THE CONCEPTUAL FRAMEWORK (CF)

The Conceptual Framework (CF) is the foundation on which all IFRSs

are built. The Conceptual Framework is not a Standard. Nothing in the
Conceptual Framework overrides any Standard or any requirement in a
Standard.

What is the Conceptual Framework (CF)?

Definition:
The Conceptual Framework for Financial Reporting (CF) is:
 A set of accounting objectives and fundamentals,
 Developed by the International Accounting Standards Board
(IASB)
 To ensure uniformity in interpretation across various accounting
methodologies.

The Conceptual Framework for Financial Reporting:

 States the “objectives” of general-purpose financial reporting, and
 Explains the various “concepts” that underpin financial reporting.

What is the “objectives of general-purpose financial reporting?”

The objective of general-purpose financial reporting is to provide

financial information about the reporting entity that is useful to the three
primary users, so that they could make decisions about providing
resources (capital) to the entity.
The three primary users are:
 Existing and potential investors,
 Existing and potential lenders and
 Existing and potential creditors.

Thus: The CF will supply users with information which will be useful in
their decision making.
However, general purpose financial reports do not and cannot provide
all of the information that existing and potential investors, lenders and
other creditors need. General purpose financial reporting only supply
information about financial information, and not information about the
general economic conditions and expectations, political events and
political climate, and industry and company outlooks.
When was the first Conceptual Framework (CF) issued and how
was the original CF revised?

The original CF was issued in 1989. During 2010, the 1989 CF was
completely revised to harmonise it amongst global stakeholders.

On 29 March 2018 the International Accounting Standards Board (IASB)

published its revised 'Conceptual Framework for Financial Reporting',
which is the one currently in use.
Significant changes in the 2018 version are:
 Revised definitions of an asset, a liability, an income and an
expense.
 Revised recognition criteria.
 Improved guidance on measurement and recognition,
derecognition, presentation and disclosure.

The new Conceptual Framework does not constitute a substantial

revision of the previous version of the Conceptual Framework but
instead the IASB focused on topics that were not yet covered or that
showed obvious shortcomings that needed to be addressed.

Why do we need a Conceptual Framework in accounting? (What is

the purpose of the Conceptual Framework?)

The CF is basically a tool that has three purposes:

1. To help the IASB in developing IFRSs,

2. To help those preparers of financial statements who may need to

create their own accounting policies (when a suitable IFRS does
not exist or an existing IFRS allows an alternative policy) and

3. To help all parties to understand and interpret the IFRSs.

Concepts currently contained in the CF include the

1. Objective of general-purpose financial reporting,

2. Qualitative characteristics of useful financial statements.
3. Financial statements and the Reporting entity.
4. Elements of financial statements (Assets, liabilities, equity, income
expenses)
5. Recognition and derecognition.
 6. Measurement bases that may be used when measuring the
elements.
7. Presentation and Disclosure.
8. Capital and capital maintenance.

QUALITIVE CHARACTERISTICS OF USEFUL

FINANCIAL INFORMATION

FUNDAMENTAL QUALITATIVE ENHANCING QUALITATIVE

CHARACTERISTICS CHARACTERISTICS
 Relevance  Comparability
 Faithful representation  Verifiability
 Timeliness
These characteristics are  Understandability
essential for usefulness.
These characteristics improve
usefulness.
THE QUALITIVE CHARACTERISTICS AND CONSTRAINTS

For financial statements to be useful to its users, it must have certain

qualitative characteristics.

The qualitative characteristics of useful financial information recognise:

 The types of information that are likely to be most useful to the
existing and potential investors, lenders and other creditors
 For making decisions about the reporting entity on the basis of
information in its financial report (financial information).

The Conceptual Framework separates the qualitative

characteristics into the following two types:

Fundamental qualitative characteristics

Those that are essential for financial information to be useful for users
are:
 Relevance
In order for information to be relevant, one should consider
whether it could make a difference in users’ decision-making.

