Conceptual Framework

and Accounting
Standards
CHAPTERS 3 TO 5
 Chapter 3: FINANCIAL STATEMENTS
AND THE REPORTING ENTITY
 Objective of Financial Statements: To provide information about the
entity’s
Information FS

Assets, Liabilities and Equity

Income and Expenses

Recognised assets, liabilities, equity, income and expenses including information about their nature and
about the risks arising from those recognized assets and
liabilities
Assets and liabilities that have not been recognized, including information about their nature and about
the risks arising from them
Cash flows

Contributions from holders of equity claims and distributions to them

The methods, assumptions and judgements used in estimating the amounts presented or disclosed, and
changes in those methods, assumptions and judgements
 Reporting Period

 Financial statements are prepared for a specified period of time (reporting period) and provide
information about:
 assets and liabilities—including unrecognised assets and liabilities— and equity that existed
at the end of the reporting period, or duringthe reporting period; and
 income and expenses for the reporting period.
 Financial statements also provide comparative information for at least one preceding reporting
period
 Information about possible future transactions and other possible future events (forward-looking
information) is included in financial statements if it:
 relates to the entity’s assets or liabilities—including unrecognized assets or liabilities—or
equity that existed at the end of the reporting period, or during the reporting period, or to
income or expenses for the reporting period; and
 is useful to users of financial statements.
Perspective Adopted in the FS

 Financial statements provide information about

transactions and other events viewed from the
perspective of the reporting entity as a whole, not from
the perspective of any particular group of the entity’s
existing or potential investors, lenders or other creditors.
Going Concern Assumption

 The entity is assumed that it will continue in operation for the foreseeable future and has
no intention nor need to enter liquidation or cease trading.
 If such an intention or need exists, the financial statements may have to be prepared on a
different basis
Reporting Entity

 Is an entity that is required, or chooses, to

prepare financial statements.
 Can be a single entity or a portion of an entity
or can comprise more than one entity.
 Is not necessarily a legal entity
 Types of Financial Statements

Information Provided FS Type

Assets, liabilities, equity, income and expenses of both the parent Consolidated FS
and subsidiaries as a SINGLE reporting entity

Assets, liabilities, equity, income and expenses of the parent but not Unconsolidated
of the subsidiaries FS

Assets, liabilities, equity, income and expenses of two or more entities Combined FS
that are not linked by a parent-subsidiary relationship
Basic Elements
 Forms of RIGHTS

Rights that correspond to an obligation of Rights that do not correspond to an obligation of

another party another party

 Rights to receive cash  Rights over physical objects, such as PPE

 Rights to receive goods or services or inventories (to use or to benefit from
 Rights to exchange economic resources residual value of assets)
with another party on favourable terms  Rights to use intellectual property
 Rights to benefit from an obligation of
another party to transfer an economic
resources if a specified uncertain future
event occurs
 RIGHT

 An entity’s right to obtain the economic benefits produced by goods or services exists
momentarily until the entity consumes the goods or services. (par 4.8)
 Not all of an entity’s rights are assets of that entity—to be assets of the entity, the rights must both
have the potential to produce for the entity economic benefits beyond the economic benefits
available to all other parties and be controlled by the entity. (par 4.9)
 An entity cannot have a right to obtain economic benefits from itself (par 4.10)
 In principle, each of an entity’s rights is a separate asset. However, for accounting purposes,
related rights are often treated as a single unit of account that is a single asset (par 4.11)
 In many cases, the set of rights arising from legal ownership of a physical object is accounted for
as a single asset. Conceptually, the economic resource is the set of rights, not the physical
object. (par 4.12)
 In some cases, it is uncertain whether a right exists. Until that existence uncertainty is resolved—for
example, by a court ruling—it is uncertain whether the entity has a right and, consequently,
whether an asset exists. (par 4.13)
 Potential to produce economic
benefits

 An economic resource could produce economic benefits for an

entity by entitling or enabling it to do, for example, one or more of
the following:
 receive contractual cash flows or another economic resource;
 exchange economic resources with another party on favourable terms;
 produce cash inflows or avoid cash outflows
 receive cash or other economic resources by selling the economicresource; or
 extinguish liabilities by transferring the economic resource.
Control

 An entity controls an economic resource if it has

the present ability to direct the use of the
economic resource and obtain the economic
benefits that may flow from it.

