Mater Dei College | Tubigon, Bohol | (038)508-8106

College of Accountancy, Business and Management - Business Department

Course Title Conceptual Framework and Accounting Standards Course No. AE 102
Instructor Ma. Angelica C. Balatucan, CPA, MSA Schedule 10:30-12:00 TF

Week 3
Course Learning Outcome Explain the various theoretical concepts in the development of the Financial
Accounting Framework
Student Learning Outcomes 1. Identify the qualitative characteristics of accounting information

Learning Content
CONCEPTUAL FRAMEWORK: QUALITATIVE CHARACTERISTICS

Introduction
Here we are on the third week of the course Conceptual Framework and Accounting Standards. In this week’s lesson, we
will get to know what are the qualitative characteristics of useful financial information. These qualitative characteristics
constitute the second component of the scope of the Conceptual Framework.

Lesson Content

B. QUALITATIVE CHARACTERISTICS

✔are qualities or attributes that make financial accounting information useful to the users.
✔ are classified into:
1. Fundamental Qualitative Characteristics
2. Enhancing Qualitative Characteristics

Fundamental Qualitative Characteristics (FQC)

✔ relate to the content or substance of financial information.

✔ Information must be both relevant and faithfully represented to be useful.

1. Relevance
– Is the capacity of the information to influence a decision
Ingredients:
a. Predictive value – the information can be used as an input to make predictions about the
future.
b. Confirmatory value – the information can be used to confirm or correct the decision maker’s
earlier expectations. It is affected by its nature and materiality.

Materiality
- also known as the doctrine of convenience, a quantitative “threshold” linked very closely to
the qualitative characteristic of relevance
- a practical rule in accounting which dictates that strict adherence to GAAP is not required
when the items are not significant enough to affect the evaluation, decision, and fairness of
the financial statements.
- depends on:
▪ relative size rather than absolute size
▪ nature of an item
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College of Accountancy, Business and Management - Business Department
▪ good judgment, professional expertise, and common sense
2. Faithful Representation
– financial information represents economic phenomena or transactions in words and in numbers.
Ingredients:
a. Completeness – a complete depiction includes all information necessary for a user to
understand the phenomenon being depicted, including all necessary depictions and
explanations. It is a result of the adequate disclosure standard or the principle of full disclosure
(which means that all significant and relevant information leading to the preparation of financial
statements shall be clearly reported).
✔ To be complete, the financial statements shall be accompanied by “notes to the financial
statements”, the purpose of which is to provide the necessary disclosures required by the PFRS.
b. Neutrality – freedom from bias in the preparation or presentation of the financial statements. –
is synonymous with the “principle of fairness”.
✔ The information should not favor one party to the detriment of another party.
✔ To be neutral is to be fair.
✔ Neutrality is supported by the exercise of prudence (the exercise of care and caution when
dealing with uncertainties in the measurement process such that assets or income are not
overstated, and liabilities or expenses are not understated)

Conservatism – synonymous with prudence, which means that when alternatives exist, the
alternative which has the least effect on equity should be chosen.
✔”In case of doubt, record any loss and do not record any gain.”
✔Anticipate no profit and provide for probable and measurable loss”
Examples:
▪ choosing the lower figure in valuing an asset
▪ measuring inventories as lower of cost and net realizable value
▪ recognizing a “provision” if the loss is probable and can be measured reliably
▪ not recognizing a contingent gain, only a disclosure is made
c. Free from error – there are no errors or omissions in the descriptions of the phenomenon or
transaction, and the process used to produce the reported information has been selected and
applied with no errors in the process.

