http://www.disas.unisi.it/mat_did/dipietra/732/3%29_IFRS_Conceptual_Framework.

pdf

IFRS Conceptual Framework

Prof. Roberto Di Pietra
Department of Business and Social Studies

University of Siena
Roberto Di Pietra 1

Pre-requisites and learning objectives

Pre-requisites
Basic financial accounting and reporting concepts Introductory accounting course

Learning objectives
Understand the purpose of the IASB Framework Describe the primary group of users Identify the qualities that make Financial Statements (FS) useful Define the basic elements of FS

Roberto Di Pietra

IASB Framework
Some historical notes
The IASC (predecessor of IASB) has issued in 1989 the Framework for the preparation and presentation of Financial Statements (as part of the Comparability project) This Framework in 2001 was re-adopted by the IASB

Roberto Di Pietra

Purpose and status of the IASB Framework

The Framework
describes the basic concepts that underlie FS prepared under the IFRSs Serves as a guide to
the IASB in developing accounting standards resolving accounting issues that are not addressed directly in a IFRS

Is not itself an IASB standard

Roberto Di Pietra

Purpose and status of the IASB Framework

The Framework
Defines the objective of FS Identifies the qualitative characteristics that make information in FS useful Defines the basic elements of FS and the concepts for recognising and measuring them in FS

IAS 8 (2003) on Accounting policies has introduced a hierarchy of sources by which an entity would choose its accounting policies
In the absence of a specific standard addressing an issue, an entity is required to look to the IASB Framework
Roberto Di Pietra 5

Purpose and status of the IASB Framework

The Framework has a variety of uses:
The Framework guides the IASB and IFRIC members in deliberating and establishing IFRS and interpretations of those standards The Framework helps to ensure that the body of standards is internally consistent Preparers and Auditors of FS use the Framework as a point of reference to resolve an accounting question in the absence of a standard or interpretation that specifically deals with the question The Framework establishes precise terminology by which people can discuss accounting questions The Framework reduces the volume of standards (without the F., each accounting question would have to be answered ad hoc)
Roberto Di Pietra 6

Purpose and status of the IASB Framework

The Framework has a variety of uses:
The Framework makes it more likely that the standards will be principles based rather than detailed rules that try to cover every conceivable potential situation The Framework reduces the need for interpretations and other detailed implementation guidance The Framework enhances public confidence in financial reports
Roberto Di Pietra 7

Purpose and status of the IASB Framework

Authority of the Framework
IASB Preface to IFRS (2002)
IFRSs are based on the Framework, which addresses the concepts underlying the information presented in general purpose FS. The objective of the Framework is to facilitate the consistent and logical formulation of IFRSs. The Framework also provides a basis for the use of judgement in resolving accounting issues ( 8)

Roberto Di Pietra

Purpose and status of the IASB Framework

Authority of the Framework
The IASB Preface also describes a due process steps that have to be followed in developing IFRS Step 1: the Staff are asked to identify and review all of the issues associated with the topic and to consider the application of the Framework to the issues
An identical Step 1 is set out in the due process followed by IFRIC in developing its interpretations

Step 2: see 10 and 11 of IAS 8 (2003). IAS 8 is an authoritative, binding standard, and it states that the Framework is the first place to which a preparer or auditor must look in the absence of a specific standard or interpretation
Roberto Di Pietra 9

General purpose of FSs

Definition
The Framework addresses general purpose FS, which are the financial statements that an entity prepares and presents at least annually to meet the common information needs of a wide range of users external to the entity Therefore the Framework does not necessarily apply to special purpose FS such as reports to tax authorities, report to government regulatory authorities, prospectus prepared in connection with securities offerings, and reports prepared in connection with proposed business combinations, etc.
Roberto Di Pietra 10

General purpose of FSs

The Framework focuses on the FS of business entities, which would include both privately owned and state-owned business entities
The entities does not necessarily apply to the FS of governments, government non-business units, or other not-for-profit entities, although most of the concepts in the Framework would seem to be equally relevant to those types of entities
Roberto Di Pietra 11

General purpose of FSs

The Framework acknowledges that some parties who use the general purpose FSs of an entity may have the power to obtain information in addition to that contained in the FSs
Many present and potential investors, creditors, vendors, and other who seek financial information about the entity do not have the same power as the major lender to get special information They must rely on the general purpose FSs to meet their information needs

