Revised Conceptual Framework

REVISED CONCEPTUAL FRAMEWORK . REVISED CONCEPTUAL FRAMEWORK Summary of the terms and concepts that underlie the preparation and presentation of Financial Statements. The Conceptual framework for Financial Reporting is a complete, comprehensive, and single document promulgated by the International Accounting Standards Board. Theoretical foundation of Accounting Conceptual Framework is concerned with General purpose Financial Statements in accounting, including consolidated financial statements. Special Purpose reports (International Accounting Standards) are outside the scope of the framework. The Underlying theme is Usefulness of information in making economic decision. Contribute to Transparency International comparability and quality of financial information Strengthen Accountability Provides the foundation for Standards Reducing information gap between providers of capital and people whom they entrusted their money. Economic Efficiency Helping investors to identify opportunities and risks. REVISED CONCEPTUAL FRAMEWORK BASIC PURPOSE To serve as guide in developing future PFRS and as a guide in resolving accounting issues not directly addressed by existing PFRS. PURPOSES: SOLVED IN ORDER OF THE FOLLOWING: SPECIFIC PFRS RELATED PFRS CONCEPTUAL FRAMEWORK OTHER GAAP SPECIFIC PURPOSE o Conceptual Framework is not IFRS. o Nothing in the Conceptual Framework overrides any specific International Financial Reporting Standard. o In case where there is conflict, the IFRS shall prevail over the Conceptual Framework. o In the absence of a standard or an interpretation that specifically applies to a transaction, management shall consider the applicability of Conceptual Framework in developing and applying an accounting policy that results in information that is relevant and reliable. To Assist: International Accounting Standards Board - To develop International Financial Reporting Standards based on consistent concepts. Preparers of Financial Statements - To develop consistent accounting policy when no Standard applies to a particular transaction or other event where an issue is not addressed by IFRS. - To develop accounting policy when a Standard allows a choice of an accounting policy. All Parties - To understand and interpret International Financial Reporting Standards. USERS OF FINANCIAL INFORMATION Are parties to whom General purpose financial reports are primarily directed. PRIMARY USERS OTHER USERS Primary users cannot require reporting entities to provide information directly to them. They should rely on General purpose financial reports. Existing and Potential Investors Existing and Potential Lenders and other Creditors. Concern: Risk and return of investment and Ability to pay dividends. Concern: Liquidity and Solvency Employees Concern: Stability and profitability Are users of Financial Information other than the Primary Users. Customers Concern: Continuity They are parties that may find general purpose financial reports useful, but the reports are not directed to them primarily. Government and their agencies Concern: Regulation Public Concern: Various reasons NOTE! International Financial Reporting Standards are created by International Accounting Standards Board International Accounting Standards are created by International Accounting Standards Council SCOPE OF REVISED CONCEPTUAL FRAMEWORK Objective of financial reporting Qualitative characteristics of useful financial information Financial statements and reporting entity Elements of Financial Statements Recognition and Derecognition Measurement Presentation and Disclosure Concepts of capital and capital maintenance Financial Information - Anything related to the financial activities and performance of a business. - Financial information is data about the monetary transactions of a person or business. - Data of monetary transactions that is helpful to users. Financial Reporting - Aims to track, analyze, and report business income. - Provides insight and transparency into a company’s financial position and its operations. - Giving shareholders the right information, in the right amount of detail, to make better decisions. Financial Statements - Are written records that convey the business activities and the financial performance of an entity. - Are documents that report on a business in monetary terms, providing information to help people make informed business decisions. Financial Statements Financial Highlights Financial Reporting Encompasses Includes nonfinancial information such as description of major products and a listing of corporate officers and directors. Summary of important financial figures Analysis of financial statements Significant Ratios Objective of Financial Reporting It is the “WHY”, PURPOSE, or GOAL of ACCOUNTING Overall Objective To provide information useful in making decisions about providing resources to the entity RESOURCES are assets CLAIMS are liabilities CHANGES IN RESOURCES AND CLAIMS are profits or losses Provide financial information about the reporting entity that is useful to existing and potential investors and existing and potential lenders and creditors in making decisions about providing resources to the entity. Specific Objectives To provide information useful in assessing the cash flow prospects of the entity. To provide information about entity resources, claims and changes in resources and claims. LIMITATIONS REPORTING OF FINANCIAL 1. General purpose financial reports do not and cannot provide all of the information that existing and potential investors, lenders and other creditors need. 2. General purpose financial reports are not designed to show the value of an entity but these reports provide information to help the primary users estimate the value of the entity. 