Other considerations in faithful representation:

• Measurement Uncertainty
- Arises when monetary amounts in financial reports cannot be observed directly and must instead be
estimated
- Can affect faithful representation if the level of uncertainty in providing an estimate is high; however, if
the estimate is clearly and accurately described and explained, even a high level of measurement
uncertainty does not affect the usefulness of the financial information
• Substance Over Form
- Transactions and events are accounted in accordance with their substance and reality and not merely
their legal form
- Is not considered as a separate component of faithful representation since the latter inherently
represents the substance of an economic phenomenon or transaction rather than merely representing
the legal form

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College of Accountancy, Business and Management - Business Department
Example: A lessee leases a property from the lessor and the terms provide that the lease transfers
ownership of the asset to the lessee by the end of the lease term. In form, the contract is a lease but in
substance, the real intent is an installment purchase of an asset by the lessee from the lessor. Hence,
the lessee shall record an acquisition of right of use asset and set up a liability to the lessor and the
periodic rental is conceived as the installment payment.

Enhancing Qualitative Characteristics (EQC)

✔ relate to the presentation and form of the financial information

✔ intended to increase the usefulness of the financial information that is relevant and faithfully represented

1. Comparability
- Means the ability to bring together for the purpose of noting points of likeness and difference
- Enables users to identify and understand similarities and dissimilarities among items
✔For information to be comparable, like things must look alike and different things must look different.
✔Comparability may be made within an entity or between or across entities:
▪ horizontal comparability or Intracomparability – comparability within an entity
▪ dimensional comparability or intercomparability – comparability between and across entities

Consistency is implicit in the qualitative characteristic of comparability. Consistency refers to the use of the
same methods for the same items, either from period to period within the reporting entity or in a single
period across entities. For example, using the same method of inventory valuation for every year.
✔Consistency is the uniform application of accounting method from period to period within an entity while
comparability is the uniform application of accounting method between and across entities in the same
industry.

2. Understandability

- requires that financial information must be comprehensible and intelligible, and thus should be
presented in a form and expressed in terminology that a user understands.
- is the quality of information that enables users who have a reasonable knowledge of business and
economic activities and financial accounting, and who study the information with reasonable diligence,
to comprehend its meaning.

✔ Classifying, characterizing, and presenting information “clearly and concisely” makes it understandable.

3. Verifiability

- means that different knowledgeable and independent observers could reach consensus,
although not necessarily complete agreement, that a particular depiction is a faithful representation.
- Helps assure users that information represents the economic phenomenon or transactions it
purports to represent.

✔ The information is verifiable in the sense that it is supported by evidence so that an accountant that
would investigate the same evidence would arrive at the same economic decision or conclusion.

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Types of verification:
a. Direct – verifying an amount or other representation through direct observation, for example,
by counting cash
b. Indirect – checking the inputs to a model, formula or other technique and recalculating the
inputs using the same methodology understandable.

4. Timeliness
- the financial information must be available or communicated early enough when a decision is to
be made.
✔Generally, the older the information, the less useful.
✔ What happened in the past would become the basis of what would happen in the future.

Cost Constraint on Useful Information

Reporting financial information imposes cost and it is important that such cost is justified by the benefit derived
from the financial information.
✔The benefit derived from the information should exceed the cost incurred in obtaining the information.

Predictive value
Relevance
Confirmatory
value
Fundamental
Qualitative Characteristics

Completeness

Faithful
Neutrality
Representation

Comparability Free from Error

Understandability
Enhancing
Verifiability

Timeliness

Figure 1. The Qualitative Characteristics

Review Questions
Recall the lesson and try to answer the following review questions:
1. Name the fundamental qualitative characteristics and briefly describe them.
2. Name the enhancing qualitative characteristics and briefly describe them.
3. Differentiate consistency from comparability
4. Explain the concept of substance over form.
5. Explain cost constraint on useful financial information.

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College of Accountancy, Business and Management - Business Department
Exercises
Exercise 3.
A. Identify the qualitative characteristics, including the ingredients described in the following statements.
1. It refers to the quality of information that is not biased in favor of one group of users to
the detriment of others.
2. The concept of accounting that holds that, to the maximum extent possible, financial
statements shall be based in arm’s length transactions.
3. It refers to the quality of information that enables users to better forecaset future
operations .
4. The concept where there are no errors or omissions in the description of the
phenomenon.
5. It is the quality of information where financial statements shall be accompanied by
notes to financial statements.
6. It is the ability to bring together for the purpose of noting points of likeness and
difference.
7. It is the quality of information that influences the economic decisions of users.
8. It refers to the quality of information where the description and numbers or figures
must watch what really existed or happened.
9. It refers to the quality of information when two different entities engaged in the same
industry has been prepared and presented in similar manner.
10. It is the quality of information when an entity has started placing its quarterly financial
statements on its eab page, thereby reducing by ten days the time to get information
to investors and creditors.

