The Conceptual Framework for Financial Reporting
Update 2019: As the new Framework was issued in 2018, there’s a summary of updated Framework with the new video here on this link.
The Conceptual Framework for the Financial Reporting (I will call it just “IFRS Framework”) serves as a pillar on which the whole IFRS stand. It describes the basic principles for presentation and preparation of financial statements in line with IFRS. In my opinion it’s a “must-read” document prior starting to dig in any other IFRS or IAS standard.
The IFRS Framework underwent certain changes over past years. Previously, it was called “Framework for the Preparation and Presentation of Financial Statements”. IASB, the standard setter body, is in the process of updating it. Last update happened in September 2010, but it was just partial update. Currently, it is a kind of a mix—new text approved in September 2010 plus old text that is to be replaced in the future.
The IFRS Framework itself is not a standard, but it is still very important though, as gives the users some guidance of how the financial statements shall be prepared.
So let’s quickly look inside. IFRS Framework consists of 4 chapters:
Chapter 1: The objective of General Purpose Financial Reporting
Here, IFRS Framework explains who needs information about entity’s financial situation and why—investors, lenders, creditors, but also other parties.
Financial statements shall provide information about a reporting entity’s economic resources and claims, plus their changes. The following small table shows how:
Chapter 2: The Reporting Entity
This chapter is empty as I write this article and will be inserted in the later process of updates. I will let you know when it actually happens.
Chapter 3: Qualitative Characteristics of Useful Financial Information
In this Chapter, IFRS Framework describes 2 types of characteristics for financial information to be useful:
- Fundamental Qualitative Characteristics are relevance and faithful representation.
- Enhancing Qualitative Characteristics are comparability, verifiability, timeliness and understandability.
Chapter 4: The 1989 Framework: The Remaining Text
Here you can see that the IFRS Framework is still in progress. Chapter 4 contains the original text of “old” IFRS Framework before any changes. As IASB adds new text, relevant paragraphs in this older text will be deleted and replaced by the new Chapters.
So what is in? Chapter 4 has 5 main parts:
1. Underlying Assumption
Underlying assumption is so-called going concern. It means that an entity will continue to operate for the foreseeable future (usually 12 months after the reporting date). Well, I will explain this concept together with example in another article.
2. The Elements of Financial Statements
The elements of financial statements are broad classes that group various transactions and items info financial statements. Short classification of the elements is shown in the following table:
3. Recognition of the Elements of Financial Statements
Recognition of asset (or any other element) means simply showing this asset in the balance sheet (or somewhere else in the financial statements). IFRS Framework discusses WHEN to recognize or show certain item in the financial statements.
There are 2 basic criteria for recognition of any item:
- it is probable that any future economic benefit associated with the item will flow to or from the entity; and
- the item’s cost or value can be measured with reliability.
4. Measurement of the Elements of Financial Statements
While recognition means WHEN (or WHETHER) to recognize, measurement means IN WHAT AMOUNT to recognize asset, liability, piece of equity, income or expense.
There are several ways used to measure the items in the financial statements, such as historical cost, current cost, net realizable value or present value. The most common one is historical cost, but also other bases are used in combination.
5. Concept of Capital and Capital Maintenance
The IFRS Framework discusses 2 concepts of capital and capital maintenance: financial and physical.
Based on selected concept of capital, an entity determines basis of measurement and accounting model used in preparation of the financial statements.
IFRS Framework is summarized in the following free video:
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