Summary Notes for Conceptual Framework

Conceptual Framework

1. General-Purpose Financial Statements- Provide financial reporting information to a wide variety of users.
Provide the most useful information possible at the least cost.

2. Why do wee need Conceptual Framework?

Answer: To develop a coherent set of standards and rules. To solve new and emerging practical problems.

3. The FASB has issued seven Statements of Financial Accounting Concepts (SFAC) for business enterprises.

SFAC No.1 - Objectives of Financial Reporting (superseded by SFAC No. 8)

SFAC No.2 - Qualitative Characteristics of Accounting Information. (superseded by SFAC No. 8)

SFAC No.3 - Elements of Financial Statements. (superseded by SFAC No. 6)

SFAC No.5 - Recognition and Measurement in Financial Statements.

SFAC No.6 - Elements of Financial Statements (replaces SFAC No. 3).

SFAC No.7 - Using Cash Flow Information and Present Value in Accounting Measurements.

SFAC No.8 - The Objective of General Purpose Financial Reporting and Qualitative Characteristics of Useful
Financial Information (replaces SFAC No. 1 and No. 2)

4. Overview of Conceptual Framework

First Level = Basic Objectives

Second Level = Qualitative Characteristics and

Elements

Third Level = Recognition, Measurement, and

Disclosure Concepts.

5. First Level of Conceptual Framework-

Objective of Financial Reporting- Provide financial information about the reporting entity that is useful to present
and potential equity investors, lenders, and other creditors in making decisions in their capacity as capital
providers.

6. Qualitative Characteristics of Accounting Information- Second Level

Fundamental Qualities

A. Relevance- To be relevant, accounting information must be capable of making a difference in a decision.

A.1 Ingredients of Relevance

A.1.1. PREDICTIVE VALUE- Financial information has predictive value if it has value as an input to predictive
processes used by investors to form their own expectations about the future.
 A.1.2 CONFIRMATORY VALUE- Relevant information also helps users confirm or correct prior expectations.

A1.3. MATERIALITY- Information is material if omitting it or misstating it could influence decisions that users
make on the basis of the reported financial information.

B. Faithful Representation- means that the numbers and descriptions match what really existed or happened.

B.1. Ingredients of FR

B.1.1. Completeness- means that all the information that is necessary for faithful representation is
provided

B.1.2. Neutrality- means that a company cannot select information to favor one set of interested parties
over another.

B.1.3. Free from Error- An information item that is free from error will be a more accurate (faithful)
representation of a financial item.

Enhancing Qualities

A. Comparability- Information that is measured and reported in a similar manner for different companies is
considered comparable.

B. Verifiability -occurs when independent measurers, using the same methods, obtain similar results.

C. Timeliness- means having information available to decision-makers before it loses its capacity to influence
decisions.

D. Understandability is the quality of information that lets reasonably informed users see its significance.

2nd Level- Elements

Concepts Statement No. 6 defines ten interrelated elements that relate to measuring the performance and
financial status of a business enterprise.

“Moment in Time” “Period of Time”

A. Assets A. Investment by owners

B. Liabilities B. Distribution to owners

C. Equity C. Comprehensive income

D.Revenue

E.Expenses

F.Gains

G.Losses

3RD Level- Recognition and Measurement

The FASB sets forth most of these concepts in its Statement of Financial Accounting Concepts No. 5, “Recognition
and Measurement in Financial Statements of Business Enterprises.”

3rd Level- Basic Assumptions

A. Economic Entity – company keeps its activity separate from its owners and other businesses.

B. Going Concern - company to last long enough to fulfill objectives and commitments.
C. Monetary Unit - money is the common denominator.

D. Periodicity - company can divide its economic activities into time periods.

3rd Level- Basic Principles

Measurement Principle – The most commonly used measurements are based on historical cost and fair value.

Issues:

A. Historical cost provides a reliable benchmark for measuring historical trends.

B. Fair value information may be more useful.

Recently the FASB has taken the step of giving companies the option to use fair value as the basis for
measurement of financial assets and financial liabilities. Reporting of fair value information is increasing.

Recognition Principles

A. Revenue Recognition - requires that companies recognize revenue in the accounting period in which the
performance obligation is satisfied.

B. Expense Recognition - “Let the expense follow the revenues.”

Full Disclosure – providing information that is of sufficient importance to influence the judgment and decisions of
an informed user.

