Conceptual Framework for Financial Reporting

(2018)
HISTORY OF THE CONCEPTUAL FRAMEWORK- current situation
2010
• Revised CF for financial reporting published with new chapters on the objective of general purpose f/s and
the qualitative characteristics. Rest based on 1989 version.
2012
• IASB restarted CF project due to public demanding CF to be regarded as a priority project.
2018
• Conceptual Framework published (effective 1 January 2020).

2
ROLE OF THE CONCEPTUAL FRAMEWORK

• Describes the objective of, and concepts for, general purpose financial reporting (GPFR)
• CF is the foundation of IFRS which sets out guiding principles.

• The purpose of the CF is to assist:

IASB to develop IFRS based on consistent concepts;
Preparers to develop consistent accounting policies where no IFRS applies or choice exists (not
common in practice); and
All parties to understand and interpret IFRSs.

• The CF is not a Standard (IFRS). Does not override any IFRS.

• IFRSs requirements sometimes depart from CF

3
CONTENT OF CONCEPTUAL FRAMEWORK

Chapter 1 The objective of general purpose financial reporting (GPFR)

Chapter 2 Qualitative characteristics of useful financial information

Chapter 3 Financial statements and the reporting entity

Chapter 4 The elements of financial statements

Chapter 5 Recognition and derecognition

Chapter 6 Measurement

Chapter 7 Presentation and disclosure

Chapter 8 Concepts of capital and capital maintenance (N/A for syllabus)

4
CHAPTER 1 - THE OBJECTIVE OF GENERAL PURPOSE FINANCIAL
REPORTING (GPFR)
OBJECTIVE OF GENERAL PURPOSE FINANCIAL REPORTING

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.
NB!

Let us look at a set of financial statements

6
WHO ARE THE USERS AND WHAT ARE THOSE DECISIONS

Users • Primary users cannot demand

• Existing and potential investors direct information
• Lenders • Rely on GPFR for most financial
needs
• Other creditors
• Obtain info from other sources
• Other (regulators, members of the public, SARS)

Decisions
• Buying, selling and holding equity and debt instruments;
• Providing or settling (paying off) loans and other forms of credit; and
• Exercising rights to vote on (or otherwise influence) management’s actions that affects the use of the entity’s
economic resources

7
WHAT DO THOSE DECISIONS DEPEND ON?

Returns that the users expect:

• Dividends;
• Principal and interest payments
• Market price increases

WILL I BE ABLE TO MAKE MONEY OUT OF WILL MY MONEY BE SAFE?

THIS?
Management’s stewardship of the entity’s
Amount, timing and uncertainty of the resources.
(prospects for) future net cash inflows to the
entity.

Financial position - Economic resources of Stewardship - How efficiently and effectively

the entity (ASSETS), claims against the entity management and governing board have
(LIABILITIES) discharged those responsibilities to use the
economic resources.

8
SHORTCOMINGS OF GENERAL PURPOSE FINANCIAL
REPORTING
• Does not & cannot provide all required information
• Does not show value of entity (provides information to users to estimate value)
• Provides information to meet the needs of maximum number of primary users
• Additional information (that is useful to particular subset) may be included
• Not specifically directed at:
• Management
• Regulators
• Members of the public

9
ACCRUAL BASIS OF ACCOUNTING (NB)
Depicts effects of transactions and other events and circumstances on an entity’s economic resources and
claims in the periods in which it occurs, even if the resulting cash receipts and payments occur in a
different period.

Provides a better basis for assessing the entity’s past and future performance than information solely about cash
receipts and payments during the period.

Example:
Entity A has a 31 December 2024 reporting period. Entity A’s annual warehouse insurance policy is effective
from 1 October 2024 – 30 September 2025. Entity A paid an upfront payment of R120 000 on 1 October 2024
for the full annual policy. Should the full R120 000 be recognised as an expense in FY24?

Solution:
No. The portions should be split between the FY24 and FY25 year (based on months).

10
WHO IS RESPONSIBLE FOR PREPARATION?
Co’s Act 71 of 2008:
• Management is responsible
• Directors will be held liable

11
CHAPTER 2 - QUALITATIVE CHARACTERISTICS OF USEFUL
FINANCIAL INFORMATION
PROCESS WHEN APPLYING THE FUNDAMENTAL
CHARACTERISTICS
Step 1: Identify an economic phenomenon that has the potential to be useful to users

Step 2: Identify the type of information about that phenomenon that would be most relevant

Step 3: Determine whether that information is available and can be faithfully represented

13
QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL
INFORMATION
• To be useful, financial information must be: relevant and faithfully represent what it purports to represent.

