Conceptual Framework and Accounting Standards

Chapter 3: Conceptual Framework and Theoretical Structure of

Financial Accounting and Reporting, Part II
January 31, 2018

Financial Statements These are the principal means through which a company
communicates its financial information to those outside it. These
provide a company’s history quantified in money terms.

Forms of Financial a. Consolidated financial statements- provide financial

Statements information of both parent and its subsidiaries as a single
reporting entity
b. Unconsolidated financial statements- provide financial
information of the parent only
c. Combined financial statements- provide financial information
of two or more entities that are not all linked by a parent-
subsidiary relationship

Reporting Entity An entity that chooses or is required to prepare financial statements

and is not necessarily a legal entity.

Complete Set of a. Statement of Financial Position - it shows the assets

Financial Statements (resources), liabilities (obligations), and the owners’ equity
(net difference between its assets and liabilities)

b. Statement of Profit or Loss and Other Comprehensive Income-

this reflects revenues and expenses

c. Statement of Cash Flows- reports the amount of cash generated

and consumed by a company through operating, investing, and
financing activities

d. Statement of Changes in Equity- summarizes the changes in

each item of equity for a period of time

e. Notes to the Financial Statements- contains supplemental

information

Auditor An independent certified public accountant who examines the

financial statements and issues an opinion about the fairness and their
adherence to proper accounting principles

Objective of Financial a. To provide information about the financial statements of an entity

Statements that is useful to a wide range of users in making economic
decisions
b. To show the management’s stewardship over the entity’s resources
Users and Their Existing and potential investors need information about returns
Needs that they expect from an investment

Existing and potential creditors depend on principal and interest

payments or other returns that they expect

*Existing and potential investors, lenders, or creditors need

information to help them assess the prospects for future net cash
inflows to an entity

Elements of Financial 1) Assets

Statements 2) Liabilities
3) Equity
Assets The elements directly related to the measurement of financial
position are:

Assets- are present economic resources controlled by the entity as

a result of past events and from which future economic benefits are
expected to flow to the entity

To qualify as assets, the resources must:

a. Produce economic benefits
b. Controlled by the entity
c. Result from past transaction
Liabilities Liabilities- are presents obligations arising from past events the
settlement of which is expected to result in an outflow from the
entity of resources embodying economic benefits

To qualify as liabilities, obligations must:

a. Require transfer of economic benefit
b. Specify to whom the assets must be transferred
c. Result from past transaction
d. Represent a duty or responsibility that the entity has no
practical ability to avoid

Equity Equity- residual interest in the assets of the entity after

deducting all its liabilities

Profit Is frequently used as a measure of performance or as the basis for

other measures

Income Is increases in assets, or decreases in liabilities, that results in

increase in equity, other than contribution of from equity
 participants

Revenue Arises in the entity’s course of ordinary activities such as sales,

fees, interest, dividends royalties, and rent

Gains Represent items that may or may not arise in the entity’s course of
ordinary activities such as revaluation of marketable securities,
gains from disposal of non-current assets, etc.

Expenses Are decreases in assets, or increases in liabilities, that result in

decreases in equity, other than distribution to equity participant

These may arise in the entity’s course of the ordinary activities

involving an outflow or depletion of costs such as cost of sales,
wages and depreciation

Losses Represent other expenses that may or may not arise in the entity’s
course of ordinary activities and also decreases in economic
benefit such as losses from accidents, and disposal of non-current
assets

Capital Maintenance Revaluation or statement of assets and liabilities gives rise to

Adjustment increase or decrease in equity. These are included in equity as
capital maintenance adjustments or revaluation reserves rather than
recognizing them as part of income statement

Unit of Account Refers to the rights or obligations to which recognition criteria and
measurement concepts are applied

Recognition of It is the process of capturing for inclusion in the statement of

Elements of Financial financial position or statement of financial performance. These
Statements statements are linked because income and expenses are linked to
changes in assets and liabilities

Recognition Criteria a. Relevance- whether recognition of an item results in relevant

information may be affected by low probability of a flow of
economic benefits, and existence uncertainty
b. Faithful Representation- whether recognition of an item results
in a faithful representation may be affected by measurement
uncertainty, recognition inconsistency, and presentation and
disclosure

Derecognition of the It is the removal of all or part or recognized asset or liability from an
Elements of Financial entity’s statement of financial position. This occurs when:
Statements a. For an asset, the entity loses control of all or part of the
 recognized asset
b. For a liability, the entity no longer has present obligation to all
or part of the recognized liability

Measurement Is the process of determining the monetary amounts at which the

elements of the financial statements are to be recognized and carried in
the statement of financial position and income statement

Historical Cost The price of the transaction or other event that gave rise to the item
Measurement Bases being measured at the time of acquisition

Current Value Provide information updated to reflect conditions at the measurement

Measurement Bases date. This include:
a. Fair value- Reflect market participants’ current expectations
about the amount, timing and uncertainty of future cash flows
b. Value in use (for assets) fulfilment value (for liabilities)-
reflects entity-specific current expectations about the amount,
timing and uncertainty of future cash flows
c. Current cost- reflects the amount that would be paid to acquire
an equivalent asset and received to take in an equivalent
liability

Factors to Consider in a. Relevance- relevance of information provided by a

Selecting a measurement basis is affected by:
Measurement Basis 1) Characteristics of the asset or liability
2) Contribution to future cash flows

b. Faithful Representation- whether a measurement basis can

provide a faithful representation is affected by:
1) Measurement inconsistency
2) Measurement uncertainty

Concepts of Capital a. Financial Concept- this concept should be adopted by the users
if financial statements are primarily concerned with the
maintenance of nominal invested capital or purchasing power
of invested capital
b. Physical Concept- if the main concerns of the users is with the
operating capability of the enterprise, a physical concept
should be used

Concepts of Capital a. Financial capital maintenance- a profit is earned only if the

Maintenance financial amount of the net assets at the end of the period
exceeds the financial amount of net assets at the beginning of
the period, after excluding any distributions to and
contributions from, owners during the period. Under this
 concept, capital is defined in terms of nominal monetary units,
profit represents the increase in nominal money capital over
the period
b. Physical capital maintenance- a profit is earned only if the
physical productive capacity of the enterprise 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.