Financial Accounting 2

⮚ The Conceptual Framework

⮚ Gripping GAAP: Chapter 2

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The Conceptual Framework

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 The Status of the Conceptual Framework

• not an IFRS!
• forms the basis of IFRSs.
• may not override an IFRS

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Concepts in the framework:
1. Objective of general-purpose financial reporting
2. Qualitative characteristics of useful information
3. Financial statements and the reporting entity
4. Elements of financial statements
5. Recognition and derecognition
6. Measurements bases
7. Presentation & disclosure
8. Capital and capital maintenance

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 PURPOSE OF CONCEPTUAL FRAMEWORK:

• Assists IASB to develop new IFRS and review existing IFRS;

• Assists preparers of AFS where there is no IFRS;
• Assists all parties in understanding and interpreting the AFS

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What is the objective of general purpose financial
reporting?

⮚ 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.

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The following information is required in order to make
decisions:

oEconomic resources (assets) of the entity, claims

against the entity (liabilities and equity) and changes to
these resources;

ohow efficiently and effectively the entity’s

managing/governing board have discharged their
responsibilities.

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Economic resources and claims: Financial position
o Liquidity
o Solvency
o Funding structure
o Financial strengths & weaknesses

Economic resources and claims: Financial position

Changes in economic resources (A's) & claims (Ls & Eq)
are caused by either/both:
o financial performance (e.g. profits)
o other reasons

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 2 methods of presenting financial performance

ACCRUAL ACCOUNTING CASH ACCOUNTING

involves recording transactions & involves recording the effects of these
events in the period in which they transactions and events in the
occur and not on a cash basis (even period in which the cash flows occur
if cash flow is in another period)

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 Qualitative characteristics:

Fundamental Enhancing

less critical, but highly

Critical to the
desirable to the
representation of representation of the
financial financial information
information

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 FUNDAMENTAL

Relevance Faithful
- Predictive value Representation
- Confirmatory value

Relevant when it influences -Complete

the economic decisions of -Neutral
users (materiality/timeliness) -Free from error
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 Comparability: Verifiability:
Other accounting Authenticating the info
periods, similar in the AFS by using
entities etc independent tools to
calculate the same

ENHANCING
The enhancing
characteristics are less
critical, but highly
desirable to the
representation of the
financial information Understandability:
Timeliness: Info in the AFS is
Information is available prepared in a clear and
in time to influence accurate manner for
decisions of users ease of undertanding
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3. Financial statements and the reporting entity
Objective and scope:
- Provide financial information to users of the financial statements
regarding the entitys assets, liabilities, equity, income and expenses

Where is the financial information?

• Statement of financial position by recognising assets, liabilities and
equity;
• Statement of financial performance by recognising income and
expenses;
• Other statements and notes

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Reporting period:

• Specific period.
• Comparative information; consistency of preparation, if accounting
policies/standards have changed then this is justified.

Going concern assumption:

• The entity is a going concern and will continue to be a GC for the

foreseeable future.
• If not a GC, prepare on a different basis and disclose.

THE COST CONSTRAINT

● Benefit should justify the cost

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 The Elements of the Financial Statements

Elements

Financial
Financial
Position
Performance

Assets Liabilities Equity Income Expenses

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 EXAM
Recognize an element when it; TECHNIQUE
1. Meets the definition
2. Satisfies the recognition criteria

DEBITS CREDITS

Assets Liabilities

Expenses Equity

Income

Deferred income/negative asset

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 DEFINITION: ASSET

A present economic resource controlled by the entity as a result of past

events

PRESENT ECONOMIC RESOURCE: An economic resource is a right that has

the potential to produce economic benefits

• Potential to contribute,
directly or indirectly, to the • Right corresponds to an
flow of cash and cash obligation of another party
equivalents to the entity • Right that does NOT
correspond to an obligation of
• Extinguishing liabilities another party
• Avoid cash outflows
• Receiving of cash 17
DEFINITION: ASSET

CONTROLLED BY THE ENTITY:

For the entity to have control, it must have the present ability to both;

o Direct the use of the economic resources

o Obtain the benefits that arise from the economic resources directly or indirectly
o Prevent others from directing the use and obtaining the benefits
o Ability to enforce legal rights

AS A RESULT OF PAST EVENTS:

• Before year end

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DEFINITION: LIABILITY
A present obligation of the entity to transfer an economic resource, as a result of
past events.

OBLIGATION (CONSTRUCTIVE/LEGAL):
• Duty/responsibility that an entity has no practical ability to avoid.
• Established by contract, legislation and legally enforceable.

arises from the entity's

actions, through which it
has indicated to others that
it will accept certain
responsibilities, and as a
Constructive result has created an
expectation that it will
discharge those
responsibilities

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 arises from the entity

Legal
entering into a legal
contract/or by any
other legal authority

TRANSFER ECONOMIC RESOURCE:

• POTENTIAL to transfer ER.
Potential – does not need to be certain or even likely

Some examples of transfer of ER:

• Pay cash
• Transfer other assets
• Exchange economic resources with another party on unfavourable terms
• Provide services

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DEFINITION: LIABILITY

PAST EVENTS:
• Entity has already obtained economic benefits
• As a consequence, will have to transfer the economic
resources (things happening in the past that result in present
obligation)

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UNIT OF ACCOUNT

Rights or group of rights to which recognition & measurements principles are

applied. This provides us with more useful information

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DEFINITION: EQUITY
Residual interest in the assets of an enterprise after deducting all the liabilities.