Roberto Di Pietra

12

Users and their information needs

The Framework identifies the principal classes of users of general purpose FSs as
Present and potential investors (and their advisers) Lenders Suppliers and other trade creditors Employees (and their representative groups) Customers Governments (and their agencies) The general public
Roberto Di Pietra 13

Users and their information needs

All of these 7 categories of users rely on FSs to help them in making various kinds of economic and public policy decisions
The Framework also concludes that
Because investors are providers of risk capital to the entity, FSs that meet their needs will also meet most of the general financial information needs of the other classes of FS users

Common to all of these user groups is their interest in the ability of an entity to generate cash and cash equivalents, and the timing and certainty of those future cash flows
Roberto Di Pietra 14

Users and their information needs

The Framework regards investors as the primary, overriding user group
The Framework notes that FSs cannot provide all the information that users may need to make economic decisions FSs show the financial effects of past events and transactions, whereas the decisions that most users of FSs have to make relate to future The information in FSs helps users to make their own forecasts
Roberto Di Pietra 15

Responsibility for FSs

The management of an entity has the primary responsibility for preparing and presenting the entitys FSs
This responsibility is noted in the auditors report in most countries Some countries require that company management include, as part of the FSs, an explicit statement of managements responsibility for the FSs

Roberto Di Pietra

16

Responsibility for FSs

The auditors responsibility is to form and express an opinion as to whether the FSs are prepared in accordance with IFRS or some other identified financial-reporting framework The fact that FSs are audited does not relieve management of its fundamental responsibility In a converse case this could show a sort of conflict of interest that could affect the expression of an independent opinion
ISA 700 on the Auditors Report on FSs requires that the auditors report include a statement that the FSs are the responsibility of the entitys management
Roberto Di Pietra 17

The objective of FSs

Objective of FSs is
To provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions Decision usefulness is an objective of FSs (this has been subject of heated debate)

Roberto Di Pietra

18

The objective of FSs

From one hand the objective as set out in the IASB Framework is to help people to make decision From the other hand large part of the decisions are future-oriented
Some disagree with this objective They argue that the FSs is strictly to be a scorecard of the past (stewardship objective of FSs) The IASB Framework does not reject this objective, but it says that people want to know about the past (stewardship) not merely out of curiosity, but because they want to use the information about the past to help them in making future-oriented economic decisions
Roberto Di Pietra 19

The objective of FSs

Decision as a predictive process Information from the past Time series

Actualized Values

Roberto Di Pietra

20

10

The objective of FSs

Financial position
The financial position of an entity is affected by economic resources
its controls, its financial structure, its liquidity and solvency and Its capacity to adapt to changes in the environment in which it operates

The Balance sheet presents this kind of information

Roberto Di Pietra 21

The objective of FSs

Performance
Performance is the ability of an entity to earn a profit on the resources that have been invested in it Information about the amount and variability of profits helps in forecasting future cash flows from the entitys existing resources and in forecasting potential additional cash flows from additional resources that might be invested in the entity Information about performance is primarily provided in an Income statement (or statement of profit and loss, or statement of financial performance)

Roberto Di Pietra

22

11

The objective of FSs

Performance
IAS 1 added a fourth basic financial statement: The statement showing the changes in equity It is important to look to both the income statement and the equity statement in assessing performance because several IFRS provide that certain items if income and expense should be reported directly in equity (thereby by passing the income statement) permanently or temporarily
Roberto Di Pietra 23

The objective of FSs

Performance Some examples
Changes in FV of available-for-sale financial assets are reported directly in equity until financial asset is sold Major classes of property, plant and equipment are remeasured to FV at each BS, with the change in FV reported in a revaluation reserve directly in equity Foreign currency translation adjustment arising when the FSs of a foreign operation are translated from the foreign currency into the reporting companys currency are reported directly in equity Companies have an option of reporting actuarial gains and losses on their pension funds directly in equity when they arise

This value changes are part of an entitys performance, but under existing IFRSs they are not reported in the IS; They show up in the Equity statement; In assessing performance, both of those FSs must be considered
Roberto Di Pietra 24