Relevance Faithful representation

Capable of making a difference in decisions Financial information must faithfully represent
made by users. Has either predictive value or the substance of the phenomenon that it
confirmatory value. purports to represent. Should be complete,
neutral and free from error.
Information is relevant if it is material.

• The usefulness is enhanced if it has:

Comparability Verifiability Timeliness Understandabi

lity
.

14
RELEVANCE
Capable of making a difference in decisions made by users

Predictive Confirmatory
value value

Used as input to processes Provides feedback about

employed to predict future previous evaluations
outcomes

15
RELEVANCE
Information is material if omitting, misstating or obscuring it could reasonably be expected to
influence decisions that the primary users.

Helps assess relevance of information

If omitting or misstating information could influence decisions

Entity specific

Based on nature and magnitude

No uniform quantitative threshold

16
FAITHFUL REPRESENTATION
• Financial information must faithfully represent the substance of the phenomenon that it purports to
represent.
• Substance and legal form of economic phenomena are mostly the same, but providing information only on
legal form does not always faithfully represent the economic phenomena
• To be a perfectly faithful representation, a depiction would have three characteristics:

Complete

Neutral (Prudent)

Free from error

17
FAITHFUL REPRESENTATION

Complete Neutral Free from error TITLE

TITLE

Includes all information necessary • A neutral depiction is without • No errors/omissions in

to understand phenomena: bias. description of phenomenon
• Description of nature • Neutrality is supported by process and application of
• Numerical depiction prudence: process
• Explanation of significant o Exercise of caution when • Does not imply perfectly
facts: making judgement under accurate in all respects
o Quality conditions of uncertainty
o Factors/circumstances o Assets and income are
o Process to determine not overstated and
number liabilities and expenses
are not understated

18
MEASUREMENT UNCERTAINTY
Measurement uncertainty arises when monetary amounts must be estimated.
• Use of estimates is an essential part of accounting
• Does not undermine usefulness of information if it is clearly and accurately described and explained.

An example is estimating the

expected credit loss (i.e. allowance
for doubtful debts on trade
receivables)

19
ENHANCING QUALITATIVE CHARACTERISTICS

Verifiability
1 Comparability 2
• Consistency = NB • Information faithfully represents what it purports to
• Compare items from period to period within one represent
reporting entity • Different knowledgeable and independent observers
• Compare items between entities in a single period. could reach consensus that depiction is a faithful
• Alternative methods diminishes comparability representation

Timeliness Understandability
3 4
• Classifying and presenting information clearly and
• Having information available in time to influence concisely
decisions • Don’t exclude inherently complex phenomena –
• Older information is usually less useful incomplete, potentially misleading
• Users – reasonable knowledge, review and analyse
diligently

20
SUMMARY
FUNDAMENTAL CHARACTERISTICS

RELEVANCE FAITHFUL REPRESENTATION

Materiality

PREDICTIVE CONFIRMATORY COMPLETE NEUTRAL FREE

VALUE VALUE FROM
PRUDENT ERROR

MEASUREMENT UNCERTAINTY

ENHANCING CHARACTERISTICS:
Comparability Verifiability Timeliness Understandability
21
COST CONSTRAINT
• Cost of preparing financial statements must be justified by benefit
• General purpose financial reporting cannot provide all required information
• Cost benefit assessment made by Board
• Cost vs benefit assessment differs from one entity to the next

22
OBJECTIVE TEST – QUALITATIVE CHARACTERISTICS (QC’S)
Scenario QC
A company buys a property and does not record this property as an asset while the bank still holds the title Faithful
deed. The bank is legally the owner of the property until the company has repaid the purchase price. The representation-
company is however exposed to all the risks and rewards of ownership and thus the economic reality is that Completeness,
the company controls the asset. free from error
Director’s bonuses are based on profits, and they therefore make it their goal to make profits seem as high
Faithful
as possible. They understate expenses by recognising the minimum amount of expenses and they representation-
overstate profits by recognising the maximum amount of profits. The information cannot be relied on as the Neutrality, free
directors are selecting and filtering the information to influence decisions. from error
During the year, the entity had significant impairments of non-current assets which they have correctly Relevance,
calculated. The entity did not disclose sufficient information to enable users to understand the reasons of the Faithful
impairment. ` representation -
Neutrality
A potential shareholder is trying to choose a company to invest in from those companies listed on the JSE
and needs to compare the financial results of each company to see what the best investment would be. Comparability
However, each company uses a different method of recording and measuring similar transactions.
A property developing company has to downwardly adjust the fair values of some the properties it owns due Faithful representation-
to property prices decreasing significantly. The company decides not disclose this. This may influence the Neutrality, free from
users’ decisions. error
A multi-billion rand entity purchased a new office table for the receptionist. The entity disclosed details of this
Relevance
purchase in the financial statements.

