INTERMEDIATE

ACCOUNTING
TENTH CANADIAN EDITION
Kieso Weygandt Warfield Young Wiecek McConomy

CHAPTER 2
Conceptual
Framework
Underlying
Financial
Prepared by:
Dragan Stojanovic, CA
Reporting
Rotman School of Management,
University of Toronto

CHAPTE
2
R

CONCEPTUAL FRAMEWORK UNDERLYING FINANCIAL REPORTING

After studying this chapter, you should be able to:

Indicate the usefulness and describe the main components of a
conceptual framework for financial reporting
Identify the qualitative characteristics of accounting information
Define the basic elements of financial statements
Describe the foundational principles of accounting
Explain the factors that contribute to choices and/or bias in
financial reporting decisions
Discuss current trends in standard setting for the conceptual
framework
Copyright John Wiley & Sons Canada,
Ltd.

hilarious math things

Conceptual Framework
Underlying Financial
Reporting
Conceptual
Framework

Objective of
Financial
Reporting

Foundational
Principles

Financial
Reporting
Issues

Rationale

Qualitative

Recognition
characterist
Developme
/
ics of
nt
derecognitio
Information
useful

n
information Measureme
asymmetry
Elements
revisited

nt
of financial Presentatio
statements
n and
disclosure

Principlesbased
approach
Financial
engineering
Fraudulent
financial
reporting

IFRS / ASPE
Comparison

Looking
ahead

Usefulness of a Conceptual
Framework

Conceptual Framework of
Accounting

Usefulness of a Conceptual
Framework

Conceptual Framework of
Accounting

Usefulness of a Conceptual
Framework

Conceptual Framework of
Accounting

Usefulness of a Conceptual
Framework
Conceptual Framework is:
A system of concepts that leads to consistent
standards for the accounting profession
Increases financial statement users
understanding of, and confidence in, financial
reporting
Enhances comparability of financial statements of
different companies
Accounting
Accounting
Accounting

Part I
Part II

2016 Edition

The Conceptual Framework of

Accounting Standards

General Accounting

Conceptual Framework
Conceptual Framework updates:
Currently the IASB and FASB are working on a joint
project to develop a conceptual framework that
could be used by both organizations
After a few years of stagnant progress, the joint
project was turned into an IASB only project in
September 2012
Two sections have been published:
Chapter 1: Conceptual Framework for Financial Reporting
(notes)
9
Chapter 3: Updating References to the Conceptual

Conceptual Framework

10

Objective of Financial
Reporting
The overall objective of financial reporting is to
provide information that is:
useful to users (investors, creditors, etc.)
decision relevant (resource allocation)
OB2

Resource allocation decisions are assumed to

include assessment of management stewardship
(management role in maximizing shareholder
value)
OB3 -> OB11

Essentially the why

11

Fundamental Qualitative
Characteristics

12

Fundamental Qualitative
Characteristics

Qualitative Characteristics of Useful Financial

Information
If financial information is to be useful, it must be relevant
and faithfully represent what it purports to represent. The
usefulness of financial information is enhanced if it is
comparable, verifiable, timely and understandable *QC4

13

Fundamental Qualitative
Characteristics
Relevance
Capable of making a difference in a decision
Even if the user chooses not to take advantage of it *QC6

Has predictive value

It has predictive value if it can be used as an input to processes
/ models employed by users to predict future outcomes *QC8

Has confirmatory value

It has confirmatory value if it provides feedback about previous
evaluations *QC9

Includes all material information

Information is material if omitting it or misstating it could

14

Fundamental Qualitative
Characteristics
Faithful Representation
Complete
A complete set of information includes all information necessary
for a user to understand the situation being depicted *QC13

Neutral
A neutral set of information is without bias in the selection or
presentation of financial information.
It is not slanted, weighted, emphasized, de-emphasized or
manipulated to present the financial information in a specific
light *QC14

Free from material error

Does not mean that no errors are present
Does mean that no errors are present that are material in nature
15
As some values cannot be determined, the information is still

Enhancing Qualitative
Characteristics

16

Enhancing Qualitative
Characteristics

Enhancing Qualitative Characteristics:

