Conceptual Framework

Question 1

What is the conceptual framework purpose and status?

Answer 1

Lays out principles to follow when developing accounting standards
The purpose of the framework is to:
Assist IASB in developing future IFRSs and in reviewing existing IFRSs;
Assist IASB in promoting harmonization of regulations, accountings standards and procedures;
Assist national standard setting bodies in developing national standards;
Assist preparers of financial statements in applying IFRSs and in dealing with topics that are not subject to an IFRS;
Assist auditors in forming an opinion as to whether financial statements comply with IFRSs;

Assist users of financial statements in interpreting the information contained in a set of financial statements;
Provide those who are interested in the work of the IASB information about its approach to the formulation of IFRSs.
N.B. The Framework is not an accounting standard and does not override the requirements of any IFRS.

Question 2

What does the conceptual framework cover?

Answer 2

The objectives of financial statements;
The underlying assumption of financial statements;
Qualitative characteristics of financial statements;
Definition of the elements of financial statements;
Recognition of the elements of financial statements;
Measurement of the elements of financial statements;
Concepts of capital and capital maintenance.

Question 3

What are the objectives of financial statements?

Answer 3

The objective of financial reporting is to provide information about the reporting entity that is useful to a wide range of users in making economic decisions.
E.g.:
Resources entity controls (SFP);
Financial structure (SFP);
Liquidity (SFP); and 
Solvency (SFP);
Profitability (SPL);
Cash flows (SCF).

Question 4

What are the underlying assumptions of financial statements?

Answer 4

The underlying assumption of financial statements is GOING CONCERN.
The assumption that financial statements are prepared on the basis that the enterprise will continue trading for the foreseeable future.
The entity has neither the intention nor the need to liquidate or significantly reduce the scale of its operations.
If not a going concern, financial statements would be prepared on a break-up basis. ie. All assets valued at NRV and no non-current classification.

Accrual concept no longer considered an underlying assumption BUT still important.

Question 5

What are the elements of financial statements?

Answer 5

Assets
Liabilities
Equity
Income; and
Expenses

Question 6

What is the definition of an asset?

Answer 6

present economic resource controlled by an entity, as a result of past event, generating future economic benefit

Question 7

What is the definition of a liability?

Answer 7

present obligation, past event, settlement requires outflow of resource

Question 8

What is the definition of equity?

Answer 8

Residual interest in assets of enterprise after deducting liabilities

Question 9

What is the definition of income?

Answer 9

increase in economic benefits includes revenue and gains

Question 10

What is the definition of expenses?

Answer 10

decreases in economic benefit. Includes expenses and losses

Question 11

How do you recognise the elements of financial statements?

Answer 11

Meets the definition of an element of financial statements.
Provides relevant information regarding the particular element.
Provides a faithful representation of the particular element.
Asset – rights or access to future economic benefits. Exists, measurement.
Liability – obligation to transfer economic benefit, exist, measurement.
Income – increase in future economic benefits, measurement.
Expense – decrease in future economic benefit measurement.

Question 12

How do you derecognise elements of financial statements?

Answer 12

Assets: when an entity loses control of all or part of recognised assets.
Liabilities: when an entity no longer has a present obligation for all or part of recognised liability.

Question 13

What statements are income and expenses used?

Answer 13

Income and expenses are in principle included in the SPL.
However, income and expenses arising from a change in the current value of assets or liabilities may be included in Other Comprehensive income NOT SPL.
Relevant information should not be obscured by excessive aggregation of transactions.

Question 14

What is a historical cost?

Answer 14

derived from price of transaction at the time of transaction.
Does not reflect change in value (except through impairment of assets or liabilities becoming onerous).

Asset- historical cost is the value of costs incurred in acquiring or creating the asset plus transaction costs

Liability- historical cost is the value of consideration received to incur or take on a liability minus transaction costs.

Question 15

What is current value?

Answer 15

derived from information updated to reflect conditions at the measurement date.
Include:
Fair value
Value in use
Current cost

Question 16

What are the three current costs?

Answer 16

Fair value- price receivable to sell an asset or transfer a liability in an orderly transaction between market participants at transaction date.

Value in use- present value of future cash flows or economic benefits from using an asset.

Current cost-the cost of acquiring an equivalent asset/liability at measurement date.

Question 17

What are the advantages of historical costs?

Answer 17

Transactions recorded at original historical monetary cost.
Items/events with no monetary value usually ignored.

Advantages:
Easy to produce and understand
Free from bias
Historical values are reliable and verifiable.
Historical cost accounts do not record gains until they are realised.

Question 18

What are the disadvantages of historical costs?

Answer 18

Carrying amounts of non-current assets often lower than current values.
Inventory values in statement of financial position reflect prices on date of purchase rather than current year-end.
Expenses do not reflect current value of assets consumed so profit in real terms is exaggerated.
No account is taken of effect of inflation on monetary items.
Overstatement of profit or understatement of assets can reduce the relevance of accounting ratio analysis. Eg ROCE

Question 19

What must you consider when choosing a measurement basis?

Answer 19

Choose a base that provides the most relevant and faithful representation.
Eg. If an asset is volatile in price and is sensitive to market factors, use current value approach.
If held long-term and is stable in value, use historical cost approach

Question 20

What is the concept of capital maintenance?

Answer 20

Financial capital = net assets or equity of an entity.
The capital maintenance concept states that a profit should not be recognised unless a business has at least maintained the amount of its net assets during an accounting period.
This means profit is the increase in net assets during a period.
Technically, the capital maintenance concept means that the amount of net assets should be reviewed for changes before determining the profit generated during an accounting period.
From a practical perspective, this is rarely done - controllers simply calculate the amount of profit and do not review for compliance with the capital maintenance concept at all.

Question 21

What are the limitations of financial statements?

Answer 21

Dependence on historical costs.
Inflationary effects.
Based on specific time period.
Not always comparable across companies.
Subject to fraud.
No discussion of non-financial issues.eg sustainability performance reporting not compulsory.
No predictive value.