 Control of an economic resource usually arises

from an ability to enforce legal rights.
Obligation

 An obligation is a duty or responsibility that an entity has no

practical ability to avoid.
 If one party has an obligation to transfer an economic resource, it
follows that another party (or parties) has a right to receive that
economic resource. However, a requirement for one party to
recognise a liability and measure it at a specified amount does not
imply that the other party (or parties) must recognise an asset or
measure it at the same amount.
Types of Obligations

1. Legal Obligations - Obligations established by contract, legislation

or similar means and are legally enforceable by the party (or
parties) to whom they are owed.
2. Constructive Obligation - Obligations arising from an entity’s
customary practices, published policies or specific statements if he
entity has no practical ability to act in a manner inconsistent with
those practices, policies or statements.
 Transfer of an economic resource

 The obligation must have the potential to require the entity to transfer an
economic resource to another party (or parties through
 obligations to pay cash.
 obligations to deliver goods or provide services.
 obligations to exchange economic resources with another party on unfavourable
terms. Such obligations include, for example, a forward contract to sell an
economic resource on terms that are currently unfavourable or an option that
entitles another party to buy an economic resource from the entity.
 obligations to transfer an economic resource if a specified uncertain future event
occurs.
 obligations to issue a financial instrument if that financial instrument will oblige the
entity to transfer an economic resource.
 Transfer of economic resource

 Instead of fulfilling an obligation to transfer an economic

resource to the party that has a right to receive that resource,
entities sometimes decide to,
 settle the obligation by negotiating a release from the obligation;
 transfer the obligation to a third party; or
 replace that obligation to transfer an economic resource with another
obligation by entering into a new transaction.
Present Obligation as a result of past
events

 A present obligation exists as a result of past events only if:

 the entity has already obtained economic benefits or taken an action; and
 as a consequence, the entity will or may have to transfer an economic
resource that it would not otherwise have had to transfer.
 The enactment of legislation is not in itself sufficient to give an entity a present
obligation.
 A present obligation can exist even if a transfer of economic resources cannot
be enforced until some point in the future.
 UNIT OF ACCOUNT

 The unit of account is the right or the group of rights, the obligation or the
group of obligations, or the group of rights and obligations, to which
recognition criteria and measurement concepts are applied.
 A unit of account is selected to provide useful information, which implies
that:
 the information provided about the asset or liability and about any related income
and expenses must be relevant
 the information provided about the asset or liability and about any related income
and expenses must faithfully represent the substance of the transaction or other event
from which they have arisen.
Executory Contracts

 An executory contract is a contract, or a portion of a contract, that

is equally unperformed—neither party has fulfilled any of its
obligations, or both parties have partially fulfilled their obligations to
an equal extent.
 An executory contract establishes a combined right and obligation
to exchange economic resources. The right and obligation are
interdependent and cannot be separated.
 To the extent that either party fulfils its obligations under the
contract, the contract is no longer executory.
 Equity