Comparability, verifiability, timeliness and
understandability are qualitative characteristics that
enhance the usefulness of information that is relevant and
faithfully represented. The enhancing qualitative
characteristics may also help determine which of two ways
should be used to depict a phenomenon if both are
considered equally relevant and faithfully represented
*QC19

17

Enhancing Qualitative
Characteristics
Comparability *QC20 QC25

Information that has been measured and reported in

similar way (company to company, and year to year) is
considered to be comparable

Allows us to identify similarities in, and differences among,

items

Does not relate to a single item, but a comparison of at

least two items

Comparability enables users to identify the real similarities

and differences in financial statements because these
have not been obscured by accounting methods that
cannot be compared
18

Enhancing Qualitative
Characteristics
Verifiability *QC26 QC28

Verifiability exists when knowledgeable, independent users

achieve similar results or reach consensus regarding the
accounting for a particular transaction

Some numbers are more easily verified than others

The more assumptions that are made, the more difficult the
numbers are to verify

Numbers that are easy to verify, with a reasonable degree

of accuracy are called hard numbers

Those with more uncertainty are called soft numbers

19

Enhancing Qualitative
Characteristics
Timeliness *QC29

Information should be available to the decision maker

before it losses its ability to influence their decisions

The older the information, the less useful it is

Information is typically reported on a quarterly basis to the

users so the users have information throughout the year
as opposed to having to wait until after the year end for
the annual financial statements

20

Enhancing Qualitative
Characteristics
Understandability *QC30 QC32

Understandability is based on the premise that users have

a reasonable knowledge of business and financial
accounting matters

Financial information must be of sufficient quality and

clarity that it allows reasonable informed users to see its
significance

Provides enough information so that it is clear

Just because a transaction or area is complex, does not

mean that it can be omitted, it simply means that it must
be explained thoroughly by the company and the user may
need to see the aid of an advisor in order to understand
21
the information

Constraints

22

Constraints

Constraints
Cost is a pervasive constraint on the information that can
be provided by financial reporting. Reporting financial
information imposes costs, and it is important that those
costs are justified by the benefits of reporting that
information. There are several of costs and benefits to
consider *QC35

23

Constraints
Cost *QC36 QC39

The benefit of possessing the information must be greater

than the cost of producing it

The difficulty in the cost-benefit analysis is that the costs

and , especially, the benefits are not always measurable.
Benefits are typically more difficult to quantify than costs

The deeper, more complex the information, the higher the

cost to produce it

Providers of financial information expend most of the effort

in producing financial information, but users ultimately
bear those costs in the form of reduced returns

There are several types of costs, such as:

Collecting and processing data, distributing financial reports,

24
having the financial statements audited, disclosure of

Elements

25

Elements of Financial
Statements: Assets

Assets
An asset is a resource controlled by the entity as a result of
past events and from which future economic benefits are
expected to flow to the entity *4.4a

Recognition
An asset is recognized in the statement of financial
position when
it is probable that the future economic
benefit will flow to the entity and the asset has a cost or
value that can be measured reliably *4.44
26

Elements of Financial
Statements: Assets
Assets *4.8 4.14
Assets have three essential characteristics
There is some economic benefit to the company
The entity has control over that benefit
The benefits result from a past transaction or event

Most assets have a physical form, however, physical form

is not essential to the existence of an asset (patents,
copyrights etc.)
An entity uses its assets to produce goods or services
capable of satisfying the wants or needs of customer;
because these goods or services can satisfy these wants or
needs, customers are prepared to pay for them and
27
contribute cash flow to the entity

Elements of Financial
Statements: Liabilities

Liabilities
A liability is an obligation (duty or responsibility) to act or
perform in a certain way. Obligations may be legally
enforceable as a
consequence of a binding contract or
stator requirement

Recognition
A liability is recognized in the statement of financial
position when it is probable that an outflow of
resources embodying economic benefits will result
from the settlement of a present obligation and the

28

Elements of Financial
Statements: Liabilities
Liabilities *4.15 4.19
Liabilities have three essential characteristics
They represent a present duty or responsibility
The duty or responsibility obligates the entity, leaving it little
or no discretion to avoid it
The transaction or event results from a past transaction or
event