B. Determine if the statement is true or false by writing your answer on the space provided.

1. An information is consistent when it is measured similarly across the industry.

2. The enhancing quality of understandability means that information should be
understood by those who are experts in the interpretation of financial information.
3. An item must make a difference or it need not be disclosed.
4. Financial information should be free from cost to users.
5. The consistency standard requires that accounting procedures should be adopted
when the result is a consistent rate of return.
6. Reporting data on segments having the same expected risks to analysts estimating
future profit is a violation of the concept of faithful representation.
7. The underlying concept governing the GAAP pertaining to recording gain contingencies
is conservatism.
8. For information to be useful, the linkage between the users and the decisions made is
understandability.
9. To achieve faithful representation, the financial statements are understandable,
comparable, verifiable and timely.
10. Qualitative characteristics distinguish better information from inferior information for
decision-making purposes.

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COURSE LEARNING MODULE | 2nd Semester, 2021-2022
 Mater Dei College | Tubigon, Bohol | (038)508-8106
College of Accountancy, Business and Management - Business Department
Course Title Conceptual Framework and Accounting Standards Course No. AE 102
Instructor Ma. Angelica C. Balatucan, CPA, MSA Schedule 10:30-12:00 TF

Week 4
Course Learning Outcome Explain the various theoretical concepts in the development of the Financial
Accounting Framework
Student Learning Outcomes 1. Determine the general objective of financial statements
2. Identify the types of financial statements according to the Revised Conceptual
Framework
3. Explain the underlying and implicit assumptions in accounting
4. Identify the elements of the financial statements

Learning Content
CONCEPTUAL FRAMEWORK: FINANCIAL STATEMENTS AND THE REPORTING ENTITY AND THE FINANCIAL
STATEMENT ELEMENTS

Introduction
This is the fourth week of the course Conceptual Framework and Accounting Standards. In this week’s lesson, we will
focus on the financial statements, particularly its objectives, types and elements. Also, we will know what is a reporting
entity and what are the underlying and implicit assumptions in accounting.

Lesson Content

C. FINANCIAL STATEMENTS AND THE REPORTING ENTITY

FINANCIAL STATEMENTS
- provide information about economic resources of the reporting entity, claims against the entity and
changes in the economic resources and claims.
- provide financial information about an entity’s assets, liabilities, equity, income and expenses useful to
users of financial statements in:
✓ assessing future cash flows to the reporting entity
✓ assessing management stewardship of the entity’s economic resources.

Financial information is provided by the following:

▪ Statement of financial position – by recognizing assets, liabilities and equity
▪ Statement of financial performance – by recognizing income and expenses
▪ Other statements and notes by presenting and disclosing information about:
o Recognized assets, liabilities, equity, income and expenses
o Unrecognized assets and liabilities
o Cash flows
o Contribution from equity holders and distribution to equity holders
o Method, assumptions and judgment in estimating amount presented

Types of Financial Statements

The Revised Conceptual Framework recognizes three types of financial statements:
1. Consolidated financial statements
2. Unconsolidated financial statements
3. Combined financial statements

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Consolidated financial statements
– provide information about the assets, liabilities, equity, income and expenses of both the parent
(the entity that exercises control over the subsidiaries) and its subsidiaries as a single reporting
entity.
– Are not designed to provide separate information about the assets, liabilities, equity, income and
expenses of a particular subsidiary. A subsidiary’s own financial statements are designed to provide
such information.
Consolidated infomration is useful for existing and potential investors, lenders, and other creditors of the parent
in their assessment of future net cash inflows to the parent.
This is because net cash inflows to the parent include distributions to the parent from its subsidiaries.

