Financial Accounting

Theory

Conceptual Framework
 Current efforts of FASB and IASB
From 2005 the IASB and FASB has been jointly working
towards the development of a revised conceptual
framework that will be used by both parties. This is a
part of the ‘convergence project’ in which the IASB and
FASB are working together to converge their two sets of
accounting standards. So there is a need of one uniform
conceptual framework before convergence.

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Phases ………
Work on the conceptual framework being undertaken in eight
phases as follows. At the beginning of 2009 phases A, B, C
and D were active.
1. Objectives and qualitative characteristics
2. Definitions of elements, recognition and derecognition
3. Measurement
4. Reporting entity concept
5. Boundaries of financial reporting, presentation and
disclosures
6. Purpose and status of the framework
7. Application of the framework to non profit entities
8. Remaining issues if any…

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Objectives and qualitative
characteristics
• IASB framework-to provide information about the
financial position , performance and changes in
financial position that is useful to a wide range of
users in making economic decisions.
• Revised framework mentioned (2008) the objective
as: the objective of general purpose financial
statement is to provide financial information
about the reporting entity that is useful to the
present and potential investors, lenders and other
creditors in making decision in their capacity of
capital providers.

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Qualitative characteristics
• The Statement sets out the desirable
characteristics of financial information in a
hierarchy
• To be useful financial information must be
(i) relevant
(ii) reliable
(iii) comparable
(iv) understandable.

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Relevant
• Financial information is relevant if it would
influence economic decisions and it would be able
to do this if it has predictive value or confirmatory
value. Information with predictive value would
help users to assess what is likely to happen in
future while information with confirmatory value
would help them to confirm or correct previous
predictions which they have made. In many, if not
most, cases information will have both
confirmatory and predictive value.

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Reliable

• To be reliable, information must be free from material error and possess

certain subsidiary
1. Faithful representation. It must faithfully represent what it purports to
represent, for example, the substance of a transaction must be portrayed
when this differs from its legal form.
2. Neutral. The information should be neutral, in other words, it should not
be subject to deliberate or systematic bias.
3. Free from material error. Information which includes a material error is
unlikely to be reliable.
4. Complete. to be reliable information must be compete within the bound of
materiality and cost.
5. Prudent. Prudence is the inclusion of a degree of caution in the exercise of
the judgments needed in making the estimates required under conditions
of uncertainty, such that gains and assets are not overstated and losses
and liabilities are not understated. In particular, under such conditions it
requires more confirmatory evidence about the existence of, and a greater
reliability of measurement for, assets and gains than is required for
liabilities and losses.
6. Substance over form: information should accounted for and presented in
accordance with their substance and economic reality and not merely their
legal form.

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Comparable
• Information should be comparable both for a
reporting entity over time and across different
reporting entities. This is a tall order but, in
particular, requires disclosure of accounting
policies as well as of details of changes and the
effects of changes in accounting policies. In order
to specify understandability as a desirable
characteristic, it is necessary to make

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Understandable.

In order to specify understandability as a desirable

characteristic, it is necessary to make some
assumption about the ability of users. The ASB
assumes that the targeted users ‘have a
reasonable knowledge of business and economic
activities and accounting and a willingness to
study with reasonable diligence the information
provided. However, this is qualified a little later
when it is stated that ‘information that is relevant
and reliable should not be excluded from the
financial statements simply because it is too
difficult for some users to understand

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Definitions of elements, recognition and
derecognition
• Assets: an asset is a resource controlled by an
entity as a result of past event from which the
economic benefit are expected to flow to the entity.
• Liabilities: present obligation of an entity arising
from past transaction the settlement of which is
expected to result in an outflow from the entity
• Equity: equity is the residual interest in the asset
of the entity after deducting the liabilities.

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• Income: income is increase in economic benefit
during an accounting period in the form of inflow
or enhancement of asset or decrease of liabilities
that result in increase in equity other than those
related to the contribution from the equity
participant.
• Expense: is decrease in economic benefit during an
accounting period in the form of outflow or
depletion of asset or incurrence of liabilities that
result in decrease in equity other than those
related to the distribution to the equity
participant.

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Recognition of elements of financial
statements
An item should recognized when:
a) It is probable that any future economic benefit
associated with the item will flow to or from the
entity.
b) The item has a cost or value that can be measured
with reliably.

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Measurement

• Measurement is one of the most underdeveloped

area of two framework. Both framework contains
list some measurement attributes like:
a) historical cost
b) Current cost
c) NRV
d) Current market value
e) Present value of expected future cash flow

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Reporting entity concept

One key issues in the financial reporting is which

one is a reporting entity?
The entity which have an apparent need to provide
general purpose financial statement. these
financial statement are contrasted to special
purpose financial statements.
A reporting entity is an entity for which there are
users who rely on financial statements as their
major source of information.

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Reporting entity concept
• Factors for reporting entity are:
1. Separation of management from those with the
economic interest in the entity
2. Economic and political influence of the entity
to/on other parties
3. Financial characteristics of the entity as the
amount of sales , value of assets, number of
customers and employees etc.

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