7.1 The conceptual framework (1) Flashcards
The Conceptual Framework for Financial Reporting (the Framework)
- The Board developed a conceptual framework, which lays out the broad principles that should be applied when developing accounting standards and when determining an appropriate accounting treatment
- The frame work is not an accounting standard and does not override the requirements of any IFRS Standards
Purpose of the Framework is to
- assist the IASB to develop IFRS standards that are based on consistent concepts
- assist prepares to develop consistent accounting policies when no IFRS standard applies or when it allows a choice of accounting policy
- assist all parties to understand and interpret IFRS standards
What does the Framework cover
Chapter 1 - The objective of general purpose financial reporting
Chapter 2 - Qualitative characteristics of useful financial information
Chapter 3 - Financial statements and the reporting entity
Chapter 4 - The elements of financial statements
Chapter 5 - Recognition and derecognition
Chapter 6 - Measurement
Chapter 7 - Presentation and disclosure
Chapter 8 - Concepts of capital and capital maintenance
Chapter 1 - The objective of general purpose financial reporting
- is to provide financial information about the entity that is useful to users who may be making decisions about providing resources to the entity
- to make these decisions users will need info on performance (profits), position (assets and claims against entity), adaptability and prospects of an entity
- this enables assessment of the stewardship of the directors and their utilization of the entity’s resources
Users of the financial statements include
- existing and potential investors
- lenders
- other creditors
Decisions relating to providing resources include whether or not to
- buy, sell or hold equity and debt instruments
- provide or settle loans and other forms of credit
- exercise the rights to vote on or influence managements actions that affect the use of the entity’s economic resources
Chapter 2 - Qualitative characteristics of useful financial information
Fundamental qualitative characteristics: (must have)
- Relevance
- Faithful representation
Enhancing qualitative characteristics (nice to have):
- Comparability
- Verifiability
- Timeliness
- Understandability
Fundamental qualitative characteristic - Relevance
- Info is relevant when it influences the economic decisions of users by helping them evaluate past, present or future events or to confirm or correct their past evaluations
- The relevance of info can be influenced by it’s nature and materiality
- Some items may be relevant because of their nature and others may only become relevant once they are material
Relevance & Materiality
- Materiality is threshold for the quality of information rather than a primary characteristic
- information is material if its omission or misstatement could influence the decisions of users
- materiality is an entity specific aspect depending on the size of the item in the context of the financial statements
Fundamental qualitative characteristic - Faithful representation
- Financial info needs to faithfully represent the transactions and other events that it represents
- Transactions and other events must be accounted for and presented in accordance with their substance and economic reality and more just their legal form (applying substance over form)
To be a faithful representation, financial info would have following characteristics
- Completeness - Info must be complete and have all the necessary descriptions and explanations so the user can understand the info
- Neutrality (free from bias) - must not influence a decision or judgement in order to achieve a predetermined result or outcome
Neutrality is underpinned by prudence - an accounting mindset that favors caution in situation of uncertainty and judgement (practical application - judgmental liabilities being recorded more readily than uncertain assets) - Free from error - within the bounds of materiality
A material error or omission can cause FS to be false or misleading and thus unreliable and reduce their relevance
Measurement uncertainty - where an estimate has been used the amount must be described clearly and accurately as being an estimate
Enhancing qualitative characteristic - Comparability
- Users must be able to compare FS over a period of time to identify trends in financial position and performance
- Users must be able to compare FS of different entities to assess their relative financial position and performance
- To achieve comparability, similar items should be treated in a consistent manner (unless alternative treatments exist that would be more relevant and reliable)
- Accounting policies should be disclosed so that users can identify changes in policies or differences between polices of different entities
Enhancing qualitative characteristic - Verifiability
- Occurs if information can be independently confirmed or verified by knowledgeable third parties (audited)
- Direct verification means verifying through direct observation (counting cash)
- Indirect verification means checking the inputs to a model, formula or other technique and recalculating the outputs using the same methodology and then comparing the result
Enhancing qualitative characteristic - Timeliness
- means having information available for decision makers in time to influence their decisions
- the older info is the less useful it becomes
Enhancing qualitative characteristic - Understandability
- Info needs to be understandable to users
- But info that is relevant should not be excluded on grounds that it’s too difficult for users to understand
- For info to be understandable, users need to be able to perceive it’s significance
