Conceptual Framework for Financial Reporting

IFRSs are based on the Framework, which addresses the concepts underlying the information presented in general purpose financial statements
The objective of the Framework is to facilitate the consistent and logical formulation of IFRSs.
The Framework also provides a basis for the use of judgement in resolving accounting issues.
This Framework is not an International Accounting Standard and hence does not define standards for any particular measurement or disclosure issue.
Nothing in this Framework can override any specific IFRS
In case there is a conflict, between the Framework and the Standards, the requirements of the standards shall prevail.

Role of the Conceptual Framework

Conceptual Framework sets out agreed concepts that underlie financial reporting

    - objective, qualitative characteristics, element definitions

IASB uses Conceptual Framework to set standards

      - enhances consistency across standards
        - enhances consistency over time as Board members change
        - provides benchmark for judgments

      Preparers use Conceptual Framework to develop accounting policies in the absence of specific standard or interpretation - IAS 8 hierarchy

      The Framework deals with:
      • Objective of financial reporting;
      • Qualitative characteristics of the information in financial statements;
      • Underlying assumption
      • Elements of financial statements
      • Recognition and Measurement.
      • Basis of Measurement
      • Concepts of capital and capital maintenance.
      Objective of 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.
      Note: Users with "reasonable" knowledge.

      Qualitative characteristics
      If financial information is to be useful, it must be relevant and faithfully represent what it purports to represent (i.e. fundamental qualities).

        - Financial information without both relevance and faithful representation is not useful, and it cannot be made useful by being more comparable, verifiable, timely or understandable.

      The usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable (i.e. enhancing qualities—less critical but still highly desirable)

        - Financial information that is relevant and faithfully represented may still be useful even if it does not have any of the enhancing qualitative characteristics.
      Fundamental qualitative characteristics

      Relevance: capable of making a difference in users' decisions

        - predictive value
        - confirmatory value
        - materiality (entity-specific but user focused) – Defined in IAS 1

      Faithful representation: faithfully represents the phenomena it purports to represent

        - completeness (depiction including numbers and words)
        - neutrality (unbiased) – In place of "conservatism/prudence"
        - free from error (ideally)

      Note: faithful representation replaces reliability

      Enhancing Qualitative Characteristics

      Comparability: like things look alike; different things look different

      Verifiability: knowledgeable and independent observers could reach consensus, but not necessarily complete agreement, that a depiction is a faithful representation

      Timeliness: having information available to decision-makers in time to be capable of influencing their decisions

      Understandability: Classify, characterise, and present information clearly and concisely

      Qualitative characteristics - Comparison with IFRS for SMEs
      Sr. No Particular Full IFRS IFRS for SMEs
      1 Relevance
      (Materiality being part of relevance)
      Yes Yes
      2 Faithful representation
      (In place of substance over legal form)
      Yes No
      3 Comparability Yes Yes
      4 Verifiability Yes No
      5 Timeliness Yes Yes
      6 Understandability Yes Yes
      7 Completeness No Yes
      8 Substance over legal form No Yes
      9 Prudence No Yes
      10 Reliability No Yes
      Underlying assumption

      Going concern: For the foreseeable future

      Note:
      Previously, "accrual" was also a part of the underlying assumption however the same has been removed now as it was noted that “accrual” was more of a presumption and hence no need to list it as an assumption.

      Pervasive constraint

      Reporting financial information imposes costs, and it is important that those costs are justified by the benefits of reporting that information.

      - Benefits include more efficient functioning of capital markets and a lower cost of capital for the economy.- Costs include collecting, processing, verifying and disseminating financial information and the costs of analysing and interpreting the information provided.

      In applying the cost constraint, the IASB assesses whether the benefits of reporting particular information are likely to justify the costs incurred to provide and use that information. Those assessments are usually based on a combination of quantitative and qualitative information.

      Elements

      Asset: Resource controlled as a result of past events and from which future economic benefits are expected to flow.
      Note: Asset should be recognized based on “Neutrality” and not on "Conservatism/Prudence".

      Liability: Present obligation arising from past events, the settlement of which is expected to result in outflow of resources embodying economic benefits

      Income (expense): Increases (decreases) in economic benefits during period from inflows or enhancements (outflows or depletions) of assets (liabilities) or decreases (incurrences) of liabilities from in increases (decreases) in equity, other than contributions from (distributions to) equity.

      Equity: Residual value = Assets minus liabilities

      Recognition

      Accrual basis of accounting - recognise element (eg asset) when satisfy definition and recognition criteria

      Recognise item that meets element definition when

      - probable that benefits will flow to/from the entity
      - has cost or value that can measured reliably
       
      Measurement concepts

      Measurement is the process of determining monetary amounts at which elements are recognised and carried. (CF.4.54)

      To a large extent, financial reports are based on estimates, judgements and models rather than exact depictions. The Framework establishes the concepts that underlie those estimates, judgements and models (CF.OB11)

      IASB guided by objective and qualitative characteristics when specifying measurements.