DEFINITION: INCOME
Increase in assets or decreases in liabilities that result in increases in equity, other
than those relating to contributions from holders of equity claims.

DEFINITION: EXPENSES
Decrease in assets or increases in liabilities that result in decreases in equity, other
than those relating to distributions to holders of equity claims.

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 An element may only be
recognised if it meets both the:
Recognition criteria ⮚ Definition and the
⮚ Recognition criteria

o Once the definition of the element is met, the item will

ONLY be recognized if the recognition provides users with
information that is:
- Relevant; and
- Faithfully Represented

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RELEVANCE (recognition criteria)

1) Existence uncertainty
- It is uncertain whether an asset or liability exists
- Uncertainty should still be disclosed

2) Low probability of inflow

- The asset or liability exists but the probability of
inflow or outflow
- Disclose relevant information in the notes

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FAITHFUL REPRESENTATION (recognition criteria)

1) Measurement uncertainty
- Estimations are the norm in accounting
- If level of uncertainty is so high, this may question
the faithful representation of the item, then
disclosure is required(explanatory information or
disclosure)

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 Example 1:
On 1 July 2023, Olympus Limited purchased a new design patent for t-shirts that will be used by all
participants in the 2024 Olympics. These t-shirts will have the Olympic badge on it, designed in a new,
innovative way. The patent was purchased for R5 million and this will give Olympus Limited the exclusive
right to manufacture and distribute these t-shirts internationally.

Olympus Limited will see an increase in sales by R1.5million per annum as a result of the production and
distribution of the t-shirts with the new Olympic badge design.

The financial year-end of Olympus Limited is 30 June.

Required:
Discuss, i.t.o the Conceptual Framework for Financial Reporting, how the patent should be treated in the
books of Olympus Limited for the year ended 30 June 2024.

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SOLUTION:

An asset is a present economic resource, controlled by the entity as a result of past events

1.Present economic resource

• Right
Olympus limited is the legal owner of the patent as they have purchased it, therefore they have a legal right
to use it (manufacture and distribute the t-shirt with the new design).

• Potential to produce economic benefits

The t-shirt produced under the patent will be sold and will result in sales income thus, the trade-mark has
the potential to produce economic benefits.

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2. Controlled by the entity

The patent can only be used Olympus Limited due to them having the exclusive right to manufacture and
distribute, therefore, they have the present ability to direct the use of it.

Further, the exclusive right to the patent prevents other people from manufacturing it.

Revenue from sales made belong to Olympus Limited (they are entitled to it).

Therefore, Olympus Limited has full control over the patent.

3.Past event:

The past event is the purchasing of the contract (1 July 2023).

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RECOGNITION:

Relevant information:
The existence uncertainty of the asset is NOT LOW as it was acquired at a cost – therefore, it exists.
As per market research, the probability of future economic benefits is not low as a sales will increase by
R1.5 million due to the manufacture and sale of the t-shirts under this trademark.

Faithful representation
The patent was purchased for R5 million, therefore, it can be reliably measured (no measurement
uncertainty exists).

CONCLUSION:
The patent meets the definition and recognition criteria and can be recognised as an asset in the financial
statements of Olympus Limited Limited for the year ended 30 June 2024.

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 DERECOGNITION:

removal or part removal of a recognised asset or Par 5.26

liability from the statement of financial position.

ASSET LIABILITY
When the entity When the entity
loses control (or no longer has a
part thereof) present obligation
(or part thereof)

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 MEASUREMENT BASIS:

HISTORICAL COST CURRENT VALUE

Asset: value of the cost o Fair value

incurred in acquiring the
asset o Value in use
Liability: value of
consideration received or o Current cost
incurred less transaction
costs
A way to apply the historical
cost basis, is to measure the
asset/liability at amortised
cost.

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When deciding which measurement basis to use, the
following factors are taken into consideration:
o Relevance
o Faithful representation
o Enhancing qualitative characteristics and the cost constraint
o More than one measurement basis

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PRESENTATION & DISCLOSURE:

classification relevance
& faithful

representation

aggregation

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 Concepts of capital and capital maintenance:

Financial concept Financial capital Physical concept Physical capital

of capital maintenance of capital maintenance

Capital is = Capital is = Physical productive

net assets Profit is earned production capacity of the
when the financial capacity of entity at the end of
or equity the period exceeds
amount of net
of an entity assets at year
an entity the physical
end exceeds productive
capacity at the
amount at
beginning of the 35
beginning of year
period