Conceptual Framework
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Conceptual Framework for Financial Reporting
Describes the objective of, and the concepts for, general purpose financial reporting, serving as the foundation for IFRS Standards.
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Purpose & Status
What the Conceptual Framework is for
The Conceptual Framework assists the IASB in developing Standards, helps preparers develop consistent accounting policies when no Standard specifically applies to a transaction, and assists all parties in understanding and interpreting Standards. It describes the objective of, and the concepts for, general purpose financial reporting.
Crucially, it is NOT a Standard
The Conceptual Framework is NOT an IFRS Standard and does NOT override any specific IFRS Standard. Nothing in the Conceptual Framework overrides any Standard or any requirement in a Standard. In the rare cases where a conflict exists between the Conceptual Framework and a Standard, the Standard PREVAILS.
The IASB may, on occasion, decide to depart from an aspect of the Conceptual Framework when developing a new or revised Standard, if it concludes doing so results in more useful information.
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The Objective of General Purpose Financial Reporting
Providing information useful to primary users
The objective of general purpose financial reporting is to provide financial information about the reporting entity that is USEFUL to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity – primarily by helping users assess the entity's prospects for future net cash inflows and management's stewardship of the entity's economic resources.
PRIMARY USERS (the Framework's focus)
Existing and potential investors Lenders Other creditors
General purpose financial reports do not and cannot provide all the information primary users need – users must also consider information from other sources, and the reports are not designed to show the entity's value.
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Fundamental Qualitative Characteristics
Relevance
Financial information is relevant if it is capable of making a difference in users' decisions – it has PREDICTIVE VALUE, CONFIRMATORY VALUE, or both. Materiality is an entity-specific aspect of relevance: information is material if omitting, misstating, or obscuring it could reasonably be expected to influence decisions of primary users.
Faithful representation
To be useful, information must not only represent relevant phenomena but faithfully represent the SUBSTANCE of what it purports to represent. A faithful representation is, to the maximum extent possible: COMPLETE (includes all necessary depictions and explanations), NEUTRAL (without bias, supported by the exercise of prudence), and FREE FROM ERROR (no errors or omissions in describing the phenomenon, with estimation processes correctly applied).
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Enhancing Qualitative Characteristics
Enhance the usefulness of relevant, faithfully represented information
CharacteristicWhat it means
ComparabilityEnables users to identify and understand similarities and differences among items, both across entities and across periods for the same entity
VerifiabilityDifferent knowledgeable, independent observers could reach general consensus that a depiction is a faithful representation
TimelinessInformation is available to decision-makers in time to be capable of influencing their decisions
UnderstandabilityInformation is classified, characterised, and presented clearly and concisely
Enhancing characteristics should be maximised to the extent possible, but cannot make information useful if it is fundamentally irrelevant or not faithfully represented – they are secondary to the two fundamental characteristics.
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The Reporting Entity
Not necessarily a legal entity
A reporting entity is an entity that is required, or chooses, to prepare financial statements – it is NOT necessarily a legal entity; it could comprise a portion of an entity, or two or more entities. Financial statements may be CONSOLIDATED (parent and all subsidiaries), UNCONSOLIDATED (parent alone), or COMBINED (two or more entities not linked by a parent-subsidiary relationship).
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Elements of Financial Statements – Assets & Liabilities
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. Control links the resource to the entity such that it can direct the resource's use and obtain the benefits that flow from it.
Liability
A present OBLIGATION of the entity to transfer an economic resource as a result of past events. Three criteria must all be met: the entity has an obligation; the obligation is to transfer an economic resource; and the obligation is a present obligation that exists as a result of past events.
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Elements – Equity, Income & Expenses
Equity
The RESIDUAL INTEREST in the assets of the entity after deducting all its liabilities. Equity claims are claims on the residual interest, ranking after liability claims in a winding-up.
Income & Expenses
Income is 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 are decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims.
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Recognition & Derecognition
Recognition
The process of capturing, for inclusion in the SOFP or SOPL, an item that meets the definition of an asset, liability, equity, income, or expense. Recognition links the elements to those statements through a structured summary depicting monetary amounts. An item is recognised only if doing so provides users with relevant information AND a faithful representation – recognition may be inappropriate if, for example, it is uncertain whether an asset/liability exists, or the probability of an inflow/outflow is low, or measurement uncertainty is unacceptably high.