Provided through:

A. Financial Statements

B. Notes to the Financial Statements

Supplementary information

3rd Level- Constraints

Cost Constraint – cost of providing information must be weighed against the benefits that can be derived from
using it.

Financial Statement Elements

While the conceptual framework that underlies IFRS is very similar to that used to develop GAAP, the elements
identified and their definitions under IFRS are different. The IASB elements and their definitions are as follows.

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

B. Liabilities. A present obligation of the entity arising from past events, the settlement of which is expected to
result in an outflow from the entity of resources embodying economic benefits. Liabilities may be legally
enforceable via a contract or law, but need not be, i.e., they can arise due to normal business practice or customs.

C. Equity. A residual interest in the assets of the entity after deducting all its liabilities.

D. Income. Increases in economic benefits that result in increases in equity (other than those related to
contributions from shareholders). Income includes both revenues (resulting from ordinary activities) and gains.
E. Expenses. Decreases in economic benefits that result in decreases in equity (other than those related to
distributions to shareholders). Expenses includes losses that are not the result of ordinary activities.

IAS 1- PRESENTATION OF FINANCIAL STATEMENTS

I. Objective of IAS 1- The objective of IAS 1 is to prescribe the basis for presentation of general purpose financial
statements, to ensure comparability both with

A. the entity's financial statements of previous periods and

B. with the financial statements of other entities.

IAS 1 sets out the overall requirements for

the presentation of financial statements,

guidelines for their structure and

minimum requirements for their content

 Applies to all general purpose financial statements based on International Financial Reporting Standards

II. Objective of Financial Statements- To provide information about the financial position, financial performance,
and cash flows of an entity that is useful to a wide range of users in making economic decisions.

III. Components of Financial Statements

A complete set of financial statements should include:

A. Statement of Financial Position ”at the end of the period”,

B. Single Statement of Profit or Loss and Other Comprehensive Income “for the period” (or two statements:
Statement of Profit and Loss and Statement of Other Comprehensive Income),

C. Statement of changes in equity ”for the period”

D. Statement of Cash Flows “for the period”, and

E. Notes, comprising a summary of accounting policies and other explanatory notes

IV. An entity must also present a statement of financial position as at the beginning of the earliest comparative
period when:

 an accounting policy is applied retrospectively; or

 items are restated retrospectively; or

when items are reclassified

V. General Features

 The financial statements must be clearly identified and distinguished from other information in the same
published document.

 Each financial statement and the notes must be clearly identified

 In addition the following must be displayed prominently:

 name of the reporting entity;

 whether the financial statements are of an individual entity or a group;

 reporting date;

 presentation currency (as defined in IAS 21); and

 level of rounding used (thousands, millions, etc.)

The financial statements must "present fairly" the financial position, financial performance and cash flows of an
entity.

 Fair presentation requires the faithful representation of the effects of transactions, other events, and
conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses
set out in the Framework.

 IAS 1 requires that an entity whose financial statements comply with IFRSs make an explicit and unreserved
statement of such compliance in the notes.

 Departure from a requirement might be required (extremely rarely).

 Inappropriate accounting policies are NOT rectified either by disclosure of the accounting policies used or by
notes or explanatory material.

 An entity preparing IFRS financial statements is presumed to be a going concern. Otherwise, it should disclose
the fact to the contrary

 Accrual Basis- is the presentation in FS except cash flow

 Consistency- needed to retain but can change if necessary.

VI. Materiality and Aggregation Guide:

Guidance

A. Each material class of similar items must be presented separately

B. Items of a dissimilar nature or function must be presented separately unless they are immaterial

C. If a line item is not individually material it is aggregated with other items

D. A specific disclosure requirement in IFRS need not be satisfied if the information is not material

VIi. Offsetting- Assets and liabilities, and income and expenses, must not be offset unless required or permitted by
IFRS

IAS 32 (Financial Instruments: Presentation) contains rules on the offset of financial assets and financial liabilities
which require offset when (and only when) an entity:

 has a legal right to set off; and

 intends to settle on a net basis; or

 to realise the asset and settle the liability simultaneously

Statement of Financial Position

A. Current asset- are cash; cash equivalent; assets held for collection, sale, or consumption within the entity's
normal operating cycle; or assets held for trading within the next 12 months. All other assets are noncurrent.