 Faithful representation
“Substance over form.”
In order to achieve faithful representation, the financial information
given to users must be complete, neutral and free from error.
Fundamental qualitative characteristic: Relevance

When will financial information be relevant for its users?

Relevant financial information is capable of making a difference in the

decisions made by users.
Financial information is capable of making a difference in decisions if it
has:
 Predictive value,
 Confirmatory value,
 Or both.

Financial information has predictive value if the information can be

used as an “input” and then make a prediction on future outcomes.
forecast. Financial information with predictive value is employed by
users in making their own predictions or forecasts.

Financial information has confirmatory value if it provides feedback

about previous evaluations. (Previous predictions are confirmed.) An
example of information that has confirmatory value is, when the current
year’s revenue helps users evaluate if their previous revenue predictions
were correct or not.

Information that is confirmatory can also be predictive. For example:

The current year’s revenue can be seen as information that has a
confirmatory value, but at the same time can helps users predict their
future revenue.

How does materiality influence relevance?

Information which is relevant is clearly affected by materiality.

(Unimportant information would have no relevance.) Although
materiality is not a qualitative characteristic, materiality affects the
decisions of users. When a user has doubt if information is material, the
user should ask the following question: “Will omitting, misstating or
obscuring the information change our primary user’s decisions?” If the
answer is “yes”, then the information is indeed material.

It is important to note that there is no one specific materiality

threshold because information that is material to one entity may not be
material to another entity. Materiality is also influenced by an entity’s
specific situation. Thus, materiality is entity-specific and in deciding
whether something is material professional judgment has to be applied.
Fundamental qualitative characteristic: Faithful representation

When will financial information be faithfully represented?

Financial reports represent economic events which is expressed in

words and numbers. To be useful, financial information must not only
represent relevant events, but it must also faithfully represent the
“matter” of the event that it intends to represent. In accounting we refer
to this “matter” as the substance of the event.

What does the term “Substance over form” mean?

In many situations, the substance of an economic event and the event’s

legal form, are the same. If the legal form is different from the
substance of the event, then we must rather portray the event’s
substance and not its legal form. We need to ask ourselves ”What
actually happens here and what does really matter in this case?”
Information should rather portray the substance (or economic reality)
since that would be a faithful representation of the information.

What are the requirements for information to be faithfully

represented?

For information to be a perfectly faithful representation, a financial report

should have three characteristics. It should be:
 Complete,
 Neutral and
 Free from error.

It is seldom achieved that information is a perfectly faithful

representation.

Complete:
When will financial information be complete?

A complete representation of financial information requires that all

information (words and numbers) must be given to the users. If all
necessary descriptions and explanations are supplied, the user will
be able to understand the phenomenon being portrayed.
Thus, if the phenomenon is an asset, the following information should
be given:
 The nature of the asset, for instance it is a machine.
 Give relevant numerical information for instance the cost amount,
the accumulated depreciation amount, etc.
 Describe what the numbers mean for instance cost, accumulated
depreciation.
 Explain how we got to these amounts for instance the accumulated
depreciation is calculated at cost less depreciation and is
calculated using a nil residual value and the depreciation is
calculated over a useful life of 12 years.

Neutral:
When will financial information be neutral?

For financial statements to be neutral, the information must be selected

and presented in such a way that it is not biased. If the financial
statements were manipulated so that the users interpret the information
in a favorable or unfavorable way, the information is not neutral.
Financial information will be considered unfairly presented (or
prejudiced) if some parts of the information is over emphasized or if
another part of the information is under emphasized.

Neutrality is maintained by the application of “prudence”. Prudence is

the exercise of caution when making decisions where there is a level of
uncertainty about the information.

The exercise of carefulness requires that:

 Assets and income are not overstated, and thus portrays a

favourable representation of the asset and income.
 Assets and income are not understated, and thus portrays an
unfavourable representation of the asset and income.
 Liabilities and expenses are not understated, and thus portrays a
favourable representation of the liabilities and expenses.
 Liabilities and expenses are not overstated, and thus portrays a
unfavourable representation of the liabilities and expenses.
Free from error.
When will financial information be free from error?

