• Issues Relating to The Framework that IFRIC Did Not Add to Its Agenda

• IASB Project on Conceptual Framework.

The IASB's Framework for the Preparation and Presentation of Financial Statements describes the basic concepts by which financial statements are prepared. The Framework serves as a guide to the Board in developing accounting standards and as a guide to resolving accounting issues that are not addressed directly in an International Accounting Standard or International Financial Reporting Standard or Interpretation.

In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8.

The Framework:

• Defines the objective of financial statements;
• Identifies the qualitative characteristics that make information in financial statements useful; and
• Defines the basic elements of financial statements and the concepts for recognising and measuring them in financial statements. [Framework, paragraph 1, hereafter abbreviated F.1]

General Purpose Financial Statements

Users and their Information Needs

The principal classes of users of financial statements are present and potential investors, employees, lenders, suppliers and other trade creditors, customers, governments and their agencies and the general public. All of these categories of users rely on financial statements to help them in decision making. [F.9]

The Framework also concludes that because investors are providers of risk capital to the enterprise, financial statements that meet their needs will also meet most of the general financial information needs of other users. Common to all of these user groups is their interest in the ability of an enterprise to generate cash and cash equivalents and of the timing and certainty of those future cash flows. [F.10]

The Framework notes that financial statements cannot provide all the information that users may need to make economic decisions. For one thing, financial statements show the financial effects of past events and transactions, whereas the decisions that most users of financial statements have to make relate to the future. Further, financial statements provide only a limited amount of the non-financial information needed by users of financial statements.

While all of the information needs of these user groups cannot be met by financial statements, there are information needs that are common to all users, and general purpose financial statements focus on meeting these needs.

Responsibility for Financial Statements

The management of an enterprise has the primary responsibility for preparing and presenting the enterprise's financial statements. [F.11]

The Objective of Financial Statements

The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions. [F.12-14]

Financial Position

The financial position of an enterprise is affected by the economic resources it controls, its financial structure, its liquidity and solvency, and its capacity to adapt to changes in the environment in which it operates. [F.16]

The balance sheet presents this kind of information. [F.19]

Performance

Performance is the ability of an enterprise to earn a profit on the resources that have been invested in it. Information about the amounts and variability of profits helps in forecasting future cash flows from the enterprise's existing resources and in forecasting potential additional cash flows from additional resources that might be invested in the enterprise. [F.17]

The Framework states that information about performance is primarily provided in an income statement. [F.19] IAS 1 adds a fourth basic financial statement, the statement showing changes in equity.

Changes in Financial Position

Users of financial statements seek information about the investing, financing and operating activities that an enterprise has undertaken during the reporting period. This information helps in assessing how well the enterprise is able to generate cash and cash equivalents and how it uses those cash flows. [F.18]

The cash flow statement provides this kind of information. [F.19]

Notes and Supplementary Schedules

The financial statements also contain notes and supplementary schedules and other information that (a) explains items in the balance sheet and income statement, (b) discloses the risks and uncertainties affecting the enterprise, and (c) explains any resources and obligations not recognised in the balance sheet. [F.21]

Underlying Assumptions

The Framework sets out the underlying assumptions of financial statements:

• Accrual Basis. The effects of transactions and other events are recognised when they occur, rather than when cash or its equivalent is received or paid, and they are reported in the financial statements of the periods to which they relate. [F.22]

• Going Concern. The financial statements presume that an enterprise will continue in operation indefinitely or, if that presumption is not valid, disclosure and a different basis of reporting are required. [F.23]

Qualitative Characteristics of Financial Statements

These characteristics are the attributes that make the information in financial statements useful to investors, creditors, and others. The Framework identifies four principal qualitative characteristics: [F.24]

• Understandability
• Relevance
• Reliability
• Comparability

Understandability

Information should be presented in a way that is readily understandable by users who have a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently. [F.25]

Relevance

Information in financial statements is relevant when it influences the economic decisions of users. It can do that both by (a) helping them evaluate past, present, or future events relating to an enterprise and by (b) confirming or correcting past evaluations they have made. [F.26-28]

