Financial Reporting - Conceptual Framework

Financial Reporting - Topic 1: Conceptual Framework

• Generally Accepted Accounting Principles (GAAP) encompass all concepts, principles, conventions, laws, rules, and regulations used in preparing and presenting financial statements.

Conceptual Framework

• A conceptual framework is a coherent set of ideas or concepts organized to facilitate communication with others.
• It offers an overview of the standards and practices used in preparing financial statements.
• It includes assumptions, values, and definitions used universally by practitioners.

Purpose and Status of the Conceptual Framework

• To aid the International Accounting Standards Committee (IASC) in developing future and reviewing existing international accounting standards.

• To promote harmonization of accounting regulations, standards, and presentation procedures.

• To assist national standard-setting bodies in developing national standards.

• To help financial statement preparers use International Accounting Standards (IAS), and address topics yet to be defined by an international standard.

• To help auditors form well-supported opinions on statements' conformity with International Accounting Standards.

• To assist users in understanding information in financial statements prepared in compliance with International Accounting standards.

• Also, to provide interested parties with insights about IASC's formulation approach towards International Accounting Standards.

Scope of the Conceptual Framework

• Defines the objective of financial statements.
• Defines qualitative characteristics that determine the usefulness of information in financial statements.
• Defines the recognition, measurement, and definition of elements from which financial statements are constructed.
• Expands on capital and capital maintenance concepts.

Contents of the Conceptual Framework

• Chapter 1: Objective of General Purpose Financial Reporting.
• Chapter 2: Qualitative Characteristics of Useful Financial Information.
• Chapter 3: Financial Statements and Reporting Entity.
• Chapter 4: Elements of Financial Reporting.
• Chapter 5: Recognition and Derecognition.
• Chapter 6: Measurement.
• Chapter 7: Presentation and Disclosure.
• Chapter 8: Concept of Capital and Capital Maintenance.

Users of Financial Statements

• Investors (current and potential).
• Creditors, lenders, and suppliers.
• Financial analysts.
• Customers.
• Employees.
• Government and other agencies.
• The general public.

Objective of Financial Reporting

• To provide information about a reporting entity's financial position, performance, and changes in financial position useful to various users in making economic decisions.

Notes and Supplementary Schedules

• Contain additional information relevant to users concerning balance sheet and income statement items.
• May incorporate disclosures on risks, uncertainties, and resources/obligations not formally recognized in the balance sheet (e.g., mineral reserves).
• Often include segment details and the effect of price changes on the entity.

Underlying Assumptions: Accrual Basis

• Financial statements are prepared on an accrual basis to meet objectives.
• Transactions and events are recognized when they occur, not necessarily when cash is received or paid.
• Financial statements reflect the periods to which the transactions/events pertain.

Underlying Assumptions: Going Concern

• Financial statements are prepared based on the assumption that the entity will continue to operate in the foreseeable future.
• The entity has no intentions nor need to liquidate or materially change the scale of its operations.

Qualitative Characteristics: Fundamental Characteristics

• Relevance: Financial information is capable of making a difference in user decisions.
• Faithful Representation: Reports accurately reflect economic phenomena.

Qualitative Characteristics: Enhancing Characteristics

• Comparability: Ability of users to compare figures/decisions between alternatives.
• Verifiability: Consistent and reliable measurement.
• Timeliness: Information available in time for influencing user decisions. 
- Understandability: Clear, concise presentation of information.

Cost Constraint

• Cost is a constraint on the information provided by financial reporting.
• Cost must be balanced with the benefits.

Definitions

• Asset: A present economic resource controlled by the entity as a result of past events.
• Liability: A present obligation of the entity to transfer an economic resource as a result of past events. (meeting three conditions:1. Obligation, 2.Economic resource transfer, 3.Past event.)
• Equity: The residual interest in the assets of the entity after deducting all its liabilities. Includes share capital and reserves (share premium, revaluation reserves, and retained earnings).
• Income: Increases in assets, or decreases in liabilities, that result in increases in equity.
• Expenses: Decreases in assets, or increases in liabilities, that result in decreases in equity.

Recognition Process

• Meets the definition of a financial statement element.
• Probable future economic benefits will flow to or from the entity.
• Cost or value can be reliably measured.

Derecognition

• The removal of all or part of a recognized asset or liability from the entity's financial statement.
• For assets, derecognition typically occurs when the entity loses control of the asset.
• For liabilities, derecognition occurs when the entity no longer has a present obligation for the liability.

Measurement: Historical Cost

• Assets are recorded at the amount of cash or cash equivalents paid, or the fair value of the consideration given for acquisition.
• Liabilities are recorded at the amount of proceeds received in exchange for the obligation or the amount of cash or cash equivalents expected to be paid to satisfy the liability.

Measurement: Current Cost

• Assets are recorded at the amount of cash or cash equivalents that would be paid if the equivalent asset was acquired currently.
• Liabilities are recorded at the undiscounted amount of cash or cash equivalents required to settle the obligation.

Measurement: Realizable (Settlement) Value

• Assets are carried at the amount of cash or cash equivalents currently obtainable by selling the asset in an orderly disposal.
• Liabilities are carried at their settlement values, that is, the undiscounted amount of cash/equivalent expected to be paid.

Measurement: Present Value

• Assets are carried at the present discounted value of future net cash inflows.
• Liabilities are carried at the present discounted value of future net cash outflows expected.

Measurement: Fair Value

• The price received to/paid to transfer an asset/liability in an orderly transaction between market participants.
• Fair value reflects the perspective of market participants in a market where the entity has access to.
• Uses the same assumptions as the market participants in pricing the asset/liability.

Measurement: Fair Value (details)

• In some cases, fair value is directly observed in the market.
• In other cases, it is indirectly determined using established measurement techniques (e.g., cash flow-based).
• Factors considered include future cash flows, variations, the time value of money, risk premium/discounts, and liquidity (if applicable).

Measurement: Value in Use

• Value in use is the present value of cash flows or economic benefits that an entity expects to derive from an asset and its eventual disposal.

Measurement: Fulfillment Value

• The present value of cash or economic resources that an entity expects to transfer in fulfilling a liability.

Presentation and Disclosure

• Reporting entities communicate about assets, liabilities, equity, income, and expenses.
• Effective communication enhances relevance and faithful representation in financial statements.
• Enhance understandability and comparability.
• Focusing on presentation/disclosure objectives and principles.
• Grouping similar, and separating dissimilar items.
• Aggregating to avoid unnecessary detail or excessive aggregation.

Concept of Capital: Financial Capital Maintenance

• Profits are recognized when the period's net assets exceed the beginning net assets (after excluding distributions and contributions).

Concept of Capital Maintenance: Physical Capital Maintenance

• Profits are recognized only when the physical productive capacity (operating capability) of the entity at the end of the period is greater than that at the beginning (excluding distributions/contributions).

This quiz explores the key components of the conceptual framework in financial reporting, focusing on GAAP and its significance in creating financial statements. Participants will learn about the purpose and status of the framework, and its role in standardization and harmonization of accounting practices. Test your understanding of these essential accounting principles.