3. General purpose financial reports are intended to provide common information to users and cannot accommodate every request for information. 4. To a large extent, general purpose financial reports are based on estimate and judgement rather than exact depiction. CONCEPTUAL FRAMEWORK Qualitative Characteristics Fundamental Characteristics Relevance Qualities or attributes of the Content or Substance of Financial accounting information that is useful to users. Predictive Value Confirmatory Value Faithful Representation Completeness Free from error Neutrality Enhancing Characteristics Verifiability Comparability Understandability Timeliness Increases the usefulness of financial information through presentation or form. Revised Conceptual Framework Reintroduced the concept of PRUDENCE. Neutrality is supported by the exercise of Prudence. Prudence is synonymous to Conservatism. ▪ Information must be both relevant and faithfully represented if it is to be useful. ▪ Materiality (also known as doctrine of convenience) is not an ingredient of relevance but rather a specific aspect of relevance. All material items are relevant nut not all relevant items are material. ▪ Strict adherence to GAAP is not required when the items are not significant enough to affect the evaluation, decision and fairness of the FS. ▪ Faithful representation is the new term for reliability. (e.g. recognition of an impairment loss on PPE). ▪ Completeness is the principle of full disclosure. ▪ Comparability is the goal while Consistency is the means of achieving the goal. It is the exercise of care and caution when dealing with the uncertainties in the measurement process such that assets or income are not overstated, and liabilities or expenses are not understated. Means, “in case of doubt, record any loss and do not record any gain.” Anticipate no profit and provide for probable and measurable loss. Relevance Faithful Representation COST CONSTRAINT The benefit derived from the information should exceed the cost incurred in obtaining the information. (Benefit > Cost) Since it is difficult to measure whether cost of reporting is greater than or lesser than the benefit, the evaluation is a matter of Professional Judgement. Financial Statements and Reporting Entity Statement of Financial Position Complete Set of Financial Statement Statement of Financial Performance Statement of Cash Flows The objective of financial statements is to provide financial information about the reporting entity’s assets, liabilities, equity, income and expenses that is useful in assessing: Statement of Changes in Equity • Future net cash inflows Notes to Financial Statements • Management’s Stewardship REPORTING ENTITY CONSOLIDATED FINANCIAL STATEMENTS Types of Financial Statements UNCONSOLIDATED FINANCIAL STATEMENTS COMBINED FINANCIAL STATEMENTS Accounting Cycle Both the parent and its subsidiary Parent alone Two or more entities combined but not linked by a parent and subsidiary relationship 1. Analyzing Transaction 2. Journalizing 3. Posting to ledger 4. Preparation of Unadjusted Trial Balance 5. Journalizing and posting of Adjusting Journal Entries 6. Preparation of adjusted trial balance 7. Preparation of Financial Statements 8. Journalizing and posting of closing entries 9. Preparation of post-closing trial balance 10. Journalizing and closing of reversing entries REPORTING ENTITY Required or chooses to prepare financial statements. REPORTING PERIOD Individual corporation, partnership or proprietorship Parent alone Parent and its subsidiaries as one reporting entity Two or more entities without parent-subsidiary relationship - Time span for which a company reports its Financial statements. Traditionally, Calendar year of 12 months or 12-month Fiscal year. - Reporting period can also be Interim period. It is a period that is shorter than a full 12-month fiscal year. Interim financial statements are not required but optional. Reportable business segment of an entity ACCOUNTING ASSUMPTIONS EXPLICITLY STATED IMPLICITLY STATED Also known as “ACCOUNTING POSTULATES” are fundamental premises that serves as foundation to avoid misunderstanding but to enhance the usefulness of Financial Statements. GOING CONCERN Also known as “CONTINUITY ASSUMPTION” which means that the entity will continue to operate indefinitely unless otherwise there’s evidence to prove that the entity will stop or liquidate. ACCOUNTING ENTITY The transaction of the entity should not be merged with personal transaction of owners, employees, and managers. TIME PERIOD Indefinite life of an entity is divided into periods. A calendar year (12-month) is one period in an indefinite life of the company. MONETARY UNIT Assets, liabilities, equity, income, and expenses are measured in terms of Philippine Peso and to account for