      Presentation and disclosure

      Presentation: financial statements portray financial effects of transactions and events by:
      - grouping into broad classes (the elements, eg asset)
      - sub-classify elements (eg assets sub-classified by their nature or function in the business)
      IAS 1
      - application of IFRSs with additional disclosures when necessary results in a fair presentation (faithful representation of transactions, events and conditions)
      - don’t offset assets & liabilities or income & expenses

      Derecognition of assets

      Derecognition of an asset refers to when an asset previously recognised by an entity is removed from the entity’s statement of financial position
      - derecognition requirements are specified at the standards level.
      - derecognition does not necessarily occur when the asset no longer satisfies the conditions specified for its initial recognition (ie derecognition does not necessarily coincide with the loss of control of the asset )
      IASB guided by objective, qualitative characteristics and elements

      The Framework does not… Clarification—the Framework includes
      include a matching concept accrual basis of accounting—recognise elements when satisfy definition and recognition criteria
      include prudence/conservatism concept neutrality concept
      include an element other comprehensive income (or a concept for OCI) only the following elements—asset, liability, equity, income and expense
      mention management intent or business model  
      Misunderstanding Clarification
      Uniformity = comparability Comparability is achieved when like things are accounted for in the same way. Comparability is not achieved when accounting rules require unlike things be accounted for in the same way
      There is a clear concept for the historical cost of an item The Framework provides only a vague description—assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition.
      What is cost when:
      - advance/deferred payment?
      - purchased option exercised?
      - contingent purchase price?
      Principles are necessarily less rigorous than rules Rules are the tools of financial engineers
      There are few judgements and estimates in cost-based measurements Inventory, e.g. allocate joint costs and production overheads
      PPE, e.g. costs to dismantle/restore site, useful life, residual value, depreciation method
      Provisions, eg uncertain timing and amount of expected future cash flows
      International Financial Reporting Standards

      IAS 1 sets out overall requirements for presenting financial statements, guidelines for their structure and minimum requirements for content.
      - the nature and amount of economic resources (and claims) is useful because different types of resources affect a user's assessment of the entity's prospects for future cash flows differently.
      - information about the variability and components of the return produced is useful in assessing the uncertainty of future cash flows.

      Financial Statements

      A complete set of financial statements comprises a
      - statement of financial position,
      - statement of profit or loss and comprehensive income,
      - statement of changes in equity,
      - statement of cash flows
      - notes to financial statements
      - statement of financial position as at the beginning of the earliest comparative period (incase of IAS 8)
      - Refer to the Implementation Guidance to IAS 1 in Part B.

      Financial statements must present fairly the financial position, financial performance and cash flows of an entity (paragraph 15).
      - complying with IFRSs (with additional disclosures) is presumed to result in a fair presentation.

      General Features

      Going concern
      - financial statements may only be prepared on this basis if management assess that this is appropriate
      Accrual basis of accounting
      Materiality
      - Each material class of similar items is presented separately
      - Dissimilar items are presented separately, unless they are immaterial
      - Materiality is determined by the potential of the information, or its omission, to influence economic decisions made by users of the financial statements
      - Materiality is entity specific and user focused

      Examples-materiality decisions

      Is the error material?
      Ex 1: Before its 20X8 FS approved for issue discovered depreciation expense for 20X8 overstated by CU150. Ignored the error (reported profit for 20X8 at CU600,000, ie understated by CU150).

      Ex 2: Same as Ex 1, except had the error been corrected the entity would have breached a borrowing covenant on a significant long‑term liability.
      Offsetting
      - not applicable unless required or permitted by IFRS
      Frequency of reporting
      - at least annually
      Comparative information
      - required unless IFRS specifies not- consider comparatives when changing the presentation or classifications of items
      Consistency of presentation
      - retain the presentation and classification of items unless IFRS requires a change or due to changes in an entity’s operations another alternative would be more appropriate.

      Current/non-current distinction

      Presentation of current and non current assets and liabilities as separate classifications on the Statement of Financial Position
      The distinction is based on:
      - timing of realisation or settlement of the asset or liability
      - primary purpose for holding the asset or liability

      Make current/non-current distinction unless liquidity presentation is reliable and more relevantIn liquidity presentation present assets and liabilities in order of liquidity
      Current assets and current liabilities are defined
      All other assets and liabilities are non-current
      Deferred tax balances are non-current

      Current asset (IAS 1.66)

      Current asset if
      - expect to realise, sell or consume in entity’s normal operating cycle.
      - held for trading.
      - expects to realise in next 12 months.
      - cash or equivalent, unless restricted for at least 12 months.
      - All other assets are classified as Non-current.