Unconsolidated financial statements

– Are designed to provide information about the parent’s assets, liabilities, equity, income and
expenses and not about those of the subsidiaries. Such information can be useful to the existing and
potential investors, lenders and other creditors of the parent because a claim against the parent
typically does not give the holder of that claim against the subsidiaries.
– Cannot serve as substitute for consolidated financial statements when consolidated financial
statements are required.

Combined financial statements

– Provide financial information about the assets, liabilities,equity, income and expenses of two or
more entities not linked with parent and subsidiary relationship.

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.

The following can be considered a reporting entity:

1. Individual corporation, partnership or proprietorship
2. The parent alone
3. The parent and its subsidiaries as single reporting entity
4. Two or more entities without parent and subsidiary relationship as a single reporting entity
5. A reportable business segment of an entity

Reporting period
– the period when financial statements are prepared for general-purpose financial reporting.

Financial statements may be prepared on an interim basis, for example, three months, six months or nine
months. Interim financial statements are not required but optional. However, financial statements must be
prepared on an annual basis or a period of twelve months.

To help users of financial statements to identify and assess change in trends, financial statements also provide
comparative information for at least one preceeding reporting period.

Financial statements may include information about transactions and other events that occurred after the end
of reporting period if the information is necessary to meet the general objective of financial statements.
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UNDERLYING ASSUMPTIONS

Accounting Assumptions
- basic notions or fundamental premises on which the accounting process is based.
- Also known as postulates
- Serve as foundation or bedrock of accounting in order to avoid misunderstanding but rather enhance
the understanding and usefulness of the financial statements

The Conceptual Framework for Financial Reporting mentions only one assumption, namely going concern.
However, implicit in accounting are the basic assumptions of accounting entity, time period and monetary unit.

Going Concern
- Means that in the absence of evidence to the contrary, the accounting entity is viewed as continuing in
operation indefinitely. In other words, financial statements are normally prepared on the assumption
that the entity will continue in operations for the foreseeable future.
- Is the very foundation of the cost principle. Thus, assets are normally recorded at cost. As a rule, market
values are ignored. However, some new standards require measurement of certain assets at fair value.

Accounting Entity (or Entity Assumption)

- Is the specific business organization, which may be a proprietorship, partnership or corporation
- Is the assumption that the entity is separate from the owners, managers, and employees who constitute
the entity. The reason for this assumption is to have a fair presentation of financial statements.

Accordingly, the transactions of the entity shall not be merged with the transactions of the owners. The personal
transactions of the owners shall not be allowed to distort the financial statements of the entity.

If an enterprising entrepreneur owns a department store, restaurant and bookstore, separate statements shall
be prepared for each business in order to determine which business is profitable.

Each business is an independent accounting entity. When a major shareholder of a corporation borrows money
from a bank on his personal account, the loan is a liability of the shareholder alone and not of the corporation.

The shareholder is not the corporation and the corporation is not the shareholder. However, when parent and
subsidiary relationship exists, consolidated statements for the affiliates are usually made because for practical
and economic purposes, the parent and the subsidiary are a “single economic entity”. The consolidation,
however, does not eliminate the legal boundary segregating the affiliated entities. Accounting will continue to
be done separately for each entity.

Time Period

A completely accurate report on the financial position and performance of an entity cannot be obtained until
the entity is finally dissolved and liquidated. Only then can the final net income and net worth of the entity be
determined precisely. However, users of financial information need timely information for making an economic
decision. It becomes necessary therefore to prepare periodic reports on financial position, performance and
cash flows of an entity.

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Time period assumption requires that the indefinite life of an entity is subdivided into accounting periods which
are usually of equal length for the purpose of preparing financial reports on financial position, performance and
cash flows.

Accounting period or fiscal period

- by convention, is one year or a period of twelve months. The “one-year period” is traditionally the
accounting period because usually it is after one year that government reports are required.
- may be a:
▪ calendar year – a twelve-month period that ends on December 31
▪ natural business year – a twelve-month period that ends on any month when the business is at
the lowest or experiencing slack season

Monetary Unit
- has two aspects:
▪ Quantifiability of peso – the assets, liabilities, equity, income and expenses should be stated in
terms of a unit of measure which is the peso in the Philippines
▪ Stability of peso – the purchasing power of the peso is stable or constant and that its instability
is insignificant and therefore may be ignored. It is an amplification of the going concern assumption so
much so that adjustments are unnecessary to reflect any changes in purchasing power.