Materiality is a component of relevance. Information is material if its omission or misstatement could influence the economic decisions of users. [F.29]

Timeliness is another component of relevance. To be useful, information must be provided to users within the time period in which it is most likely to bear on their decisions. [F.43]

Reliability

Information in financial statements is reliable if it is free from material error and bias and can be depended upon by users to represent events and transactions faithfully. Information is not reliable when it is purposely designed to influence users' decisions in a particular direction. [F.31-32]

There is sometimes a tradeoff between relevance and reliability - and judgement is required to provide the appropriate balance. [F.45]

Reliability is affected by the use of estimates and by uncertainties associated with items recognised and measured in financial statements. These uncertainties are dealt with, in part, by disclosure and, in part, by exercising prudence in preparing financial statements. Prudence is the inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. However, prudence can only be exercised within the context of the other qualitative characteristics in the Framework, particularly relevance and the faithful representation of transactions in financial statements. Prudence does not justify deliberate overstatement of liabilities or expenses or deliberate understatement of assets or income, because the financial statements would not be neutral and, therefore, not have the quality of reliability. [F.36-37]

Comparability

Users must be able to compare the financial statements of an enterprise over time so that they can identify trends in its financial position and performance. Users must also be able to compare the financial statements of different enterprises. Disclosure of accounting policies is essential for comparability. [F.39-42]

The Elements of Financial Statements

Financial statements portray the financial effects of transactions and other events by grouping them into broad classes according to their economic characteristics. These broad classes are termed the elements of financial statements.

The elements directly related to financial position (balance sheet) are: [F.49]

• Assets
• Liabilities
• Equity

The elements directly related to performance (income statement) are: [F.70]

• Income
• Expenses

The cash flow statement reflects both income statement elements and changes in balance sheet elements. [F.47]

Definitions of the elements relating to financial position

• Asset. An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise. [F.49(a)]
• Liability. A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits. [F.49(b)]
• Equity. Equity is the residual interest in the assets of the enterprise after deducting all its liabilities. [F.49(c)]

Definitions of the elements relating to performance

• Income. Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. [F.70]
• Expense. Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. [F.70]

The definition of expenses encompasses losses as well as those expenses that arise in the course of the ordinary activities of the enterprise. Expenses that arise in the course of the ordinary activities of the enterprise include, for example, cost of sales, wages and depreciation. They usually take the form of an outflow or depletion of assets such as cash and cash equivalents, inventory, property, plant and equipment. Losses represent other items that meet the definition of expenses and may, or may not, arise in the course of the ordinary activities of the enterprise. Losses represent decreases in economic benefits and as such they are no different in nature from other expenses. Hence, they are not regarded as a separate element in this Framework. [F.78]

Recognition of the Elements of Financial Statements

Recognition is the process of incorporating in the balance sheet or income statement an item that meets the definition of an element and satisfies the following criteria for recognition: [F.82-83]

• It is probable that any future economic benefit associated with the item will flow to or from the enterprise; and
• The item's cost or value can be measured with reliability.

• An asset is recognised in the balance sheet when it is probable that the future economic benefits will flow to the enterprise and the asset has a cost or value that can be measured reliably. [F.89]
• A liability is recognised in the balance sheet when it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and the amount at which the settlement will take place can be measured reliably. [F.91]
• Income is recognised in the income statement when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably. This means, in effect, that recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities (for example, the net increase in assets arising on a sale of goods or services or the decrease in liabilities arising from the waiver of a debt payable). [F.92]
• Expenses are recognised when a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably. This means, in effect, that recognition of expenses occurs simultaneously with the recognition of an increase in liabilities or a decrease in assets (for example, the accrual of employee entitlements or the depreciation of equipment). [F.94]

Measurement of the Elements of Financial Statements

Measurement involves assigning monetary amounts at which the elements of the financial statements are to be recognised and reported. [F.99]

The Framework acknowledges that a variety of measurement bases are used today to different degrees and in varying combinations in financial statements, including: [F.100]

• Historical cost
• Current cost
• Net realisable (settlement) value
• Present value (discounted)