12

The objective of FSs

Changes in financial position
Users of FSs seek information about the sources and users of an entitys cash and cash equivalents such as bank deposits during the reporting period Cash comes into and goes out of an entity from 3 broad categories of activity Its operations (producing and selling its goods and services) Its investing activities (buying and selling long-lived assets and financial investments) Its financing activities (raising and repaying debt and equity capital)
Roberto Di Pietra 25

The objective of FSs

Changes in financial position
The cash flow statement (CFS) provides this kind of information All investors, creditors, and other capital providers to an entity want to get cash out of their investment The cash flow statement helps them assess the prospects of receiving cash from the entity

Roberto Di Pietra

26

13

The objective of FSs

Notes and Supplementary schedules The FSs also contain notes and supplementary schedules and other information that
Explain items in the balance sheet and IS Explain any resources and obligations not recognised in the BS

The notes also sometimes contain information that meets disclosure requirements arising under national laws or regulations

Roberto Di Pietra

27

Underlying assumptions
The Framework sets out the underlying assumptions of FSs
There are:
Accrual basis of accounting Going concern assumption

Roberto Di Pietra

28

14

Underlying assumptions
Accrual basis
Accounting recognises the effects of transactions and other events when they occur rather than only when cash (or its equivalent) is received or paid and accounting reports these effects in the FSs of the period to which they relate The accrual basis recognises that a companys financial position and performance can change without any cash changing hands Accrual accounting recognises these changes when they occur The cash basis is not consistent with IASB Framework
Roberto Di Pietra 29

Underlying assumptions
Going concern The FSs presume that an entity will continue in operation indefinitely or disclosure and a different basis of reporting are required
An entity that is not a going concern is likely to be liquidated in the near term

The users of the FSs of such an entity will have a great interest in the net amount of cash that can be generated from the entitys assets in the very short term IFRS
are not necessarily designed to provide this kind of information presume that entity will continue to operate for the foreseeable future and therefore will generate its cash flows from operations rather than from liquidation sales

Roberto Di Pietra

30

15

Qualitative characteristics of FSs

Attributes that make the information in FSs useful to investors, creditors, and others
Four principal qualitative characteristics
Understandability Relevance Reliability Comparability

Roberto Di Pietra

31

Qualitative characteristics of FSs

Understandability
Information should be presented in a way that is readily understandable by users
Who have a reasonable knowledge of business economic activities and accounting Who are willing to study the information diligently

Roberto Di Pietra

32

16

Qualitative characteristics of FSs

Relevance
Information in FSs is relevant when it influences the economic decisions of users It can do that by Helping users to evaluate past, present or future events relating the entity Conforming or correcting past evaluations users have made There are sub-characteristics under the relevance: Materiality Timeliness
Roberto Di Pietra 33

Qualitative characteristics of FSs

Relevance
Materiality: is a component of relevance Information is material if its omission or misstatement could influence the economic decisions of users Conversely if information does not have a bearing on the economic decisions of users, it is immaterial Neither the IASB Framework nor individual IFRS provide quantified measures of materiality (some traces are in IAS 14 and IAS 19) Timeliness: is another component of relevance To be useful, information must be provided to users within the time period in which it is most likely to bear on their decisions
Roberto Di Pietra 34

17

Qualitative characteristics of FSs

Reliability
Information in FSs is reliable if it is free from material error and bias and can be dependent on by users to represent events and transactions faithfully 5 attributes that make information reliable
Representational faithfulness Substance over form Neutrality Prudence Completeness
Roberto Di Pietra 35

Qualitative characteristics of FSs

Reliability
Representational faithfulness
To be reliable, information must represent accurately the transaction or other circumstance that the information purports to present

Substance over form

FSs should reflect the substance of transactions and not-necessarily their legal form

Roberto Di Pietra

36

18

Qualitative characteristics of FSs

Reliability
Neutrality The Framework is clear that accounting information must be decision-neutral This means that information is not designed in a way that intentionally leads the users of that information to make an economic decision that the preparer of the information would like them to make Saying that accounting information should be decision-neutral is entirely consistent with saying that accounting information should be relevant Relevance requires that the information bear on the economic decisions that users want to make
Roberto Di Pietra 37

