Conceptual Framework for Financial Reporting 2018 (the Framework) is published by International Accounting Standards Board (IASB).
Its predecessor, Framework for the preparation and presentation of the financial statements was issued back in 1989. Then in 2010, IASB issued a document, Conceptual Framework for the Financial Reporting, to improve the 1989 paper. However, it was found the document did not fully cover all concepts needed.
It is the reason why the 2018 Framework is published.
The latest and completed Framework comprising 8 chapters and will be effective for annual reporting period beginning on or after 1 January 2020.
As stated by IASB, there are three purposes of the Framework –
To assist IASB to develop IFRS standards (Standards) based on consistent concepts, resulting in financial information that is useful to investors, lenders and other creditors;
To assist preparers of financial reports to develop consistent accounting policies for transactions or other events when no Standard applies or a Standard allows a choice of accounting policies;
To assist all parties to understand and interpret Standards
One important point to highlight is the Framework is not a Standard and it does not override any Standard or any requirement in Standard.
You many find there is inconsistency between accounting standard and the Framework, which is not rare. In this case, please follow Standard.
Summary of major changes
As compared to the Framework published in 2010, there are three new concepts introduced in the latest edition –
Measurement
Presentation and disclosure
Derecognition
In addition, IASB updated the definitions of an asset and a liability, it also updated the recognition criteria for both of assets and liabilities in financial statements.
Prudence, stewardship, measurement uncertainty and substance over form were clarified in this edition as well.
Chapter 1 – The objective of financial reporting
The objective of financial reporting is to provide financial information that is useful to users in making decisions relating to providing resources to the entity. In here, users mean –
Existing and potential investors;
Lenders;
Other creditors.
Users’ decisions involve about buying or selling or holding the shares, loans arrangement or voting on management’s actions. From the financial reports, users assess –
Prospects for future net cash inflows to the entity;
Management’s stewardship of the entity’s economic resources.
But remember, Chapter 1 is not about financial statements itself. It describes general purpose of reports that should contain the following information about the reporting entity:
Economic resources,
Claims against the entity; and
Changes in those resources and claims.
The key change in Chapter 1 is increasing the prominence of stewardship in the objective of financial reporting, which is to provide information that is useful in making resource allocation decisions.
Chapter 2 – Qualitative characteristics of useful financial information
In this chapter, it explains qualitative characteristics which is divided into fundamental and enhancing characteristics.
For information to be useful it must both be relevant and provide a faithful representation of what it purports to represent. Relevance and faithful representation are fundamental qualitative characteristics of useful financial information, and the guiding concepts that apply throughout the Framework.
There are four enhancing qualitative characteristics, namely, comparability, verifiability, timeliness and understandability. These four qualitative characteristics enhance the usefulness of information but they cannot make non-useful information useful.
The key change in Chapter 2 in the Framework 2018 is reinstating prudence, defined as the exercise of caution when making judgements under conditions of uncertainty, as a component of neutrality.
Chapter 3 – Financial statements and the reporting entity
Chapter 3 defines what are financial statements and reporting entity.
According to the publication from IFRS Foundation, financial statements refer to a particular form of financial reports that provide information about the reporting entity’s assets, liabilities, equity, income and expenses.
The reporting entity here has two characteristics –
An entity that is required, or chooses, to prepare financial statements;
Not necessarily a legal entity – could be a portion of an entity or comprise more than one entity.
Per Chapter 3, 3.13-3.14, “Determining the appropriate boundary of a reporting entity is driven by the information needs of the primary users of the reporting entity’s financial statements.”
It is a new chapter as compared to previous edition. It clarifies what is a reporting entity, which might be a legal entity or a portion of a legal entity.
Chapter 4 – The elements of financial statements
This chapter exclusively defines and explains the five elements of financial statements, asset, liability, equity, income and expenses.
Other than equity, all other elements definitions are revised in the latest Framework. Here I summarize all five elements definition as below –
Asset: A present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits;
Liability: A present obligation of the entity to transfer an economic resource as a result of past events. An obligation is a duty or responsibility that the entity has no practical ability to avoid;
Equity: The residual interest in the assets of the entity after deducting all its liabilities is unchanged;
Income: Increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity claims;
Expenses: Decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims.
Chapter 5 – Recognition and derecognition
Recognition is a process of including an element (i.e. asset, liability, equity, income or expenses) in the statement of financial position or the statement of financial performance.
There are two recognition criteria, relevance and faithful representation.
In the past, an entity should recognize an item that met the definition of an element if it was probable that economic benefits would flow to the entity and if the item had a cost or value that could be determined reliably.
But under the revised Framework, the probability threshold is removed for recognition. It is now referring explicitly to the qualitative characteristics of useful information.
Derecognition is new in the Framework. It is the removal of all or part of asset or liability from an entity’s statement of financial position.
Generally speaking, when an entity has no control of asset of no obligation for a liability, recognition occurs.
Chapter 6 – Measurement
Measurement is used to assigning monetary amounts at which the elements of the financial statements are to be recognized and recorded.
There are two basic measurement basis –
Historical cost – it is the price of the transaction incurred when an element in financial statement is recognized;
Current value – it is the updated price to reflect conditions at the measurement date. There are three bases for current value measurement –
Fair value;
Value in use;
Current cost.
When choosing a measurement basis, you need to consider the nature of information in both the statement(s) of financial performance and the statement of financial position.
The relative importance of each factor to be considered is subject to the facts and circumstances of individual cases.
Chapter 7 – Presentation and disclosure
It is a new chapter in the Framework.
The objective of presentation and disclosure is better communication of financial statement elements information to investors, lenders and other creditors.
There are three key takeaways for you in this chapter –
Concepts describing how information should be presented and disclosed in financial statements will guide IASB in standards setting;
Guidance on classifying income and expenses for IASB to use when deciding whether the elements should be included in which type of financial statements;
Stating that profit or loss is the primary performance indicator and that, in principle, income and expenses in other comprehensive income should be recycled where the relevance or faithful representation of the financial statements would be enhanced.
Chapter 8 – Concepts of capital and capital maintenance
There is no change in Chapter 8 in Framework 2018. It explains two concepts of capital –
Financial capital – it is simply the net assets or equity of an entity. In other words, financial capital is the residual amount remains after expenses have been deducted from income for a period while the amount of net assets is greater than net assets at the beginning.
Physical capital – it is the production capacity of an entity based on. A profit is earned only if the physical productive capacity of an entity at the end of period exceeds the physical productive capacity at the beginning of the period.
ACCA SBR past paper on conceptual framework
One of examples in ACCA SBR past paper questions on conceptual framework can be found from Question 1d in December 2018 session.
As stated in the beginning, inconsistency between conceptual framework and accounting standards are often found. It is a question asking students to explain why framework is not consistently applied across accounting standards.
Conclusion
The Framework was just published in March 2018 and be fully effective for reporting period beginning from 1 January 2020.
No matter for practitioner or ACCA students, mastering conceptual framework is important. It can help the preparers of financial reports to develop consistent accounting policies in their entities when no standards applies.
For students attempting ACCA SBR exam, it is expected the Framework will be asked in the question paper. Gaining a thorough knowledge of it is definitely helpful to increase your chance to pass exam.
I hope the information in this article could help you to have fundamental understanding of the latest Framework. The following links are resources for you to have deeper understanding of this topic.
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