B. Current Liabilities- are those to be settled within the entity's normal operating cycle or due within 12 months,
or those held for trading, or those for which the entity does NOT have an unconditional right to defer payment
beyond 12 months. Other liabilities are noncurrent.

IAS 1 does NOT prescribe the format of the Statement of Financial Position. Assets can be presented current then
noncurrent, or vice versa, and liabilities and equity can be presented current then noncurrent then equity, or vice
versa. A net asset presentation (assets minus liabilities) is allowed.

 Certain items (“line items”) must be shown on the face of the statement of financial position as a minimum:

1. Cash and Cash Equivalents

2. Financial Assets

3. Trade and Other Receivables

4. Inventories

5. Property, Plant and Equipment

6. Investment in Associate (Equity Method)

7. Intangible Assets

8. Investment Property

9. Biological Assets

10. Assets Held for Sale

11. Trade and Other Payable

12. Current Tax Liability

13. Deferred Tax Asset and Deferred Tax Liability

14. Provisions

15. Financial Liabilities

16. Liabilities in disposal group of HELD FOR SALE

17. Non-controlling interest

18. Share Capital and Reserves

Statement of Profit or Loss and other Comprehensive Income

 All items of income and expense recognized in a period must be included in profit or loss unless a Standard or
an Interpretation requires otherwise.

Some IFRSs require or permit that some components to be excluded from profit or loss and instead to be
included in other comprehensive income.

The components of other comprehensive income include:

A. Changes in revaluation surplus (IAS 16 and IAS 38)

B. Actuarial gains and losses on defined benefit plans recognized in accordance with IAS 19

C. Gains and losses arising from translating the financial statements of a foreign operation (IAS 21)

D. Gains and losses on remeasuring available-for-sale financial assets (IAS 39)

E. The effective portion of gains and losses on hedging instruments in a cash flow hedge (IAS 39).

Entity has the choice to issue single or 2 statements

1. Income Statement

2. Statement of Other Comprehensive Income

Or

Statement of Profit or Loss and other Comprehensive Income

 No items may be presented in the statement of profit or loss and other comprehensive income (or in the
statement of profit or loss, if separately presented) or in the notes as ‘extraordinary items’.

 Expenses recognized in profit or loss should be analyzed either by nature (raw materials, staffing costs,
depreciation, etc.) or by function (cost of sales, selling, administrative, etc).

 If an entity categorizes by function, then additional information on the nature of expenses – at a minimum
depreciation, amortization and employee benefits expense – must be disclosed.

Components of Expense

A. Cost of Sales

B. Selling Expenses

C. Administrative Expenses

D. Other Expenses

E. Income Tax Expense

Line Items in SPLOCI

A. Revenue

B. Gain/loss from derecognition of financial asset at amortized cost

C. Finance Cost

D. Share in income or loss of associate and joint venture at equity method

E. Income tax Expense

F. Total of Post-tax Profit (discontinued operation)

G. Profit or loss for the period

H. Each component of Other Comprehensive Income

I. Share in OCI of associate and joint venture at equity method

J. Total Comprehensive Income

Statement of Changes in Equity

IAS 1 requires an entity to present a statement of changes in equity as a separate component of the financial
statements. The statement must show:
 total comprehensive income for the period, showing separately amounts attributable to owners of the parent
and to non-controlling interests

 the effects of retrospective application, when applicable, for each component

 reconciliations between the carrying amounts at the beginning and the end of the period for each component
of equity, separately disclosing:

 profit or loss,

 each item of other comprehensive income, and

transactions with owners.

Notes to Financial Statements

IAS 1 suggests that the notes should normally be presented in the following order:

1. a statement of compliance with IFRSs

2. a summary of significant accounting policies applied, including:

1.1 the measurement basis used in preparing the financial statements

1.2. the other accounting policies used

2. supporting information for items presented on the face of the statement of financial position, statement of
profit or loss and other comprehensive income, statement of changes in equity and statement of cash flows, in the
order in which each statement and each line item is presented

3. other disclosures, including:

3.1 contingent liabilities (see IAS 37) and unrecognized contractual commitments

3.2 non-financial disclosures, such as the entity's financial risk management objectives and policies (see IFRS
7)

Disclosures-

An entity must disclose, in the notes, information about the key assumptions concerning the future, and other key
sources of estimation uncertainty at the end of the reporting period, that have a significant risk of causing a
material adjustment to the carrying amounts of assets and liabilities within the next financial year.