Qualitative characteristics of FSs

Reliability
Prudence: is the inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated While there is noting wrong with healthy scepticism, prudence has sometimes been used to justify the deliberate overstatement of liabilities or expenses, or the deliberate understatement of assets or income When this happens, the FSs measurements lose their reliability
Roberto Di Pietra 38

19

Qualitative characteristics of FSs

Reliability
Completeness Reliability requires that the FSs must report what they purport to report completely, subject to constraints of cost and materiality Omissions make FSs just as wrong as unreliable or irrelevant information Balance between benefit and cost The benefits that users of FSs derive from information should exceed the cost of providing that information The evaluation of benefits and costs is a difficult judgemental process (costs of providing information should include direct and indirect costs for its preparation) Trade-off between relevance and reliability
Roberto Di Pietra 39

Qualitative characteristics of FSs

Comparability
User must be able to compare the FSs of an entity over time so that they can identify trends in its financial position and performance Users must also be able to compare the FSs to different entities to make decisions about where to invest their capital and at what price Disclosure of accounting policies is essential for comparability

Roberto Di Pietra

40

20

Qualitative characteristics of FSs

Roberto Di Pietra

41

The elements of FSs

FSs portray the financial effects of transactions and other events by grouping them into broad classes according to their economic characteristics
The elements directly related to financial position (BS) are: Assets Liabilities Equity The elements directly related to performance (IS) are: Income Expenses The CFS reflects both IS elements and changes in BS elements
Roberto Di Pietra 42

21

The elements of FSs

Definitions of the elements relating to financial position
Asset 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 Liability 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 Equity The residual interest in the assets of the entity after deducting all its liabilities
Roberto Di Pietra 43

The elements of FSs

Definitions of the elements relating to financial position
Economic benefits means future flows of cash or other assets An assets is expected to help generate cash or other assets coming into the entity, and a liability is expected to result in cash or other assets flowing out of the entity Both the Asset and Liability definitions refer to past events
Roberto Di Pietra 44

22

The elements of FSs

Definitions of the elements relating to performance
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 the incurrence of liabilities that result in decreases in equity other than those relating to distributions to equity participants
Roberto Di Pietra 45

The elements of FSs

Definitions of the elements relating to performance The definition of income encompasses both revenue and gains
Revenue arises in the course of the normal operating activities of the entity Gains represent other items that meet the definition of income but that do not reflect from the normal sales of goods and services produced by the entities

The definition of expenses encompasses expenses and losses

Expenses arise in the course of the ordinary activities of an entity (cost of sales, wages, marketing costs, administrative costs, depreciation) Losses represent other items that meets the definition of expenses and may or may not arise in the course of the ordinary activities of the entity

Roberto Di Pietra

46

23

Recognition of the elements of FSs

Recognition:
is the process of incorporating in the BS an item that meets the definition of an element and satisfies both the following criteria for recognition
Probable economic benefits
It is probable that any future economic benefit associated with the item will flow to or from the entity

Measurement reliability
The items cost or value can be measured reliably

All items that satisfy these recognition criteria should be recognised in the BS or IS
Roberto Di Pietra 47

Recognition of the elements of FSs

The recognition criteria for the elements of FSs under the Framework are as follows:
An asset is recognised in the BS when it is probable that the future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably A liability is recognised in the BS 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

Roberto Di Pietra

48

24

Recognition of the elements of FSs

The recognition criteria for the elements of FSs under the Framework are as follows:
Income is recognised in the IS when an increase in future economic benefits related to an increase in an asset or a decrease in a liability has arisen that can be measured reliably Expenses are recognised when a decrease in future economic benefits related to a decrease in an asset or an increase in a liability has arisen that can be measured reliably

Because equity is the arithmetic difference between assets and liabilities, a separate recognition criterion for equity is not needed
Roberto Di Pietra 49

Recognition of the elements of FSs

Recognition of revenue from the sale of goods
This revenue should be recognised when all of the following criteria have been satisfied The seller has transferred to the buyer the significant risks and rewards of ownership The seller retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold The amount of revenue can be measured reliably It is probable that the economic benefits associated with the transaction will flow to the seller The costs incurred or to be incurred in respect of the transaction can be measured reliably
Roberto Di Pietra 50