      Example 1-current assets

      Entity A produces whisky from barley, water and yeast in a 24-month distillation process. Inventories include barley and yeast raw materials, partly distilled whisky and distilled whisky.

      Current assets-expected to be realised (ie turned into cash) in the entity’s normal operating cycle.

      Example 2—current assets

      On 1/1/20X7 B invested CU900,000 in corporate bonds.
      Fixed interest of 5% per year is payable on 1 January each year.
      Capital is repayable in 3 annual instalments of CU300,000 each starting 31/12/20X8.

      At 31/12/20X7 A presents
      - current assets—CU45,000 accrued interest & CU300,000 capital repayable on 31/12/20X8—expected to be realised within 12 months
      - non-current asset—CU600,000 in +12 months

      Current liability

      Current liability if
      - expect to settle in entity’s normal operating cycle
      - held for trading
      - due to be settled in next 12 months
      - entity does not have an unconditional right (debtor) to defer settlement for at least 12 months after reporting date

      Example 1-current liabilities

      An obligation to suppliers for the purchase of raw materials.

      Current liability—expected to settle (ie pay) the supplier in the entity’s normal operating cycle.

      Example 2-current liabilities

      At 31/12/20X7 A was in breach of a covenant in a loan that is otherwise repayable 3 years later. The breach entitles (but does not oblige) the bank to require immediate repayment.

      At 31/12/20X7 the loan is a current liability—at 31/12/20X7 A does not have an unconditional right to defer settlement for at least 12 months.

      Example 3-current liabilities

      Same as in Ex 2 except after the end of the reporting period (31/12/20X7) and before the financial statements were approved for issue, the bank formally agreed not to demand early repayment of the loan.

      At 31/12/20X7 the loan is a current liability—at 31/12/20X7 A does not have an unconditional right to defer settlement for at least 12 months.

      Judgement and Estimates

      Preparing financial statements requires judgement and the use of estimates (eg materiality judgements and going concern assessments—when it is doubtful whether the entity has no realistic alternative but to liquidate).

      IAS 1 requires disclosure of:
      - judgements that management has made in the process of applying the entity’s accounting policies that have the most significant effect
      - Information about major sources of estimation uncertainty.
      - Preparing financial statements requires judgement regarding the best way in which to present financial information
      - Financial statements are, generally, prepared on the going concern basis-judgement may be required when determining whether this basis is appropriate.

      Structure and content

      This Standard requires particular disclosures in all the financial statements and requires disclosure of other line items either in those statements or in the notes.

      An entity shall clearly identify the financial statements and distinguish them from other information in the same published document.

      Additional information:
      - The name of the reporting entity.
      - Whether the FS are for an individual entity or a group.
      - The period which the financial statements cover.
      - The presentation currency as defined in IAS 21.
      - The level of rounding used.

      Complete set of financial statements

      Complete set of financial statements comprises:
      - Statement of financial position (SOFP)
      - Statement of comprehensive income (SOCI)
      - Statement of changes in equity (SOCIE)
      - Statement of cash flow (SOCF)
      - Accounting policies and explanatory notes
      Statement of financial position as at the beginning of the earliest comparative period when IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors applies

      Additional statements encouraged.

      Other Comprehensive Income (OCI)

      OCI has the following five components (all net of taxes):
      - Actuarial gains and losses on defined benefit plans (IAS 19)
      - Gains and losses on re-measuring available-for-sale financial assets (IAS 39)
      - Translation gains and losses (IAS 21)
      Note: While "transaction" difference are to be recognised in Profit or Loss, "translation" difference is to be recognized in OCI.
      - Effective portion of gains and losses on hedging instruments in a Cash flow hedges.
      - Changes in revaluation surplus (IAS 16 and IAS 38).
      - Self risk gains and losses on financial liabilities (IFRS 9 – Not applicable as of now).
      An entity shall disclose:
      - the amount of income tax relating to each component of OCI.
      - reclassification adjustments relating to components of OCI.

      Reclassification Adjustments

      These are amounts reclassified to profit or loss in the current period that were recognised in Other Comprehensive Income in previous periods.

      The following items of the OCI shall be reclassified to profit or loss:
      - Foreign exchange differences.
      - Effective portion of Cash flow hedges

      The other items of the OCI shall not be reclassified to profit or loss but should be transferred to Retained Earnings directly.

      Statement of changes in equity

      Separate statement
      - Total comprehensive income for period
      - Amounts of transactions with owners in their capacity as owners
      - For each component of equity effect of retrospective application or restatement (IAS 8)
      - For each component of equity reconciliation between carrying amount at the beginning and the end of period
      In addition either in this statement or in notes, need to present dividends recognised as distributions to owners during period and their amount per share.