23
CHAPTER 3 – FINANCIAL STATEMENTS AND THE REPORTING
ENTITY
OBJECTIVE OF GENERAL PURPOSE FINANCIAL REPORTING
To provide
• financial information
• about the reporting entity’s assets, liabilities, equity, income and expenses
• that is useful to users of financial statements in assessing management’s stewardship of the
economic resources.
FROM THE REPORTING ENTITY’S PERSPECTIVE

25
THE INFORMATION IS PROVIDED IN
• SFP by recognising assets, liabilities and equity;
• SP/L&OCI by recognizing income and expenses; and
• Other statements and notes:
o Statement of cash flows;
o Statement of changes in equity (contributions and claims of equity holders)
o Notes - Information about nature and risk ; and
o Accounting policies - methods, assumptions and judgements used.

26
REPORTING PERIOD
• Financial statements (F/S) are prepared for a specified period (reporting period) – Generally a year
o assets, liabilities and equity existing at end of reporting period or during the reporting period
o income and expenses for the period

• Comparative information must be supplied (to identify changes and trends)

• Forward-looking information (events after the reporting period) is provided if it provides useful
information

27
GOING CONCERN ASSUMPTION
It is assumed the reporting entity is a going concern and will continue for the foreseeable future:
• Entity has neither intention nor the need to enter liquidation or to cease trading;
• If the intention or need exists, different basis for preparation should be used and described as such

28
THE REPORTING ENTITY
Entity is required or chooses to prepare F/S (not necessarily a legal entity)

Following description applies:

• Financial statements – single entity

• Where a group exists:

• Consolidated financial statements – parent plus subsidiaries’ f/s combined (2nd semester).
• Unconsolidated (or separate financial statements) - parent’s own f/s

• Where reporting entity consists of more than one entity, but it is not a group – combined financial
statements (N/A for ACC200)

29
CHAPTER 4 – THE ELEMENTS OF FINANCIAL STATEMENTS
THE ACCOUNTING EQUATION

Assets Liabilities Equity

NB: Remember this equation

for the rest of your life as a
CA(SA)

31
ASSET DEFINITION

Present economic resource A right that has the

potential to
produce economic
benefits

Controlled

Past event

32
RIGHTS
• Rights that correspond to an obligation of another party, for example:
o right to receive cash;
o right to receive goods or services;

• Rights that do not correspond to an obligation of another party, for example:

o rights over physical objects (e.g. PPE/inventories)
o rights to use intellectual property (e.g. copyright)

• Rights established by contract, legislation or similar means:

o rights obtained from leasing a physical object;
o rights from owning a registered patent;
o by acquiring know-how not in the public domain.

33
POTENTIAL TO PRODUCE ECONOMIC BENEFITS
• Economic benefits could be potentially produced as follows:
• Receive contractual cash flows/other economic benefits;
• Exchanging economic resources with another party on favourable terms;
• Produce/avoid cash flows by using economic resources individually or in combination with others;
• Leasing economic resources to another entity;
• Pay off (extinguish) liabilities;
• Receive cash by selling the asset.

Economic benefits do not have to be certain or

likely. Keyword = “potential”

34
OBJECTIVE TEST - ASSETS

Does the following meet the definition of an asset? YES/NO

Machine used in manufacturing

Yes
Know-how developed to save costs in manufacturing process – has been patented Yes
Fishing rights obtained at no cost from government Yes

Company plans to buy a new plant in the next reporting period No

Inventories donated to the entity by a supplier to encourage its future use Yes
Vehicle obtained through a lease, entity has the rights to direct the use of the vehicle Yes

The employees of the entity No

35
LIABILITY DEFINITION
A duty or
Obligation
responsibility that
an entity has no
practical ability to
avoid

Transfer economic resource

Past event

36
OBLIGATION
An obligation could:
• Arise from contract/legislation and be legally enforceable, or

• Could also arise from entity’s customary practices/published policies/specific statement that the entity has no
practical ability to act in a manner inconsistent with those practices (constructive obligations).

Sometimes it is uncertain whether an obligation exists. Until existence uncertainty is resolved it is uncertain
whether a liability exists.