 Equity claims are claims on the residual interest in the assets of the entity after deducting all
its liabilities. Such claims may be established by contract, legislation in the forms of:
 shares of various types, issued by the entity; and
 some obligations of the entity to issue another equity claim.
 Different classes of equity claims, such as ordinary shares and preference shares, may
confer on their holders different rights, for example, rights to receive some or all of the
following from the entity:
 dividends, if the entity decides to pay dividends to eligible holders;
 the proceeds from satisfying the equity claims, either in full on liquidation, or in part at other times;
or
 other equity claims.
 Second Level: Basic Elements
Exercise 2-5: Identify the element or elements associated with
items below. Elements
(a) Arises from peripheral or Assets
incidental transactions. Liabilities
(b) Obligation to transfer resources Equity
arising from a past transaction.
Investment by owners
(c) Increases ownership interest.
Distribution to owners
(d) Declares and pays cash
Comprehensive income
dividends to owners.
Revenue
(e) Increases in net assets in a
period from nonowner sources. Expenses
Gains
Losses
LO 5
 Second Level: Basic Elements
Exercise 2-5: Identify the element or elements associated with
items below. Elements
(a) Arises from peripheral or Assets
incidental transactions. (b) Liabilities
(b) Obligation to transfer resources Equity
arising from a past transaction.
(c) Investment by owners
(c) Increases ownership interest.
(d) Distribution to owners
(d) Declares and pays cash
(e) (c) Comprehensive income
dividends to owners.
Revenue
(e) Increases in net assets in a
period from nonowner sources. Expenses
(a) Gains
(a) Losses
LO 5
 Second Level: Basic Elements
Exercise 2-5: Identify the element or elements associated with
items below. Elements
(f) Items characterized by future Assets
economic benefit. Liabilities
(g) Equals increase in net assets Equity
during the year, after adding
Investment by owners
distributions to owners and
subtracting investments by Distribution to owners
owners. Comprehensive income
(h) Arises from income statement Revenue
activities that constitute the Expenses
entity’s ongoing major or
Gains
central operations.
Losses
LO 5
 Second Level: Basic Elements
Exercise 2-5: Identify the element or elements associated with
items below. Elements
(f) Items characterized by future (f) Assets
economic benefit. Liabilities
(g) Equals increase in net assets Equity
during the year, after adding
Investment by owners
distributions to owners and
subtracting investments by Distribution to owners
owners. (g) Comprehensive income
(h) Arises from income statement (h) Revenue
activities that constitute the (h) Expenses
entity’s ongoing major or
Gains
central operations.
Losses
LO 5
 Second Level: Basic Elements
Exercise 2-5: Identify the element or elements associated with
items below. Elements
(i) Residual interest in the net Assets
assets of the enterprise. Liabilities
(j) Increases assets through sale Equity
of product.
Investment by owners
(k) Decreases assets by
Distribution to owners
purchasing the company’s
own stock. Comprehensive income

(l) Changes in equity during the Revenue

period, except those from Expenses
investments by owners and Gains
distributions to owners.
Losses
LO 5
 Second Level: Basic Elements
Exercise 2-5: Identify the element or elements associated with
items below. Elements
(i) Residual interest in the net Assets
assets of the enterprise. Liabilities
(j) Increases assets through sale (i) Equity
of product.
Investment by owners
(k) Decreases assets by
(k) Distribution to owners
purchasing the company’s
own stock. (l) Comprehensive income

(l) Changes in equity during the (j) Revenue

period, except those from Expenses
investments by owners and Gains
distributions to owners.
Losses
LO 5
 Second Level: Basic Elements

Review:
According to the FASB conceptual framework, an entity’s
revenue may result from

a. A decrease in an asset from primary operations.

b. An increase in an asset from incidental transactions.

c. An increase in a liability from incidental transactions.

d. A decrease in a liability from primary operations.

LO 5 Define the basic elements of financial statements.

 Second Level: Basic Elements

Review:
According to the FASB conceptual framework, an entity’s
revenue may result from

a. A decrease in an asset from primary operations.

b. An increase in an asset from incidental transactions.

c. An increase in a liability from incidental transactions.

d. A decrease in a liability from primary operations.

LO 5 Define the basic elements of financial statements.

Recognition and Derecognition
 Recognition

 Recognition is the process of capturing for inclusion in the statement of

financial position or the statement(s) of financial performance an item that
meets the definition of one of the elements of financial statements—an asset,
a liability, equity, income or expenses.
 Recognition involves depicting the item in one of those statements—either
alone or in ggregation with other items— in words and by a monetary
amount, and including that amount in one or more totals in that statement.
 Recognition links the elements, the statement of financial position and the
statement(s) of financial performance as follows.
Recognition criteria

 Only items that meet the definition of an asset, a liability or equity

are recognised in the statement of financial position.
 Only items that meet the definition of income or expenses are
recognised in the statement(s) of financial performance.
 An asset or liability is recognised only if recognition of that asset or
liability and of any resulting income, expenses or changes in
equity provides users of financial statements with information that
is useful (relevant and faithfully represented)
Uncertainty

ON:
 EXISTENCE – it is uncertain whether an asset or liability
exists
 MEASUREMENT – For an asset or liability to be
recognised, it must be measured. In many cases, such
measures must be estimated and are therefore subject
to measurement uncertainty
 Derecognition

 Derecognition is the removal of all or part of a recognised asset or liability

from an entity’s statement of financial position.
 Derecognition normally occurs when that item no longer meets the
definition of an asset or of a liability:
 for an asset, derecognition normally occurs when the entity loses control of all or
part of the recognised asset; and
 for a liability, derecognition normally occurs when the entity no longer has a present
obligation for all or part of the recognized liability.
END