Useful information must be without errors. But, in this context, free from
error does not mean the information must be “accurate in all respects.”

Some amounts in financial statements are directly observable and are

consequently “accurate in all respects”. Example: On 28 February 2021
the listed share investment’s value in the Statement of Financial
Position, can be verified as an accurate value if it is compared with the
quoted share price on the stock exchange.

However, some amounts or values in financial statements are not

directly observable and the amount or value will have to be estimated.
An example of such estimate is when there has been a provision relating
to a legal matter, were the court case is still in progress and the
accountant is relying on the lawyer’s estimations.

When estimates are made there is an element of uncertainty whether the

estimate is accurate or almost accurate. At the time an estimate is
made it is difficult to prove whether the estimate is “truthful” or
“correct.” The term “measurement uncertainty” refers to situations
were an estimate is made and there is difficulty to prove the accuracy
of the value estimated. In some cases, if the level of measurement
uncertainty is high, it may be questionable whether the estimate would
provide a sufficiently faithful representation of that event.

It is completely normal to use an estimate in financial statements, and

claim that the measurement of the estimate is a “reasonable estimate”
as long as:

 The amount is described clearly and accurately as being an

estimate,
 The nature and limitations of the estimating procedure are
explained, and
 No errors have been made in selecting and applying an
appropriate process for developing the estimate.

Thus, to refer to the court case again: Using the estimate will be
considered to be a faithful representation, as long as the estimate
adheres to the above mentioned three criteria.
How do we apply fundamental qualitative characteristics?

Users will be able to make good decisions if the financial information

supplied is both relevant and faithfully represented. Information
cannot be useful if it is relevant, but not a faithful representation of
the event. Furthermore, a faithful representation of an irrelevant
event will not help users to make good decisions.

The Conceptual Framework explain that information that is both

relevant and faithfully represented can be achieved by:
Step 1: Identifying the event that has the potential to be useful to the
user.
Step 2: Identifying the type of information which would be the most
relevant.
Step 3: Determine whether the information is obtainable and can be
faithfully represented.

The objective of financial reporting is to provide useful information

about economic events or economic phenomena. In some cases, a
trade-off between presenting relevant information and presenting
information faithfully needs to be made in order to meet the objective
of financial reporting.

If the level of “measurement uncertainty” is too high:

Then, even if the information is relevant, the information will be ignored

because presenting that piece of information, will not be a sufficient
faithful representation of that event. In such a case, the accountant
will have to choose the next most relevant information which has a
lower level of measurement uncertainty and which allow him to conclude
that it is a faithful representation of the event.
ENHANCING QUALITATIVE CHARACTERISTICS

Enhancing qualitative characteristics (Gripping GAAP Pg. 47-49)

Explain what is meant by “Enhancing qualitative characteristics?”

If information is both relevance and faithfully represented, the

information is considered to be useful information.

To boost (or increase) the usefulness of the supplied information, the

accountant should then apply the following four enhancing qualitative
characteristics:

 Comparability
 Verifiability
 Timeliness
 Understandability

Comparability

Explain how “Comparability” will enhance the usefulness of

financial information?

Information about a reporting entity’s financial statements is more

useful if it can be compared:

 With similar information about other entities. E.g. The net profit
for 2021 for Company A is R20 000 and it compares favourably
with Company B’s 2021-net profit of R18 000.

 With similar information about the same entity for another period
or another date. E.g. The net profit for 2021 for Company A is
R25 000 and it compares favourably with this company’s 2020-net
profit of R18 000.
Verifiability

Explain how “Verifiability” will enhance the usefulness of financial

information?

When information is “verified,” it give the user of the information the

assurance that the information is true, accurate, or justified.

In the accounting context financial information has to be verified:

 By independent knowledgeable observers and
 They have to certify that the information is faithfully represented.

Note:
1. The observers do not necessarily have to be in complete
agreement, but they will have to have consensus that the
particular representation is a faithful representation.

