Conceptual framework
In July 1989, a document titled “Framework” was released by the defunt International Accounting Standard Committee (IASC now IFRS Foundation to set out guidelines for preparing financial statement. The process which made the body to be sometimes called “Conceptual Framework”.
Conceptual framework can be described as a set of principles designed to help in developing accounting standards. It forms the model upon which accounting standards are developed.
Why Conceptual Framework
· To assist IASB in developing future accounting standards and reviewing the existing ones.
· To guide preparer and users of financial statement on the topics not covered by the standards.
· It makes it easier for users to read and understand financial statement.
· It helps to bring consistency to accounting standards.
Areas Covered by the Framework
The conceptual framework covers the following areas:
1. Objectives of financial statement
2. Underlying assumptions
3. Qualitative characteristics of the financial statement
4. Definition, recognition and measurement of a financial statement
OBJECTIVES OF FINANCIAL STATEMENT
The primary objective of a financial statement is to assist users in decision making. According to the framework, the primary objective of the financial statement is to provide financial information about the reporting entity that will assist users and potential users such as creditors, investors, employers, government and the public.
UNDERLYING ASSUMPTIONS
The framework identify two major assumptions that underline the preparation and presentation of financial statements. These are:
a) Accrual concept
b) Going concern concept
a) Accrual Concept: This states that transactions are to be recognized when they take place and not when they are paid for. Such transactions are to be recorded for the accounting period they are related to.
b) Going Concern Concept: This concept indicates that the entity is going to be in operation for unforeseeable future. A financial statement that in prepared on going concern basis gives users assurance that the entity in not in the blink of liquidating or folding up in a time soon.
QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENT
These are features that made up a good accounting information. They are those attributes that are contained in accounting information that help users in making accurate decision. These attributes can be categorized into two:
a) Fundamental attributes and
b) Enhanced attributes
a) Fundamental Attributes
These are attributes that help in separating useful information from non-useful information or misleading information.
Fundamental attributes are characterize by two features which are:
i. Relevance
ii. Faithful representation
i. Relevance: This means that the information to be contained and must be relevant to the need of users and assist them in decision making. Relevant information according to the framework are those information that help the users to assess the past and present activities of an entity and make good economic decision. Any information that its omission or misstatement will affect the decision of the user is considered relevant.
ii. Faithful Representation: This is otherwise known as reliability. According to the framework, a financial statement is said to be reliable if it present the true and fair view of an entity. This is by ensuring that the information contain there are free from bias and can be relied on by the users for decision making.
There are certain principles to be observed before a financial statement can be said to faithfully represent an entity. These include:
v Substance over form: Substance in this aspect is refereeing to the future economic benefits that may be derived due to the financial information while the form refers to he legal record of the transactions. This principle means that the financial statement should give complete information and must be relevant and reliable for decision making instead of focusing on the legal aspect of the statement.
v Neutrality: objectivity must be maintained by ensuring that the information contained in a financial statement is correct and free from manipulation or bias. The statement should report what an entity is based on provable record, not on opinion or view of the preparer.
v Completeness: the information must be complete to aid users understanding and decision making.
v Prudence: he information provided in a financial statement must reveal the true worth of the entity by not overstating it.
b) Enhanced Attributes
These attributes help to differentiate more useful information from less useful information. It can be identified though the following features:
i. Comparability: This is the attribute that makes it easy for users to compare financial statements either to identify the similarities of differences in the information contained in it for easy decision making. Users should be able to compare financial statements over time to determine the performance of an entity or compare it with financial statements of other entities who are in the same line of trade with the industry.
ii. Understandability: Financial information must be presented in a way that be understandable by the users who may be willing to study the statement. Technical jargons that may influence the decision of the users must not be excluded for the sake of understandability.
DEFINITION, RECOGNITION AND MEASUREMENT OF THE ELEMENTS OF A FINANCIAL STATEMENT
Elements of Financial Statement
The elements of a financial statement according the framework, the financial elements can be classified into the following:
i. Assets
ii. Liabilities
iii. Equity
iv. Income
v. Expenditure
The first three of these elements can be found in the statement of financial position which is formerly known as balance sheet while the last two can be found in the income statement otherwise known as the profit and loss account.
i. Assets: These are economic resources owned and control by an entity as a result of past event and from which future economic benefits are expected to flow back to an entity.
ii. Equity: This is the excess of assets over liabilities. It represents the stake of the owners and other contributors who pledge their resources for the successful operations of the business.
iii. Income: This according to the framework represent an increase in economic value of the current period as a result of increase in assets based on inflow or decrease in liabilities which in turn increase the equity value of an entity without direct contribution to the equity by the equity holders.
iv. Expenses: this is a decrease in economic value as a result of outflow or decrease in assets or increase in liabilities which in turn led to a decrease in equity of a business without direct decrease in equity by the equity holders.
RECOGNITION
This describes how items that meet definition criteria of an element of financial statement are to be incorporated into the statement of financial otherwise known as the balance sheet or income statement formerly known as the profit and loss account.
There are certain criteria for an element to be recognized in the financial statement, these include:
· It is probable that future economic benefits related to the item will flow back to anentity.
· The item has a cost or value that can be measured reliably.
Stages of Recognition
Recognition of an item especially asset can be in three stages which are:
i. Initial recognition
ii. Subsequent recognition
iii. De-recognition
i. Initial Recognition: This occur when an item first meet recognition criteria as an asset or a liability. This mostly occur when an asset is first acquired or a liability is first incurred.
ii. Subsequent Stage: This is also referred to as re-measurement stage. It is about how an asset is to be re-measure due to passage of time which has affected the economic value of the asset or liability that are currently recognized in the book of account.
iii. De-recognition Stage: This refers to a period when an item does no more meet recognition criteria as an asset or liability. This occurs when the asset is sold off or the liability is settled.
MESUREMENT OF THE ELEMENT OF A FINANCIAL STATEMENT
Measurement of financial statement deals with the monetary value of the elements of the financial statement. It involves how an element is to be recognized and recorded in the statement of financial position otherwise known as the balance sheet or income statement which is also known as profit and loss account.
The framework identifies four basis of measurement which are:
i. Historical cost
ii. Current cost
iii. Realizable value
iv. Present cost
i. Historical Cost: This is the amount of cash or cash equivalent used to acquire an asset or charged to settle an obligation in the case of a liability.
ii. Current Cost: Assets are valued at cash or cash equivalent amount of acquiring such asset during the accounting period while liabilities are measured at the current value required to settle the obligation.
iii. Realizable Value or Settlement Value: Realizable or settlement value as defined by the framework is the amount that will be realized by selling an asset while settlement value refers to the undiscounted amount that will be required to settle an obligation in the case of a liability.
iv. Present Cost: This refers to the present value of an asset based on the discounted amount.
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