These disclosures do not involve disclosing budgets or forecasts

Capital Disclosures

An entity should disclose information about its objectives, policies and processes for managing capital.

IFRIC 17- Distributions of Non-cash Assets to Owners

A. A dividend payable should be recognized when the dividend is appropriately authorized and is no longer at the
discretion of the entity

B. An entity should measure the dividend payable at the fair value of the net assets to be distributed

C. An entity should remeasure the liability at each reporting date and at settlement, with changes recognized
directly in equity
D. An entity should recognize the difference between the dividend paid and the carrying amount of the net assets
distributed in profit or loss, and should disclose it separately

E. An entity should provide additional disclosures if the net assets being held for distribution to owners meet the
definition of a discontinued operation.

IAS 7- Statement of Cash Flows

IAS 7 objective:

A. to provide a statement to help investors assess the prospects for future cash flows, and to confirm or change
their past expectations

B. Statement provides historical information on the entity’s operating, investing and financing cash flows and how
its cash balances have changed in the period as a result

Cash and cash equivalents:

Cash on hand and on deposit and “short-term, highly liquid investments that are readily convertible to known
amounts of cash and which are subject to an insignificant risk of changes in value”

Can include bank overdrafts if part of cash management activities and balance fluctuates between positive and
negative amounts

Statement of Cash Flows

Operating activities are the principal revenue-producing activities; and those that are not investing or financing
activities

Operating cash flows are important: surplus cash flows needed to invest in increased capacity, pay debt when due,
and provide a return to shareholders

Operating cash flows:

A. Cash received from customers for the sale of goods and provision of services, or on account of royalties, fees, or
commissions

B. Cash payments to suppliers for goods and services provided; and to and on behalf of employees for their
services

C. Cash received from or paid for financial instruments held specifically for dealing or trading purposes

Two methods for presenting Cash Flows:

Direct method- use actual amounts

Indirect method- Start with Profit

 Common adjustments to convert profit or

loss to cash from operations:

A. Changes in working capital accounts

B. Elimination of non-cash items

C. Elimination of investing and financing items

Either allowed although preference for direct method

Investing activities:

“the acquisition and disposal of long-term assets and other investments not included in cash equivalents”

Importance:

Is the entity maintaining its capacity and increasing the potential for increased operating cash flows in the future?

Examples:

1. Cash payments to acquire property, plant, and equipment; intangibles; and other long-term assets, including
capitalized development costs

2. Cash receipts from the disposal of items in (a)

3. Cash payments to acquire debt and equity instruments of other entities or interests in joint ventures; excluding
investments held for trading or in cash equivalents

4. Cash receipts from the disposal of items in (c)

5. Cash advances and loans to other parties and their cash repayments

Cash payments for and receipts from futures, forwards, options and swaps unless they are held for trading or are
classified as financing flows.

Financing activities:

“result in changes in the size and composition of the contributed equity and borrowings of the entity”

Importance:

Financing cash flows change the capital structure of the firm and affect the relative interests of those with claims
to future cash flows of the entity

 No netting of inflows and outflows

 Interest and dividends received and interest and dividends paid – choice of operating, investing or financing
flows as appropriate

 Income tax cash flows – generally operating flows

 Non-cash transactions – not included in statement; disclosed instead

A. Cash flows between an entity and its subsidiaries, associates and joint ventures reported only if accounted for
by the cost or equity method

B. Acquisition/loss of control of subsidiary – investing cash flow

C. Exchange rate changes on foreign cash balances – reconciling item at bottom of statement

Disclosures

1. Operating, investing, financing flows

2. Change in cash and cash equivalents

3. Components of cash and cash equivalents

4. Reconciliation of change to amounts on statement of financial position

5. Explanation of significant cash balances not available for use

 Compensating Balance- generally takes the form of minimum checking or demand deposit account balance
that must be maintaineed/

 Kinds of Checks- Undelivered Checks, Postdated Checks, Stale Checks

Kinds of Fraudulent Acts Committed for Cash Accounts

A. Window Dressing- extending the opening of books to record next year’s collection in current year.

B. Lapping- Covering up shortage by using current collection to cover up shortage from previous collection.

C. Kiting- Drawing check from one bank and deposited to another bank to reflect additional cash to cover up
shortage.