Conceptual Framework for Financial Reporting PDF

## **Based on Normative Approach** - Accounting principles are prescribed based on what should or ought to be. - IASB, US FASB and MASB generally take this approach to develop reporting standards. - In deciding what should or ought to be, an accounting framework needs to be developed first to provi...

## **Based on Normative Approach** - Accounting principles are prescribed based on what should or ought to be. - IASB, US FASB and MASB generally take this approach to develop reporting standards. - In deciding what should or ought to be, an accounting framework needs to be developed first to provide a starting point or as a foundation for the formulation of reporting standards. ## **Definition of Accounting Framework (AF)** - A structured or coherent system of interrelated objectives, fundamental characteristics and concepts that lead to the formulation of high quality and consistent reporting standards to prescribe the nature, existence and number of financial accounts. ## **Reasons for Developing AF** - To identify the foundation for financial reporting. - To identify the objective of financial statements. - To identify the desirable qualitative characteristics of financial information. - To provide a basis for setting of high-quality and consistent reporting standards. - To serve as a reference point for resolving accounting issues and disputes. ## **Conceptual Framework for Financial** - **MASB CF for FR** - July 2007 - MASB issued Framework for Preparation and Presentation of Financial Statement. - Nov 2011 - MASB issued Conceptual Framework (CF) for Financial Reporting (FR). - April 2018 - MASB issued a revised version of CF for FR. - Conceptual Framework is not a MFRS/FRS and hence does not define standards for any particular measurement or disclosure issue. - If there is a conflict between Conceptual Framework and MFRS/FRS, the requirements of the MFRS/FRS prevail. ## **Contents of CF** - **Chapter 1** - The objective of general purpose financial reporting. - **Chapter 2** - The reporting entity. - **Chapter 3** - Qualitative characteristics of useful financial information. - **Chapter 4** - The assumption, elements, recognition and measurement of the elements from which financial statements are constructed. ## **Purpose of Conceptual Framework** - To assist MASB in development of future MFRSs/FRSs and review of existing MFRSs/FRSs. - To assist preparers of financial statements in applying MFRSs/FRSs and in dealing with topics that have yet to form the subject of MFRSs/FRSs. - To assist auditors in forming an opinion on whether financial statements comply with MFRSs/FRSs. - To assist users of financial statements in interpreting the information whether financial statements comply with MFRSs/FRSs. - To provide those who are interested in the work of MASB with information about its approach on formulation of MFRSs/FRSs. ## **Objective** - To provide 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. ## **Information provided to Users** - Information provided to users are information about the nature and amounts of reporting entity's: - Economic resources (Assets) - Claims (Equity and Liabilities) - This information can help users to identify the reporting entity's: - Financial strengths and weaknesses - Liquidity and solvency - Needs for additional financing and how successful in obtaining financing. ## **Objective of General Purpose Financial** ## **Decisions to be made by Users** - Buying, selling or holding equity and debt instruments. - Providing or settling loans. - Other forms of credit ## **Users of Financial Reporting** - Capital providers ie existing and potential investors, lenders and other creditors - Exclude other users such as management, regulators and public. - The users need to consider pertinent information from other sources eg. economic conditions, political events and climate, industry and company outlooks. - They use the information to estimate the value of the reporting entity. ## **Fundamental Qualitative Characteristics** - **Relevance** - Relevant financial information is capable of making a difference in the decisions made by users. - Information is relevant when it influences economic decisions of users by helping them evaluate past, present and future events or confirming, correcting past evaluations. - Financial information is capable of making a difference in decisions if it has predictive value, confirmatory value or both. - Judgement is required in deciding whether an information is relevant. - Both the nature and materiality of the item are important considerations in deciding its relevance. - Information is considered material if omitting it or misrepresenting it could influence the decisions made by users. - **Faithful Representation** - Financial reports represented economic phenomena in words and numbers. - Financial information must faithfully represent the phenomena that it is purport to represent. - To be a perfectly faithful representation, it has to be complete, neutral, and free from error. ## **Qualitative Characteristics of Useful Financial** - **Faithful Representation** - Financial reports represented economic phenomena in words and numbers. - Financial information must faithfully represent the phenomena that it is purport to represent. - To be a perfectly faithful representation, it has to be complete, neutral, and free from error. ## **Enhancing Qualitative