The accounting function is to account for nominal pesos only and not for constant pesos or changes in
purchasing power.

D. ELEMENTS OF FINANCIAL STATEMENTS

Elements Of Financial Statements

- broad classes in which transactions and other events are grouped according to their economic
characteristics
- the quantitative information reported in the statement of financial position and income statement.
- are “building blocks” from which financial statements are constructed.

Elements directly related to the measurement of

Financial Position Financial Performance
▪ Asset ▪ Income
▪ Liability ▪ Expense
▪ Equity

The Conceptual Framework identifies no elements that are unique to the statement of changes in equity
because such statement comprises items that appear in the statement of financial position and the income
statement.

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

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ASSET
- Is defined as present economic resource controlled by the entity as a result of past events (Revised
CFW). The new definition clarifies that an asset is an economic resource and that the potential economic
benefits no longer need to be expected to flow to the entity.

Essential Characteristics
✓ The asset is a present economic resource.
o An economic resource is a right that has the potential to produce economic benefits.

✓ The economic resource is a right that has the potential to produce economic benefits.
 Right. Rights that have the potential to produce economic benefits may take the following forms:
Rights that correspond to an Rights that do not correspond Rights established by contract
obligation of another entity to an obligation of another or legislation
entity
▪ Right to receive cash ▪ Right over physical objects ▪ Owning a debt instrument or
▪ Right to receive goods or (PPE or inventories) an equity instrument
services ▪ Right to intellectual property ▪ Owning a registered patent
▪ Right to exchange economic
resources with another party on
favorable terms
▪ Right to benefit from an
obligation of another party if a
specified uncertain future event
occurs

 Potential to produce economic benefits. For the potential to exist, it does not need to be certain or
even likely that the right will produce economic benefits. It is only necessary that the right already
exists.
A right can meet the definition of an economic resource even if the probability that it will produce
economic benefit is low. The economic resource is the present right that contains the potential and
not the future economic benefits that the right may produce.

An economic resource could produce economic benefits if an entity is entitled:

a. To receive contractual cash flows
b. To exchange economic resources with another party on favorable terms
c. To produce cash inflows or avoid cash outflows
d. To receive cash by selling the economic resource
e. To exitinguish a liability by transferring an economic resource

✓ The economic resource is controlled by the entity as a result of past events.

Control
– present ability to direct the use of the asset and obtain the economic benefits that flow from it.
– includes the ability to prevent others from using such asset and therefore preventing others from
obtaining the economic benefits from the asset.
– may arise if an entity enforces legal rights. If there are no legal rights, control can still exist if an entity
has other means of ensuring that no other party can benefit from an asset.

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LIABILITY
- Is defined as present obligation of an entity to transfer an economic resource as a result of past events
(Revised CFW).

The new definition clarifies that a liability is the obligation to transfer an economic resource and the ultimate
outflow of economic benefits. The outflow of economic benefits no longer needs to be expected similar to
the definition of an asset. The new definition of liability to some extent is inconsistent with the definition of
liability under IAS 37. In case of doubt, the IASB stated that the requirements of a Standard shall always
prevail over the Conceptual Framework.

Essential Characteristics
✓ The entity has an obligation.
Obligation
- a duty or responsibility that has an entity has no practical ability to avoid.
- can be:
• Legal – legally enforceable as a consequence of a binding contract or statutory
requirement. Ex. Accounts payable for goods and services received
• Constructive – arise from normal business practice, custom and a desire to maintain good
business relations or act in an equitable manner. Ex. An entity’s policy to rectify faults in
the products even when these become apparent after the warranty period
The entity liable must be identified. It is not necessary that the payee or the entity to whom the
obligation is owed be identified.

✓ The obligation is to transfer an economic resource.

