Conceptual Framework Chapters (1-3)

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Chapter 1: The Objective of Financial Reporting

The objective is to provide financial information that is useful to present and potential equity investors, lenders and other creditors in making decisions.

The degree to which that financial information is useful will depend on its qualitative characteristics.

A few observations about the objective:

  • Wide Scope
     
    Its scope is wider than financial statements. It is the objective of financial reporting in general.

  • Users
     
    Financial reporting is aimed primarily at capital providers. That does not mean that others will not find financial reports useful. It is just that, in deciding on the principles for recognition, measurement, presentation, and disclosure, the information needs of capital providers are paramount.

  • Decision usefulness & stewardship
     
    Decision usefulness to capital providers is the overriding purpose of financial reporting, as well as assessing the stewardship of resources already committed to the entity.

    The ability of management to discharge their stewardship responsibilities effectively has an effect on the entity’s ability to generate net cash inflows in the future, implying that potential investors are also assessing management performance as they make their investment decision.

  • Capital providers - main users 

    The Framework identifies equity investors, lenders and other creditors as ‘capital providers’. Governments, their agencies, regulatory bodies, and members of the public are identified as groups that may find the information in general purpose financial reports useful. However, these groups have not been identified as primary users.

Limitations of FS

The Boards note that users of financial reports should be aware of the limitations of the information included in such reports – specifically, estimates and the use of judgement.

Additionally, financial reports are but one source of information needed by those who make investment decisions. Information about general economic conditions, political events and industry outlooks should also be considered.

Financial reporting should also include management’s explanations, since management knows more about the entity than external users.

Chapter 2: The Reporting entity

The chapter on the Reporting Entity will be inserted once the IASB has completed its re-deliberations following the Exposure Draft ED/2010/2 issued in March 2010.

Chapter 3: Qualitative Characteristics of Useful Financial Information

Main Principle

Financial information is useful when it is relevant and represents faithfully what it purports to represent. The usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable.

Fundamental characteristics:

  1. Relevance

    Relevant information makes a difference in the decisions made by users.

    Therefore it must have a predictive value, confirmatory value, or both. The predictive value and confirmatory value of financial information are interrelated. 

    Materiality is an entity-specific aspect of relevance. It is based on the nature and/or size of the item relative to the financial report.

  2. Faithful representation

    General purpose financial reports represent economic phenomena in words and numbers.  

    To be useful, financial information must not only be relevant, it must also represent faithfully the phenomena it purports to represent.

    This maximises the underlying characteristics of completeness, neutrality and freedom from error.

Enhancing characteristics:

  1. Comparability (including consistency)

  2. Timeliness

  3. Reliable information

  4. Verifiability

    Helps to assure users that information represents faithfully the economic phenomena that it purports to represent.

    It implies that knowledgeable observers could reach a general consensus (although not necessarily absolute agreement) that the information does represent faithfully the economic phenomena.

  5. Understandability

    Enables users with a reasonable knowledge to comprehend the information.

Understandability is enhanced when the information is:

  • Classified

  • Characterised

  • Presented  clearly and concisely

However, relevant information should not be excluded solely because it may be too complex.

Two constraints that limit the information provided in useful financial reports:

  1. Materiality

    Information is material if its omission or misstatement could influence the decisions that users make on the basis of an entity’s financial information. 

    Materiality is not a matter to be considered by standard-setters but by preparers and their auditors.

  2. Cost-benefit

    The benefits of providing financial reporting information should justify the costs of providing that information.

Potential Problems

Decision usefulness seen  as more important than the giving information about how well the company is being looked after (Stewardship).

Although it may be said that stewardship is taken into account when talking about decision usefulness - perhaps there should be a more specific mention of it.

Faithful representation has replaced reliability.

This is even more vague and could lead to problems regarding treatment of some items where substance over form exists

Should it encompass not for profits also?

Why the split between fundamental and enhancing characteristics?

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