Derecognition
The removal of all or part of a recognised asset or liability from an entity's statement of financial position – normally occurring when the item no longer meets the definition of an asset or liability (e.g. the entity loses control of the asset, or no longer has a present obligation for the liability).
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Measurement Bases
Historical cost vs current value
BasisWhat it reflects
Historical costValue of the resource, claim, or item of income/expense derived, at least in part, from the price of the transaction/event that gave rise to it
Fair valuePrice to sell an asset (or transfer a liability) in an orderly transaction between market participants at the measurement date
Value in use / fulfilment valuePresent value of cash flows an entity expects to derive from an asset's use/disposal, or expects to transfer in fulfilling a liability
Current costCost of an equivalent asset at the measurement date, comprising the consideration that would be paid, plus transaction costs
Choosing a measurement basis involves considering relevance and faithful representation, factoring in the nature of the resulting information and measurement uncertainty – no single basis is universally superior across all elements.
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Presentation & Disclosure
Communication tools, not just recognition outcomes
Effective communication of information makes it more relevant and contributes to a faithful representation. Classification – the sorting of assets, liabilities, equity, income, or expenses on the basis of shared characteristics – is applied both to elements recognised in the primary financial statements AND to information disclosed in the notes. Income and expenses are classified as included either within the STATEMENT OF PROFIT OR LOSS, or, in limited circumstances specified by a Standard, in OTHER COMPREHENSIVE INCOME (OCI).
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Concepts of Capital & Capital Maintenance
Financial vs physical capital
Under a FINANCIAL concept of capital (adopted by most entities), capital is the net assets or equity of the entity. Under a PHYSICAL concept, capital is the entity's productive capacity, e.g. units of output per day.
Profit only after capital is maintained
Under either concept, PROFIT represents the increase in wealth only after allowing the entity to maintain the level of capital it held at the start of the period – capital maintenance adjustments are needed to distinguish real profit from the effects of price changes, and are treated as adjustments to equity, not profit or loss.
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Worked Example – Applying the Definitions
Does a contingent legal claim meet the definition of an asset?
Example: Applying the asset definition to a pending lawsuit
A company has filed a lawsuit against a supplier for breach of contract, seeking $2,000,000 in damages. Legal counsel assesses the outcome as uncertain, with no reliable basis to conclude a favourable outcome is more likely than not.
Applying the Framework: the company has a RIGHT (to pursue the claim) with the POTENTIAL to produce economic benefits – this could satisfy the economic resource element of the asset definition. However, given the SIGNIFICANT uncertainty over whether an inflow will occur, RECOGNITION would likely fail the "relevant information" test in Section 8 (low probability, high measurement uncertainty) – the claim is not recognised as an asset, though it may warrant disclosure as a contingent asset under the applicable Standard (IAS 37) if the inflow is probable.
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IFRS vs US GAAP Conceptual Frameworks
Comparison – IASB Conceptual Framework vs FASB Conceptual Framework
FeatureIASB Conceptual FrameworkFASB Conceptual Framework (CON series)
StatusSingle, unified document (2018 revision)A series of separate Statements of Financial Accounting Concepts (CON 1-8), issued and amended incrementally over decades
PrudenceExplicitly reintroduced in the 2018 revision as supporting neutralityUS GAAP's framework has historically been more cautious about explicitly endorsing "prudence" as a distinct qualitative characteristic
Binding effectExplicitly NOT a Standard; specific Standards prevail in a conflictSimilarly non-authoritative for GAAP purposes
Despite decades of separate development, the two frameworks have converged substantially on core concepts (asset/liability definitions, qualitative characteristics), partly due to a joint IASB-FASB conceptual framework project conducted between 2004 and 2010.
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Glossary
Prudence
The exercise of caution when making judgements under conditions of uncertainty, supporting neutrality.
Substance over form
Representing transactions and events in accordance with their economic substance, not merely their legal form.
Unit of account
The right or the group of rights, obligation or group of obligations, to which recognition criteria and measurement concepts are applied.
Financial statement key
BS Balance sheet
IS Income statement
SE Statement of changes in equity
OCI Other comprehensive income
SCF Statement of cash flows