Characteristics** - **Comparability** - information is useful if it can be compared with similar information of other entities and with similar information of the same entity for another period. - **Verifiability** - direct and indirect verification. - **Timeliness** - information available to decision makers in time to be capable of influencing their decisions. - **Understandability** - financial information presented in a clear and concise manner. ## **Applying Fundamental QC** - Identify economic phenomenon that has the potential to be useful to users of financial information. - Identify the type of information about that phenomenon that would be most relevant and can be faithfully represented. - Determine whether that information is available and can be faithfully represented. - If so, the process of satisfying the fundamental qualitative characteristics ends. If not, the process is repeated with end goal of providing useful financial information. ## **Applying Enhancing QC** - Enhancing qualitative characteristics should be maximised to the extent possible. - It is a process that does not follow a prescribed order. - Sometimes one enhancing qualitative characteristics may have to be diminished to maximise another qualitative characteristics. ## **Cost Constraint on Useful Financial Reporting** - Reporting financial information imposes costs and it is important that those costs are justified by the benefits of reporting that information. - Costs incurred by providers of financial information include collecting, processing, verifying and disseminating financial information. - Costs incurred by users include analysing and interpreting the information provided. ## **Underlying Assumption** - **Going Concern** - If the business is ongoing, going concern basis can be applied. - Assets and liabilities are recognised in the balance sheet based on cost models, revaluation model or fair market value. - If the business cannot continue going concern basis cannot be applied. Financial statements need to be prepared on other basis eg. Liquidation basis. ## **Others (1)** - **Elements of Financial Statements** - **Elements of Financial Position** - **Asset** - Resources controlled by entity (tangible/intangible). - As a result of past events. - Inflow of future economic benefits. - **Liabilities** - Present obligation of entity. - Arising from past events. - Settlement is expected to result in outflow of entity resources. - **Equity** - Asset - Liabilities. - **Elements of Performance** - **Income** - Recognised increase in asset or decrease in liability in current reporting period. - Result in increased equity. Eg. Sales of goods or services - Asset cash/bank increase. - **Expense** - Recognised decrease in asset or increase in liability in current reporting period. - Result in decreased equity. Eg. Purchased of goods, payment of salary - asset cash/bank decrease. - **Capital Maintenance and Adjustments** - Due to revaluation or restatement of assets and liabilities that will increase or decrease equity. ## **Examples** - Are the following assets? - Fish in the sea (from the fishermen's perspective) - Cattle in the farm (from the owner of the farm's perspective) - Inventory of cooking oil in the grocery shop (from the owner of the shop's perspective) ## **Others (2)** ## **Recognition of FS Elements** - Recognition is the process of incorporating in the balance sheet or income statement an item that meets the definition of an element and satisfies the following criteria for recognition: - It is probable that any future economic benefit associated with the item will flow to or from the entity. - The item has a cost or value that can be measured with reliability. - **Eg.** - On 1 August 2018, KL Bhd purchased a second hand motor van by cash RM50,000. The van is to be used by the company to send goods to customers. - Determine whether the van can be recognized in KL Bhd's financial statements. ## **Measurement of FS Elements** - Measurement is the process of determining the monetary amounts at which the elements of financial statements are recognised and carried in the SOFP and SOPL. - This involves the selection of the particular basis of measurement such as: - Historical cost. - Current cost. - Realisable value. - Present value. ## **Concept of Capital** - Selection of the appropriate concept of capital should be based on the needs of users. - **Financial Concept of Capital** - Capital is the net asset or equity of the entity. - Applied if users are primarily concerned with nominal invested capital or purchasing power of invested capital. - **Physical Concept of Capital** - Capital is regarded as the productive capacity of the entity based on eg. Units of output per day. - Applied if users are primarily concerned with the operating capability of the entity. ## **Concept of Capital Maintenance** - **Financial Capital Maintenance** - A profit is earned only if the financial amount of net assets at the end of the period exceed the financial amount of net assets at the beginning of the period, after excluding contribution from and distribution to owners during the period. - **Physical Capital Maintenance** - Profit is earned only if the physical productive capacity (operating capability) of the entity at the end of the period exceeds the physical productive capacity at the beginning of the period, after excluding contribution from and distribution to owners during the period.