25

Recognition of the elements of FSs

Recognition of revenue from the tendering of services
This revenue should be recognised when all of the following criteria have been satisfied
The amount of revenue can be measured reliably It is probable that the economic benefits will flow to the seller The stage of completion at the BS date can be measured reliably The costs incurred, or to be incurred, in respect of the transaction can be measured reliably
Roberto Di Pietra 51

Recognition of the elements of FSs

Recognition of revenue from interest, royalties and dividends
These revenues should be recognised when all of the following criteria have been satisfied
Interest should be recognised using the effective interest method set out in IAS 39 ( 5) Royalties should be recognised on an accrual basis in accordance with the substance of the relevant agreement Dividends should be recognised when the shareholders right to receive payment is established
Roberto Di Pietra 52

26

Measurement of the elements of FSs

Measurement involves assigning monetary amounts at which the elements of the FSs are to be recognised and reported
The Framework acknowledges that a variety of measurement bases are used to different degrees and in varying combinations in FSs including: Historical cost Current replacement cost Net realisable value Present value (discounted expected future cash flow)

Roberto Di Pietra

53

Measurement of the elements of FSs

Historical cost:
Is the measurement basis most commonly used today, but it is usually combined with other measurement bases

Net realisable value:

Is an assets selling price or a liabilitys settlement amount

Roberto Di Pietra

54

27

Measurement of the elements of FSs

The Framework does not include concepts or principles for selecting which measurement basis should be used for particular elements of FSs or in particular circumstances
After covering the objective of FSs, qualitative characteristics, and elements definitions, the Framework addresses measurement in only three paragraphs It is fair to say that this is a significant deficiency in the Framework
Roberto Di Pietra 55

The IASBs current Conceptual Framework project

Because the Framework does not include concepts for choosing the proper measurement attribute for various elements, the IASB standards today result in what is called a mixed attribute accounting model, with different measurement bases for different types of assets, liabilities, income and expenses
Some members of the IASB have a tendency to favour fair value measurements if at all possible Other members lean towards cost-based measures

Roberto Di Pietra

56

28

The IASBs current Conceptual Framework project

The IASB and US FASB have worked a joint project designed to update and align the two boards Conceptual Framework
Eight phases Objectives and qualitative characteristics Elements: recognition and measurement attributes Initial and subsequent measurement Reporting entity Presentation and disclosure Status of Framework in GAAP hierarchy Applicability to not-for-profit entities Reconsideration of the entire Framework
Roberto Di Pietra 57

The IASBs current Conceptual Framework project

Objective
The boards have tentatively concluded that financial reports should aim to provide information to a wide range of users that focus on the information needs of existing common shareholders only The objective is to provide information about the entity to the external users who lack the power to prescribe the information they require and therefore must rely on the information provided by an entitys management
Roberto Di Pietra 58

29

The IASBs current Conceptual Framework project

Qualitative characteristics
The 2 boards have tentatively concluded to identify the following 5 primary qualitative characteristics of accounting information Relevance: is an essential qualitative characteristics Faithful representation of real-world economic phenomena Comparability: is an important characteristics of financial reporting information and should be included in the converged conceptual framework Understandability: is an essential characteristics of financial reporting information and should be included in the converged conceptual framework Materiality: relates not only to relevance, but also to faithful representation
Roberto Di Pietra 59

The IASBs current Conceptual Framework project

Exposure Draft in May 2008
The objective of Financial reporting Is to provide 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 Information that is decision-useful to capital providers may also be useful to other users of financial reporting who are not capital providers
FSs should reflect the perspective of the entity rather than the perspective of the entitys investors The key users of FSs are capital providers Capital providers require information that is decision-useful
Roberto Di Pietra 60

30

The IASBs current Conceptual Framework project

Exposure Draft in May 2008 The objective of Financial reporting
For financial information to be useful, it must possess 2 fundamental qualitative characteristics:
Relevance Faithful representation (a depiction of an economic phenomenon have to be complete, neutral and free from material error)

The ED provides 4 enhancing qualitative characteristics

Comparability Verifiability Timeliness Understandability

This characteristics are complementary to the fundamental characteristics

Roberto Di Pietra

61

The IASBs current Conceptual Framework project

Next steps
The Convergence process between IASB and FASB on the Conceptual Framework was paused This project was paused until the IASB concludes its ongoing deliberations about its future work plan (visit the Agenda consultation project page for more information)

Roberto Di Pietra

62

31