ACCA SBR ^INT Syllabus B. The Financial Reporting Framework - Conceptual Framework - Overview - Notes ^{2 / 18}

The Conceptual Framework's purpose is:

1) To help develop and revise IFRSs that are based on consistent concepts
2) To help preparers develop consistent accounting policies for areas that are not covered by a standard or where there is choice of accounting policy, and 
3) To help everyone understand and interpret IFRS.

The framework does not override any specific IFRS.

The objective is to provide financial information that's useful to investors, lenders and other creditors in making decisions about providing resources to the entity.

This information is about the entity’s economic resources / claims against and the effects of transactions that change the resources / claims.

This information can also help users assess management’s stewardship of the resources.

3 aspects relevant to users

1. Accrual Accounting (For understanding Financial Performance)

2. Past Cash-flows (For understanding Financial Performance also)

3. Changes in Resources not from Financial Performance (eg a share issue)

Fundamental Qualitative Characteristics

Financial information is useful when it is relevant and represents faithfully what it purports to represent.

1. Relevance

   Relevant information has a predictive value or confirmatory value (or both).

   Materiality is an entity-specific aspect of relevance

   ‘Information is material if omitting, misstating or obscuring it could influence decisions

2. Faithful Representation

   Economic substance rather than legal form, and is:

   - Complete - all information necessary for understanding

   - Neutral - without bias, and with prudence

   - Free from error - not perfectly accurate in all respects though

Enhancing Qualitative Characteristics

Comparability

Between similar information in other entities and between similar information in the same entity for another period or another date.

Verifiability

Different knowledgeable observers could reach consensus (not complete agreement), that the item is faithfully represented

Timeliness

Information is available in time to influence decisions

Understandability

Classifying, characterising and presenting information clearly and concisely

Inherently complex information should still be included

A reasonable knowledge of business and economic activities is expected if users and that they review and analyse the information with diligence.

The objective of financial statements (to provide information about an entity's assets, liabilities, equity, income and expenses that helps users assess the prospects for future net cash inflows and management's stewardship of resources

Going concern is assumed.

A reporting entity is not necessarily a legal entity.

Financial statements are prepared for a specified period of time and provide comparative information and under certain circumstances forward-looking information.

Generally, consolidated financial statements are more likely to provide useful information to users of financial statements than unconsolidated financial statements.

The main focus of this chapter is on the definitions of assets, liabilities, and equity as well as income and expenses.

The definitions are quoted 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.

Equity.
The residual interest in the assets of the entity after deducting all its liabilities.

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.

The expression "economic resource" instead of simply "resource" stresses that the IASB no longer thinks of assets as physical objects but as sets of rights.

The definitions of asets and liabilities also no longer refer to "expected" inflows or outflows. Instead, the definition of an economic resource refers to the potential of an asset/liability to produce/to require a transfer of economic benefits.

Recognition

The inclusion in the accounts when the definition of one of the elements is met (Asset, Liability, Equity, Income or Expenses)

Recognising / Increasing one item requires the recognition / derecognition (Increase / decrease) of one other item

Recognising An Item

You can do this when:

(a) It meets the definition of an element (asset, liability, income, expense or equity); and

(b) Recognition provides information that is useful, ie

1. Relevant

2. Faithful Representation of the element

3. It should also justify the costs of recognising that element.

Derecognition

When an element no longer meets the definition 

Eg

1. Asset - control lost

2. Liability - No longer a present obligation

Historic Cost (uses an entry value)

Asset
Historical cost, including transaction costs, to the extent unconsumed (or uncollected) and recoverable. It includes interest accrued on any financing component.

Liability
Historical consideration as yet owing in respect of goods and services received (net of transaction costs), increased by any onerous provision. It includes interest accrued on any financing component.

Value in use/ Fulfilment value (uses an exit value)

Asset
Present value of future cash flows from the continuing use of the asset and from its disposal, net of transaction costs on disposal.

Liability
Present value of future cash flows that will arise in fulfilling the liability, including future transaction costs.

Current Cost (uses an entry value)

Asset
Consideration that would be given to acquire an equivalent asset at measurement date plus transaction costs. It reflects the current age and condition of the asset.

Liability
Consideration that would be received to incur an equivalent liability at measurement date minus transaction costs.

Fair Value (uses an exit value)

The price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. It excludes any potential transaction costs on sale or transfer.

Factors to consider when selecting a measurement basis

Choosing a measurement basis is the same as that of financial statements: i.e. to provide relevant information that faithfully represents the underlying substance of a transaction.

So it is important to consider the nature of the information & the relative importance of the information presented in these statements will depend on facts and circumstances.

Relevance
Look at how the characteristics of the asset or liability and how it contributes to future cash flows are two of the factors to see which basis provides most relevant information

For example, if an asset is sensitive to market factors, fair value might provide more relevant information than historical cost.

But FV wouldn't be relevant if the asset is held solely for use or to collect contractual cash flows rather than for sale.

Faithful representation
Uncertainty does not make a measurement basis irrelevant. However, a balance must be achieved between relevance and faithful representation.

Other considerations
In most cases, using the same measurement basis in both SFP and Income statement would provide the most useful information.

Normally select the same measurement basis for the initial measurement of an asset or a liability and its subsequent measurement.

No single factor is determinative when selecting an appropriate measurement basis. The relative importance of each factor will depend on facts and circumstances.

Effective communication

...makes information more relevant, faithfully represents and enhances understandability and comparability

This requires:

1. Focusing on objectives and principles rather than rules

2. Grouping similar items and separating dissimilar items

3. Aggregating information appropriately so it's not obscured by unnecessary detail

There are 2 concepts relating to capital:

Financial concept of capital - Net assets / equity (This is the one most adopted of course)

Physical concept of capital - The productive capacity (eg units of output per day)

2 Concepts of Capital

1. Financial

   Profit = Increase in Net Assets (disregarding dividends and capital contributions)

2. Physical

   Profit = Increase in productive capacity (disregarding dividends and capital contributions)