This include:
a. Obligation to pay cash
b. Obligation to deliver goods or noncash resources
c. Obligation to provide services at some future time
d. Obligation to exchange economic resources with another party on unfavorable terms
e. Obligation to transfer an economic resource if specified uncertain future event occurs

✓ The obligation is a present obligation that exists as a result of past event.

An obligation exists as a result of past event if both of the following conditions conditions are satisfied:
a. An entity has already obtained economic benefits.
b. An entity must transfer an economic resource.

INCOME
- Is defined as increases in assets or decreases in liabilities that result in increases in equity, other than
those relating to contributions from equity holders.
- Encompasses both revenue and gains
▪ Revenue – arises in the course of the ordinary regular activities and is referred to by variety of
different names including sales, fees, interest, dividends, royalties and rent. The essence of revenue is
regularity.
▪ Gains – represent other items that meet the definition of income and do not arise in the course of
the ordinary regular activities. These include gain from disposal of noncurrent asset, unrealized gain on
trading investment and gain from expropriation.

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EXPENSES
- Is defined as decreases in assets or increases in liabilities that result in decreases in equity, other than
those relating to distributions to equity holders.
- Encompasses losses as well as those expenses that arise in the course of the ordinary regular activities
▪ Expenses that arise in the course of the ordinary regular activities include cost of goods sold, wages
and depreciation
▪ Losses – do not arise in the course of the ordinary regular activities and include losses resulting from
disasters. Ex. Losses from fire, flood, strom surge, tsunami and hurricane, as well as those arising from
disposal of noncurrent assets.

Statement of Financial Performance

- A term introduced by the Revised Conceptual Framework, which refers to the statement of profit or
loss and a statement presenting other comprehensive income.

Statement of profit or loss – the primary source of information about an entity’s financial performance.
As a general rule, all income and expenses are included in profit or loss. However, in developing
accounting standards, there are some items of income and expenses that are included in other
comprehensive income and not in profit or loss if such presentation would provide more relevant and
faithfully represented information about financial performance. There are instances that an amount in
other comprehensive income in one reporting period may be recycled to profit or loss in another
reporting period.

Review Questions
Recall the lesson and try to answer the following review questions:
1. What is the general objective of financial statements?
2. Explain a reporting period.
3. What are the three types of financial statements according to the Revised Conceptual Framework?
4. What is a reporting entity?
5. Explain the going concern assumption.
6. Differentiate calendar year and natural business year.
7. What is quantifiability and stability of peso in relation to monetary unit assumption?
8. Explain the elements of financial statements directly related to the measurement of financial position.
9. Explain the elements of financial statements directly related to the measurement of financial performance.

Exercises
Exercise 4.
Identify what accounting concept/assumption is involved in the given situations/statements.
1. Inflation is ignored.
2. It justifies the usage of accruals and deferrals.
3. During the lifetime of an entity, accountants produce financial statements at arbitrary
points in time.
4. It is an entity that is required or chooses to prepare financial statements.
5. An electronics entity owned by a proprietor reported the cost of the proprietor’s
swimming pool as an asset of the entity.

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B. Determine if the statement is true or false by writing your answer on the space provided.

1. The going concern assumption may not be followed when an entity in bankruptcy
reports financial results.
2. When a parent and subsidiary relationship exists, consolidated financial statements are
prepared in recognition of economic entity.
3. Combined financial statements provide financial information about the subsidiaries.
4. If the reporting entity comprises both the parent and its subsidiaries, the financial
statements are referred to as separate financial statements.
5. The periodicity assumption is being violated if an entity provides financial reports in
connection with a new product introduction.
6. The valuation of a promise to receive cash in the futur at present value is valid because
of the monetary unit assumption.
7. The economic entity assumption is applicable to all forms of business organizations.
8. A present obligation exists as result of past event if the entity has already obtained
economic benefit.
9. Included in the definition of an asset is that future economic benefits from the
economic resource is expected to flow to the entity.
10. An economic resource could produce economic benefit if an entity is entitled to
exchange economic resources with another entity on favorable terms.

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