes are
termed the elements of financial statements.

The elements directly related to financial position and their definition according to the
framework are:

Asset- A resource controlled by the enterprise as a result of past events and from which
future economic benefits are expected to flow to the enterprise.

Liability- A present obligation of the enterprise arising from past events, the settlement of
which is expected to result in an outflow from the enterprise of resources embodying
economic benefits.

Equity- The residual interest in the assets of the enterprise after deducting all its liabilities.

The elements directly related to performance and their definition according to the framework
are:
Income- Increases in economic benefits during the accounting period in the form of inflows
or enhancements of assets or decreases of liabilities that result in increases in equity, other
than those relating to contributions from equity participants.

Expense- Decreases in economic benefits during the accounting period in the form of
outflows or depletions of assets or incurrence of liabilities that result in decreases in equity,
other than those relating to distributions to equity participants.

Recognition of the Elements of Financial Statements

Recognition is the process of incorporating in the financial statements an item that meets the
definition of an element and satisfies the following criteria for recognition:
It is probable that any future economic benefit associated with the item will flow to or from
the enterprise; and
The item's cost or value can be measured with reliability.

Based on these general criteria:

An asset is recognized in the statement of financial position when it is probable that the
future economic benefits will flow to the enterprise and the asset has a cost or value that
can be measured reliably.
A liability is recognized in the statement of financial position when it is probable that an
outflow of resources embodying economic benefits will result from the settlement of a
present obligation and the amount at which the settlement will take place can be measured
reliably.
Income is recognized in the when an increase in future economic benefits related to an
increase in an asset or a decrease of a liability has arisen that can be measured reliably.
This means, in effect, that recognition of income occurs simultaneously with the recognition
of increases in assets or decreases in liabilities

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Expenses are recognized when a decrease in future economic benefits related to a
decrease in an asset or an increase of a liability has arisen that can be measured reliably.
This means, in effect, that recognition of expenses occurs simultaneously with the
recognition of an increase in liabilities or a decrease in assets.

Measurement of the Elements of Financial Statements

Measurement involves assigning monetary amounts at which the elements of the financial
statements are to be recognized and reported. The Framework acknowledges that a variety of
measurement bases are used today to different degrees and in varying combinations in financial
statements, including:
Historical cost
Current cost
Net realizable (settlement) value
Present value (discounted)
Historical cost is the measurement basis most commonly used today, but it is usually combined
with other measurement bases. The Framework does not include concepts or principles for
selecting which measurement basis should be used for particular elements of financial statements
or in particular circumstances. The qualitative characteristics do provide some guidance in this
matter.

Concepts of Capital
 Financial concept of capital - capital is synonymous with net assets of the enterprise.
This is the concept of capital adopted by most enterprises. A financial concept of capital,
e.g. invested money or invested purchasing power, means capital is the net assets or
equity of the entity.

 Physical concept of capital – capital is regarded as the productive capacity of the

enterprise based on, for example, units of output per day.

Concepts of Capital Maintenance

 Financial capital maintenance – Under this concept, a profit is earned only if the financial
(or money) amount of the net assets at the end of the of the period exceeds the financial (or
money) amount of the net assets at the beginning of the period, after excluding any
distributions to, and contributions from, owners during the period.

 Physical capital maintenance – Under this concept, a profit is earned only if the physical
productive capacity (or operating capability) of the enterprise (or the resources need to
achieve that capacity) at the end of the period exceeds the physical productive capacity at
the beginning of the period, after excluding any distributions to, and contributions from,
owners during the period.

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