      Notes

      Contents of Notes:
      Disclosure of accounting policies
      - Measurement bases
      - Accounting Policies
      - Judgments that management has made
      - Key sources of estimation uncertainty
      Other disclosures
      - Details about the entity
      - Dividends
      - Disclosure about service concession arrangements
      - Capital disclosures

      Major difference between Full IFRS & IFRS for SMES
      Sr. No Accounting Issue Comparison
      1 Financial statements Full IFRS: A statement of changes in equity is required, presenting a reconciliation of equity items between the beginning and end of the period.
      IFRS for SMEs: Same requirement. However, if the only changes to the equity during the period are a result of profit or loss, payment of dividends, correction of prior-period errors or changes in accounting policy, a combined statement of income and retained earnings can be presented instead of both a statement of comprehensive income and a statement of changes in equity.
      2 Business combinations Full IFRS: Transaction costs are excluded under IFRS 3 (revised). Contingent consideration is recognised regardless of the probability of payment.
      IFRS for SMEs: Transaction costs are included in the acquisition costs. Contingent considerations are included as part of the acquisition cost if it is probable that the amount will be paid and its fair value can be measured reliably.
      3 Investments in associates and joint ventures Full IFRS: Investments in associates are accounted for using the equity method. The cost and fair value model are not permitted except in separate financial statements. To account for a jointly controlled entity, either the proportionate consolidation method or the equity method is allowed. The cost and fair value model are not permitted.
      IFRS for SMEs: An entity may account of its investments in associates or jointly controlled entities using one of the following:
      The cost model (cost less any accumulated impairment losses).
      The equity method.
      The fair value through profit or loss model.
      4 Expense recognition Full IFRS: Research costs are expensed as incurred; development costs are capitalised and amortised, but only when specific criteria are met. Borrowing costs are capitalised if certain criteria are met.
      IFRS for SMEs: All research and development costs and all borrowing costs are recognised as an expense.
      5 Financial instruments - derivatives and hedging Full IFRS: IAS 39, 'Financial instruments: Recognition and measurement', distinguishes four measurement categories of financial instruments - that is, financial assets or liabilities at fair value through profit or loss, held-to-maturity investments, loans and receivables and available-for-sale financial assets.
      IFRS for SMEs: There are two sections dealing with financial instruments: a section for simple payables and receivables, and other basic financial instruments; and a section for other, more complex financial instruments. Most of the basic financial instruments are measured at amortised cost; the complex instruments are generally measured at fair value through profit or loss.
      The hedging models under IFRS and IFRS for SMEs are based on the principles in full IFRS. However, there are a number of detailed application differences, some of which are more restrictive under IFRS for SMEs (for example, a limited number of risks and hedging instruments are permitted). However, no quantitative effectiveness test required under IFRS for SMEs.
      6 Non-financial assets and goodwill Full IFRS: For tangible and intangible assets, there is an accounting policy choice between the cost model and the revaluation model. Goodwill and other intangibles with indefinite lives are reviewed for impairment and not amortised.
      IFRS for SMEs: The cost model is the only permitted model. All intangible assets, including goodwill, are assumed to have finite lives and are amortised.
      Full IFRS: Under IAS 38, 'Intangible assets', the useful life of an intangible asset is either finite or indefinite. The latter are not amortised and an annual impairment test is required.
      IFRS for SMEs: There is no distinction between assets with finite or infinite lives. The amortisation approach therefore applies to all intangible assets. These intangibles are tested for impairment only when there is an indication.
      Full IFRS: IAS 40, 'Investment property', offers a choice of fair value and the cost method.
      IFRS for SMEs: Investment property is carried at fair value if this fair value can be measured without undue cost or effort.
      Full IFRS: IFRS 5, ‘Non-current assets held for sale and discontinued operations’, requires non-current assets to be classified as held for sale where the carrying amount is recovered principally through a sale transaction rather than though continuing use.
      IFRS for SMEs: Assets held for sale are not covered, the decision to sell an asset is considered an impairment indicator.
      Full IFRS: In addition to the cost model, the revaluation model is an option, in which classes of PPE are carried at a revalued amount less any accumulated depreciation and subsequent accumulated impairment losses.
      IFRS for SMEs: Classes of PPE are carried at cost less accumulated depreciation and any impairment losses (cost model).
      7 Employee benefits - defined benefit plans Full IFRS: under IAS 19, 'Employee benefits', actuarial gains or losses can be recognised immediately or amortised into profit or loss over the expected remaining working lives of participating employees.
      IFRS for SMEs: Requires immediate recognition and splits the expense into different components.
      8 Combined financial statements Full IFRS: Not covered in full IFRS.
      IFRS for SMEs: Combined financial statements are a single set of financial statements of two or more entities controlled by a single investor. Combined financial statements are not compulsory as per IFRS for SMEs.