Philippine Peso only and not changes in purchasing power. REVISED CONCEPTUAL FRAMEWORK Elements of Financial Statements ASSET Revised Definition: Present economic resources controlled by an entity as a result of past events. Old Definition: An economic resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. The main changes clarifies that an asset is not an inflow of economic benefits rather it is the economic resources controlled by the entity. The flow of economic benefits to the entity need not to be certain or even likely. Receive contractual Cash flows. Economic resources could produce economic benefits if entity is entitled to: CONTROL OF AN ASSET AS A RESULT OF PAST EVENT. Control may arise if an entity enforces legal rights. It is the power to influence or direct the use of the asset and obtain the economic benefits that flow from it. If there is not legal rights, control can still exist if an entity has other means of ensuring that no other party can benefit from an asset. Exchange economic resources with another party on favorable terms Produce cash inflows or avoid cash outflows. Receive cash by selling the economic resource. Extinguish a liability by transferring an economic resource. EXAMPLES OF ASSETS 11. Cash and Cash Equivalents 12. Accounts Receivable 13. Notes Receivable 14. Inventories 15. Biological Assets 16. Financial Instruments 17. Investment in Associate 18. Investment Property 19. Property Plant and Equipment 20. Government Grant 1. Wasting Asset 2. Intangible Assets 3. Prepaid Expenses 4. Marketable Securities 5. Bonds 6. Fixtures and Furniture 7. Fixed Assets 8. Loan Receivable 9. Supplies 10. Treasury Notes/Bills/Bonds NOTE! Tangibility and Ownership are not essential characteristics of assets. Also, the presence or absence of expenditure is not necessary in determining the existence of assets. LIABILITY OBLIGATIONS Revised Definition: Present obligation of an entity to transfer an economic resource as a result of past events. LEGAL OBLIGATION CONSTRUCTIVE OBLIGATION An obligation is a duty or responsibility that an entity has no practical ability to avoid. To pay cash Deliver goods or non-cash resources. Provide services at some future time. Exchange economic resources with another party on unfavorable terms. Transfer an economic resource if specified uncertain future events occur. Old Definition: A present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of the resources embodying economic benefits. A liability is an obligation to transfer economic resources not an ultimate flow of economic resource, and entity should not have practical ability to avoid transfer of resources, which includes responsibilities that arise from the entity customary practices, published policies or specific statements. Obligations exist as a result of past events of both of the following conditions are met: 1. An entity has already obtained economic benefits. 2. An entity must transfer an economic resource. EXAMPLES OF LIABILITIES 11. Premium 12. Warranty 13. Deferred Revenue 14. Bonds Payable 15. Notes Payable 16. Loans Payable 17. Accounts Payable 18. Mortgages 19. Accrued Expenses 20. Long-term debt 1. Lease obligation 2. Unearned Revenue 3. Pension 4. Income Tax Payable 5. Salaries and Wages 6. Dividends Payable 7. Bonds Payable 8. Bank loans 9. Rent 10.Contingent liabilities EQUITY Old Definition: Residual interest in the assets of the enterprise after deducting all its liabilities. INCOME The definition of equity under Revised Conceptual Framework is unchanged. It is a residual definition. It would be the company’s book value, which is the difference between liabilities and assets on the balance sheet. Increases in assets or decreases in liabilities that results in increases in equity, other than those relating to contributions from equity holders. COMPREHENSIVE INCOME PROFIT or LOSS General Rule: an income is part of Profit or Loss unless it will be classified as Other Comprehensive Income. ENTITY THEORY OF ACCOUNTING (Asset = Liability + Capital) PROPRIETORY THEORY OF ACCOUNTING (Capital = Asset - Liability) REVENUE Encompasses Revenue always arises in the ordinary course of the business. (e.g Sales, Fees, Interest, Dividends, Royalties and Rent) GAIN Represents other items that meet the definition of income and do not arise in the course of the ordinary business activities. OTHER COMPREHENSIVE INCOME 1. Unrealized Gain or loss on financial asset measured at Fair value through other comprehensive income. 2. Gain or Loss from translating the financial statements of a foreign operation. 3. Revaluation Surplus during the year. 4. Unrealized gain or loss from derivative contracts designated as cash flow hedge. 