Similar, but opposite, to an asset, a lability has a negative

economic value and requires that the entity give up
economic resources to settle the obligation
May arise through contractual obligations or through
statutory requirements or through constructive and
equitable obligations

29

Elements of Financial
Statements: Liabilities

Equity *4.20 4.23

Equity is a residual interest in an entity that remains after
deducting its liabilities from its assets. This is known as net
worth.
Equity typically consists of:
Common Shares
Retained Earnings
Accumulated Other Comprehensive Income (IFRS)
30

Elements of Financial
Statements
Revenue
Arises in the course of the ordinary activities of an entity
and is referred to by a variety of different names
including sales, fees, interest, dividends, royalties and
rent. *4.29
Revenue is recognized in the income statement when an
increase in future economic benefits related to an
increase in an asset or a decrease of a liability can be
measured reliably *4.47
This means that recognition of income occurs
simultaneously with the recognition of increases in assets
or decreases in liabilities

31

Elements of Financial
Statements
Expenses
Arises in the course of the ordinary activities of the
entity and include: cost of sales, wages and
depreciation. *4.33
Decreases in economic benefits during the accounting
period in the form of outflows or depletions of assets or
incurrences of liabilities that result in decreased equity
*4.25b
Expenses are recognized in the income statement when
a decrease in future economic benefits related to a
decrease in an asset or an increase in a liability has
arisen that can be measured reliably *4.49
This means that recognition of expense occurs
simultaneously with the recognition of an increase in
liabilities or a decrease in assets

32

Elements of Financial
Statements
Gains
Represent increases in economic benefits *4.30
Typically arise from the disposal of non-current assets
*4.31

Losses
Decreases in equity (net assets) resulting from incidental
transactions (flood, fire etc.) *4.35
Also those arising on the disposal of non-current assets
When losses are recognized in the income statement
they are often displayed separately because knowledge
of them is useful for decision makers.
33

Measurement of the
Elements

Foundational Principles
34

Measurement of the
Elements
Measurement
Measurement is the process of determining the monetary
amounts at which the elements of the financial statements are
to be recognized and carried in the balance sheet and income
statement. This involves the selection of the particular basis of
measurement. *4.54
As a general rule, elements of a financial statement cannot be
recognized, if they cannot be measured
Uncertainty can exist when measuring elements as not all
elements can be accurately estimated (accrual accounting)

35

Measurement of the
Elements
Measurement Basis
A number of different measurement bases are employed to
different degrees and in varying combinations in financial
statements, the include the following: *4.55
Historical Cost - Assets
Assets are recorded at the amount of cash paid or the fair
value of the consideration given to acquire them at the time of
their acquisition
Historical Cost - Liabilities
Liabilities are recorded at the amount of proceeds received in
exchange for the obligation or in some circumstances, at the
amounts of cash expected to be paid to satisfy the liability in
the normal course of business *4.55a
36

Measurement of the
Elements
Measurement Basis
A number of different measurement bases are employed to
different degrees and in varying combinations in financial
statements, the include the following: *4.55
Fair Value - Assets
Assets are carried at the amount of cash that could currently
be obtained by selling the asset in an orderly disposal
Fair Value - Liabilities
Liabilities are carried at their settlement values; that is, the
undiscounted amounts of cash expected to be paid to satisfy
the liabilities in the normal course of business*4.55c
37

Measurement of the
Elements
Measurement Basis
A number of different measurement bases are employed to
different degrees and in varying combinations in financial
statements, the include the following: *4.55

The measurement basis most commonly adopted by

entities in preparing their financial statements is
historical cost.
This is usually combined with some other
measurement bases.
38

Foundational Principles
Foundational Principles
Foundational principles are concepts that help explain
which, when and how financial elements and events
should be recognized, measured and presented /
disclosed
They act as guidelines for developing rational responses to
controversial financial reporting issues
Accounting standards issued by standard setters are based
on these principles

39

Recognition/Derecognition
Revenue Recognition Principle
One of the most important questions for many companies
is:
when should we recognize revenue?
Revenue is recognized when: *4.47
Risks and rewards have passed or the earnings process is
substantially complete
Revenue is measurable and *4.41 4.43
Revenue is collectible (realized or realizable)

Revenue is realized when:

Products (goods or services), merchandise, or other assets are

exchanged for cash or claims to cash

Revenues are realizable if the assets received or held can be readily

40

Recognition/Derecognition
Matching Principle
Expenses are matched with revenues that they produce
Illustrates a cause and effect relationship between
money spent to earn revenues and the revenues
themselves
If the expense benefits the future periods and meets the
definition of asset, it is recorded as an asset
This assets cost is then systematically and rationally
matched to future revenues

41

Measurement
Going Concern Assumption
The financial statements are normally prepared on the
assumption that an entity is a going concern and will
continue in operation for the foreseeable future.
It is assumed that the entity has neither the intention
nor the need to liquidate or curtail materially the scale
of its operations; if such an intention or need exists, the
financial statements may have to be prepared on a
different basis and, if so, the basis used is disclosed.
*4.1
Full disclosure is required of any material uncertainties
of continuing as a going concern
42

Foundational Principles
Fair Value Principle
Fair value has been defined (under IFRS) as
the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market
participants at the measurement date

After to initial recognition, historical cost and fair value

often differ

Fair value is often considered more relevant for certain

assets/liabilities (e.g. financial instruments)

Fair value is essentially what the asset or liability is

worth currently in the market
43

Presentation and
Disclosure:
Full Disclosure Principle
Full Disclosure Principle
Anything that is relevant to users decisions should be
included in financial statements
This is referred to as the full disclosure principle
Disclosed information should:
Provide sufficient detail of the occurrence
Be sufficiently condensed to remain understandable,
and appropriate in terms of costs of preparing/using it

44

Presentation and
Disclosure:
Full Disclosure Principle
Full Disclosure Principle continued
Full disclosure is not a substitute for proper accounting
practice
More information is not always better
Too much information and the user may not be able to digest or
process the information
Not enough information and the user may not be able to get a clear
understanding of the financial health of the company

Disclosures may be made:

Within the main body of the financial statements
As notes to the financial statements
As supplementary information, including Management Discussion
and Analysis (MD&A)
45

Presentation and Disclosure:

MD&A
MD&A (Management Discussion and Analysis)
The purpose of the MD&A is to provide a narrative explanation,
through the eyes of management, of how an entity has
performed in the past, its financial condition, and its future
prospects
Guidance provided in the CPA Canada handbook suggests the
MD&A should:

Allow readers to view the company through the eyes of

management
Complement and supplement the financial statements
Be reliable, complete, fair and balanced
Have a forward looking orientation
Focus on management's strategy for generating value for
investors
Be written in a plain language

46

Presentation and Disclosure:

MD&A
MD&A Continued
The MD&A should contain comments relating to the companys
vision, core business operations and strategy, performance
drivers, capabilities, results and risks
While the MD&A does contain important information about
management and strategy, it is important to remember that
the MD&A is unaudited

47

Presentation and Disclosure:

AIF
Annual Information Form (AIF)
The AIF provides more information about a companys
operations and a management proxy circular which provides
more information about board and executive compensation.
Requirements pertaining to all public riling are covered in a
series of national instrument documents published by the
Ontario Securities Commission.

National instrument 51-102 which gives guidance on many of the

items discussed today is found on D2L

48

Financial Reporting Issues:

Principles Based Approach
Principles Based Approach
IFRS & ASPE are principles based

They are based on a few foundational principles and concepts like

those in the conceptual framework

The benefit is that all decisions should be consistent if they

start from the same foundational reasoning

Principles based GAAP is flexible and as a result is criticized for

being too flexible and allowing professional judgement to direct
accounting treatment and thus lack comparability

Care must be taken to ensure that the flexibility is not abused

and all decisions align with the conceptual framework of
accounting
49

Financial Reporting Issues:

Financial Engineering
Financial Engineering
The process of legally structuring a business arrangement or
transaction so that it meets the companys financial reporting
objective

This is done by creating complex legal arrangements and financial

instruments
The arrangements and instruments are created so that the
resulting accounting meets the desired objective within GAAP

Financial engineering has become more visible during the last

20 years and in that time has moved from being an accepted
practice to a potentially fraudulent activity
Both ASPE and IFRS are principles based, financial engineering
exists primarily in rules based environments
50

Financial Reporting Issues:

Fraudulent Financial
Reporting

51