2. Some information may not be verifiable. (Predictions and

expiations cannot be verified.)

3. Information which cannot be verified should be identified. If

financial information cannot be verified, users should be able to
decide if they want to use this information in their decision-making.

Verification can be direct or indirect.

Direct verification means verifying an amount or other representation

through direct observation. Example:
The bank balance could be verified by comparing the bank balance with
the amount which appear on the bank statement.

Indirect verification can be done by checking inputs, make some

calculations and compare the outputs with the amount that has to be
verified.
Example:
The inventory on hand balance could be verified:
 By taking the initial balance of number of units on hand and the
cost per unit, gather information on units and cost of units
purchased and sold during the period (the inputs),
 Apply the first-in-first-out calculation, and
 Compare the calculated balance with the actual inventory balance
on hand.
Timeliness

Explain how “Timeliness” will enhance the usefulness of financial

information?

Most financial reports are published soon after the financial year end.
Users of the information contained in the financial reports needs to
receive it as soon as possible or timeously, so that they then could make
informed decisions. If the information is not available timeously, the
information is less useful to the primary users.

Note:
 Some information may continue to be useful even though the
information was received long after the end of a reporting period.
Users may find the information useful because they may need to
identify and assess trends.

 The race to submit reports on time, could have a negative

influence on the other qualities of the information. Completeness
could be adversely affected and consequently the financial
reports might not be a faithful representation of the results.

Understandability

Explain how “Understandability” will enhance the usefulness of

financial information?

Some events/phenomena are inherently difficult to understand.

Suppliers of information are therefore tempted to exclude complex
events and by doing just that, the financial reports will be easier to
understand. However, those reports would then be not complete and
therefore possibly misleading.

Consequently, if something is difficult to understand, we need to take

extra care in how to present the information and even extra disclosure
can be supplied if it may improve the understandability of the
information.

Finally, to achieve understandable information, the information must be

classified, characterised and presented in a clear and concise
manner.
ELEMENTS OF THE FINANCIAL STATEMENTS

Transactions and events are grouped according to their economic

characteristics. These groupings are called elements. The Conceptual
Framework identifies 5 main elements: Assets, Liabilities, Income,
Expenses and Equity.

The following definitions are relevant:

An asset is:
 A present economic resource Note 1
 Controlled by the entity
 Resulting from past events
Note 1: An economic resource is defined as:
 A right that has
 The potential to produce economic benefits

A liability is:
 A present obligation Note 2
 To transfer an economic resource Note 1
 Resulting from past events
Note 2: An obligation is:
 A duty that the entity has
 No practical ability to avoid.

Equity is:
 The residual interest in the entity’s assets
 After deducting all its liabilities
(Residual interest = A - L)

An expense is:
 A decrease in assets or increase in liabilities
 Resulting in a decrease in equity
 Other than distributions to holders of equity claims.

An income is:
 An increase in assets or a decrease in liabilities
 Resulting in an increase in equity
 Other than contributions from holders of equity claims.
Recognition criteria:

Assets, liabilities, equity, income and expenses may only be recognised

in the financial statements if they meet the definition as well as the
recognition criteria.

According to the 2010 conceptual framework the recognition

criteria were:

 The flow of future economic benefits caused by this

asset/liability are probable, and
 This asset/liability has a cost/value that can be reliably
measured.

According to the 2018 conceptual framework the recognition

criteria are:

Assets and liabilities, and any resulting income expenses or changes

in equity will be recognised if the information provided by the elements
is useful for the user.
Thus: An element will be recognised if the information which is
provided is
 Relevant and
 A faithful representation.

Measurement of elements:

The term “measurement” refers to the process of deciding or calculating

the amount to be used in our financial statements.

There are a number of different methods (or possible measurement

bases) that may be used to measure the amounts of individual elements
(assets/liabilities) recognised in the financial statements.

 The historical cost

 The current value (Fair value or value in use)
 The current cost method (assets) or fulfilment value method
(liabilities).