5. Remeasurements of defined benefit plan including actuarial gain or loss on defined benefit obligation. EXPENSE Decreases in assets or increases in liability that results in decreases in equity, other than those relating to distributions to equity holders. Cause and Effect relationship Encompasses Expenses arises in the ordinary course of business activities while losses do not arise in the course of ordinary regular activities of business. It is also called, “Cause and Effect association”. It means that expense is recognized when the revenue is already recognized. This principle then defines the Strict Matching Concept. MATCHING PRINCIPLE In accordance with Generally Accepted Accounting Principle (GAAP), requires that any business expenses incurred must be recorded in the same period as related revenues. In other words, Revenue of the period is matched with expenses required to create those revenues. LOSSES Systematic and Rational allocation It is also called, “Systematic and Rational Allocation”. Some costs are expensed by simply allocating and recognized over the periods they benefit. For example, Depreciation, a piece of machine used in production would be depreciated over its useful life, with portion of its cost recognized as an expense during the year. The cost incurred is expensed immediately when: Immediate Recognition 1. An expense produces no future economic benefit. 2. If the cost does not qualify or ceases to qualify as an asset. For example, Casualty loss, immediately recognized because they are not directly related to specific revenue. RECOGNITION and DERECOGNITION New Recognition Criteria for the elements of Financial Statement Recognition is the process of capturing for inclusion in the Financial Statements an item that meets the definition of an asset, liability, equity, income or expenses. Derecognition is defines as the removal of all or part of a recognized asset or liability from the statement of financial position. It occurs when an item no longer meets the definition of an asset or a liability. “Probable future economic benefits” and “Cost can be measured reliably” are NO LONGER required in accordance with Revised Conceptual Framework. Recognition does not focus anymore on how probable economic benefits will flow to or from the entity and that the cost can be measured reliably. An asset or liability and any corresponding income or expenses can exist even if the probability of inflow or outflow of the economic benefit is low. Increase in Assets Increase in Equity RECOGNITION OF INCOME Decrease in Liabilities Decrease in Assets Decrease in Equity RECOGNITION OF EXPENSE Increase in Liabilities MEASUREMENT Under the Revised Conceptual Framework, measurement is defined as quantifying in monetary terms the elements in the financial statements. In other words, it is the process of determining the monetary amounts. The International Accounting Standards Board did not mandate a single measurement basis because the different measurement bases could produce useful information under different circumstances. ASSET Consideration Given + Transaction Cost LIABILITY Consideration Received - Transaction Cost Historical Cost The original cost to acquire an asset or incur liability. Current Value It is the updated measurement of historical cost. Fair Value Refer to the agreed price between buyer and seller or the estimated worth of assets and liabilities. Value in use for asset Present Value of the cash flow that an entity expects to derive from the continuing use of an asset and from the ultimate disposal. Fulfillment value for liability Current cost Present Value of cash that an entity expects to transfer in paying or settling a liability. Also known as replacement cost. The cost that would be incurred if an asset were to be acquired or replaced at the present time. PRESENTATION AND DISCLOSURE Presentation and disclosure is a communication tool about assets, liabilities, equity, income and expenses. The information must be relevant and faithfully represented. Financial statements must be understandable and comparable. Effective communication is supported by not duplicating information in different part of Financial Statements. CLASSIFICATION Means sorting of assets, liabilities, equity, income and expenses on the basis of similar characteristics. It is a systematic arrangement in groups according to established criteria. ASSETS and LIABILITIES INCOME and EXPENSES AGGREGATION Refers to adding together of assets, liabilities, income, expense, and equity that have similar characteristics and that are included in the same classification. Current or Non-current Profit/Loss or Other Comprehensive Income Statement of Financial position and Statement of Financial performance provides summarized or aggregation of financial information (assets, liabilities, equity, income and expenses. CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE FINANCIAL PERFORMANCE Transaction Approach Traditional preparation of an income statement. Capital Maintenance Approach Net income will only occur if the Ending Capital is higher than the Beginning Capital. Financial Capital Concept Also known as “Net asset approach” “when the nominal amount of the net assets at the end of the year exceeds the nominal amount of the net assets at the beginning of the period, after excluding distributions to and contributions by owners during the period.” Physical Capital Concept “when the physical productive capital of the entity at the end of the year exceeds the physical productive capital at the beginning of the period, also after excluding distributions to and contributions from owners during the period. Ending Capital Add: Dividends or Withdrawal Less: Beginning Capital Less: Additional Investment NET INCOME Financial Capital uses the Historical cost as its measurement, while Physical Capital uses the Current cost.