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Sunday, May 24, 2015

Summary of the Old Conceptual Framework issued by the Accounting Standards Council (ASC)



The FRSC 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 Philippine Accounting Standards or Philippine Financial Reporting Standards or Interpretations. The purpose of the framework as outlined is to:

a.    Assist the Financial Reporting Standards Council (FRSC) in developing accounting standards that represent generally accepted accounting principle;

b.    Assist the FRSC in its review and adoption of existing International Accounting Standards;

c. Assist preparers of the financial statements in applying FRSC Statements of Financial Accounting Standards and in dealing with topics that have yet to form the subject of an FRSC statement;

d. Assist auditors in forming an opinion as to whether financial statements conform with Philippine GAAP;

e. Assist users of financial statements in interpreting information contained in the financial statements prepared in conformity with Philippine GAAP;

f.     Provide those who are interested in the work of the FRSC with information about its approach to the formulation of Statements of Financial Accounting Standards

Scope of 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 recognizing and measuring them in financial statements.
·      Concepts of capital and capital maintenance.

General Purpose Financial Statements

The Framework addresses general purpose financial statements including consolidated financial statements that a business enterprise prepares and presents at least annually to meet the common information needs of a wide range of users external to the enterprise. Therefore, the Framework does not necessarily apply to special purpose financial reports such as reports to tax authorities, reports to governmental regulatory authorities, prospectuses prepared in connection with securities offerings, and reports prepared in connection with business combinations.

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.

While financial statements cannot meet all of the information needs of these user groups, 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.

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.

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. The balance sheet presents this kind of information.


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. The Framework states that information about performance is primarily provided in an income statement.

Changes in Financial Position or Cash Flows

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.  The cash flow statement provides this kind of information.

Underlying Assumptions (Postulates)

The Framework sets out the underlying assumptions of financial statements:
·       Accrual Basis. The effects of transactions and other events are recognized 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.

·   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.

The FRSC conceptual framework mentions two assumptions only.  However, it is widely believed that an inherent trait of the financial statements are the basic assumptions of:
·       Accounting Entity.  The business is separate from the owners, managers, and employees who constitute the business.  Therefore transactions of the said individuals should not be included as transactions of the business.

·         Time Period.  Financial reports are to be prepared for one year or a period of twelve months.

·         Monetary unit.  There are two aspects under this assumption.  First is the quantifiability of the peso, meaning that the elements of the financial statements should be stated under one unit of measure which is the Philippine Peso.  Second is the stability of the peso, means that there is still an assumption that the purchasing power of the peso is stable or constant and that instability is insignificant and therefore ignored.

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:

a.    Understandability

b.    Relevance

c.    Reliability

d.    Comparability

Primary Characteristics

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.
Ingredients of relevance:

·         Predictive Value – Information can help users increase the likelihood of correctly predicting or forecasting the outcome of certain events.

·         Feedback Value – Information can help users confirm or correct earlier expectations.  Note that the predictive and confirmatory roles of information are interrelated.

·         Timeliness- Information loses its relevance if it is not timely

 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.

Factors of reliability

·        Faithful Representation – Information must represent faithfully the transactions and events it either purports to represent or could reasonably purport to represent.

·     Substance over form – Transactions are to be accounted for and presented according to their substance and economic reality and not merely their legal form.

·      Neutrality - Information contained in the financial statements must be free from bias and error.

·     Prudence (Conservatism) – The inclusion of a degree of caution in the exercise of judgments needed in making estimates or choosing alternatives so that the outcome will have the least effect on equity.

·         Completeness – to be reliable, the information in the financial statements must be complete within the bounds of materiality and cost.

Constraints to Relevant and Reliable Information

·         Timeliness – Undue delay in reporting of information may lead to the loss of relevance even though enhancing it reliability.  While providing information before all aspects of a transaction or other events are known may increase the relevance of information, thus impairing its reliability.

·    Balance between Benefit and Cost - The benefits derived from relevant and reliable information should exceed the cost of providing it.

Secondary Characteristics

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.

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 especially when the enterprise adopts a new or changes its accounting policies.

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 and their definition according to the framework are: 
·         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.

·    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.

·     Equity- Equity is the residual interest in the assets of the enterprise after deducting all its liabilities.

The elements directly related to performance and their definition according to the framework are:
·        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.

·         Expense- Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

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:

·         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.

Based on these general criteria:

·     An asset is recognized 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.

·         A liability is recognized 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.

·         Income 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 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

·       Expenses are recognized 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.

Measurement of the Elements of Financial Statements

Measurement involves assigning monetary amounts at which the elements of the financial statements are to be recognized and reported.  The Framework acknowledges that a variety of measurement bases are used today to different degrees and in varying combinations in financial statements, including:

·         Historical cost
·         Current cost
·         Net realizable (settlement) value
·         Present value (discounted)

Historical cost is the measurement basis most commonly used today, but it is usually combined with other measurement bases. The Framework does not include concepts or principles for selecting which measurement basis should be used for particular elements of financial statements or in particular circumstances. The qualitative characteristics do provide some guidance in this matter.

Concepts of Capital

  • Financial concept of capital - capital is synonymous with net assets of the enterprise.  This is the concept of capital adopted by most enterprises.
  • Physical concept of capital – capital is regarded as the productive capacity of the enterprise based on, for example, units of output per day.

Concepts of Capital Maintenance

  • Financial capital maintenance – Under this concept, a profit is earned only if the financial (or money) amount of the net assets at the end of the of the period exceeds the financial (or money) amount of the net assets at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period.
  • Physical capital maintenance – Under this concept, a profit is earned only if the physical productive capacity (or operating capability) of the enterprise (or the resources need to achieve that capacity) at the end of the period exceeds the physical productive capacity at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period.

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