37
TRANSFER OF ECONOMIC RESOURCES
Examples of transfers:
• To pay cash; or
• To deliver goods/services.

Examples of ways to settle an obligation if not fulfilled through transfer of economic resources:
• By negotiating a release from the obligation;
• To transfer the obligation to a third party; or
• To replace the obligation with another obligation by entering a new transaction.

38
OBJECTIVE TEST - LIABILITIES
Does the following meet the definition of a liability? YES/NO
A loan payable in one year Yes
The amount estimated to be paid back to customers on returns of faulty products Yes
The intention to replace a machine that is essential in the manufacturing process No
The estimated amount to rehabilitate damage to the environment, no act exists to enforce
this, but company is known to act ethically Yes

The estimated amount of losses to be suffered in the following year by the company due to a No
large new customer

39
EQUITY

Equity Assets Liabilities

Claims against the entity that do not meet the definition of a liability.
• May be established by contract, legislation or similar means
o Ordinary or other classes of shares issued by the entity
• Different classes of equity may provide different rights

40
OBJECTIVE TEST – LIABILITY VS EQUITY
Are the following items liabilities (L) or equity items(E)? L/E
Class A ordinary shares, no par value, every holder entitled to one voting right E
8% Bond, payable monthly for 15 years L
Class B shares with no voting rights redeemable at a fixed future date L
Bank overdraft L
Class B shares with no voting rights and non-redeemable E

41
INCOME AND EXPENSES

Income Expenses

Income is increases in assets, or decreases in Expenses are decreases in assets, or increases

liabilities, that result in increases in equity, other in liabilities, that result in decreases in equity,
than those relating to contributions from holders other than those relating to distributions to
of equity claims. holders of equity claims.

Relate to an entity’s financial

performance

42
SUBSTANCE OVER FORM
• Generally, the substance of a transaction/arrangement is the same as the legal form.
• However, in same cases, an analysis is required.

• In Accounting, we recognise a transaction/arrangement based on the substance (NOT the legal form).

Example:
• Entity A finances the purchase of a vehicle via a bank loan. The bank legally owns the title of the vehicle. Legal
title will only transfer to Entity A after the vehicle is fully repaid.
• Even though Entity A does not legally own the vehicle, Entity A controls the vehicle (which is a present
economic resource).
• Entity A will therefore recognise the vehicle as an asset (PPE).

• However, if we had to apply the legal form, an asset would not be recognised by Entity A because Entity A
does not have legal title of the vehicle.

43
CHAPTER 5 – RECOGNITION AND DERECOGNITION
RECOGNITION
Recognition is the process of capturing for the inclusion in the F/S (amount and nature) an item that meets
the definition of asset, liability, equity, income or expense.

Relevance Faithful representation

Whether recognition of an item results in relevant Whether recognition of an item results in a faithful
information may be affected by, for example: representation may be affected by, for example:
• low probability of a flow of economic benefits • measurement uncertainty
• existence uncertainty • presentation and disclosure of items may enhance
the understanding of a recognised amount

Cost constraint

45
DERECOGNITION

Derecognition is the removal of all or part of a recognised asset or liability from an entity’s statement
of financial position

No longer an asset No longer a liability

Derecognition normally occurs when the entity Derecognition normally occurs when the entity
loses control of all or part of the recognised no longer has a present obligation for all or part
asset of the recognised liability.

46
CHAPTER 6 – MEASUREMENT
MEASUREMENT

Historical cost measurement bases Current value measurement bases

• include fair value, value in use, fulfilment
• include amortised cost
value and current cost

Selecting a measurement basis

Relevance Faithful representation

• characteristics of the asset or liability • measurement inconsistency
• contribution to future cash flows • measurement uncertainty

Information in both the statement of financial position and the statement(s) of

financial performance

Enhancing qualitative characteristics and cost constraint

48
CHAPTER 7 – PRESENTATION AND DISCLOSURE
PRESENTATION AND DISCLOSURE

• Primary source of information about economic resources

Statement of financial
and claims
position
• Default location for assets and liabilities

Statement of profit or loss • Primary source of information about performance

• Default location for income and expenses

Other comprehensive • Exceptional circumstances

income • Only changes in current values of assets and liabilities
• In principle, OCI items are recycled

Classification in the f/s sorts elements that Offsetting of assets and liabilities = grouping
may be similar in nature, function and separate asset/s and liability/ies. Generally
measurement not appropriate (i.e. dissimilar items)
Questions?
REFER TO THE MEASUREMENT & RECOGNITION
MINDMAP DOCUMENT