Conceptual Framework for Financial Reporting
Overview of the Conceptual Framework
The Conceptual Framework for Financial Reporting is a comprehensive document created by the
International Accounting Standards Board (IASB). It serves as a guiding principle for the
preparation and presentation of financial statements aimed at external users. The framework
provides a theoretical foundation for accounting, enhancing transparency, accountability, and
economic efficiency.
Key Purposes
1. To assist the IASB in developing IFRS Standards based on consistent concepts.
2. To help preparers develop consistent accounting policies when no standard applies.
3. To aid in interpreting IFRS Standards.
4. To strengthen the understanding of financial information among users.
Authoritative Status
The Conceptual Framework does not override any specific IFRS. If a standard or interpretation
specifically applies to a transaction, that standard takes precedence. In the absence of such
standards, management should apply the principles of the Conceptual Framework to ensure
relevant and reliable information.
Users of Financial Information
Users are categorized into two main groups:
1. Primary Users: Existing and potential investors, lenders, and other creditors who rely on
general-purpose financial reports for decision-making.
2. Other Users: Employees, customers, governments, agencies, and the public who may find
financial reports useful but are not the primary audience.
Characteristics of Primary Users
Investors: Concerned with risks and returns, they require information for investment
decisions (buy, hold, sell).
Lenders: Need information to determine whether loans and interest will be repaid on time.
Characteristics of Other Users
Employees: Interested in the stability and profitability of the entity for job security and
benefits.
Customers: Concerned about the entity's viability for long-term relationships.
Governments: Require information for regulation, taxation, and economic statistics.
Public: May use financial reports to understand the economic impact of the entity.
Objective of Financial Reporting
The primary objective of financial reporting is to provide useful financial information that aids
existing and potential investors, lenders, and other creditors in making decisions about providing
resources to the entity. This objective emphasizes the need for information that reflects
management's stewardship of economic resources.
Specific Objectives
1. To supply information useful for decision-making.
2. To assist in assessing cash flow prospects.
3. To provide details about resources, claims, and changes in these areas.
Financial Reporting and Economic Decisions
Financial reporting plays a vital role in economic decision-making by:
Enabling investors to decide on equity investments.
Helping lenders make informed choices regarding loans and credit.
Assessing Cash Flow Prospects
Investors rely on financial reporting to gauge expected returns, such as dividends. Similarly,
lenders assess expected principal and interest payments. Financial reporting should provide
insights into:
Amount
Timing
Uncertainty of future cash flows
Economic Resources and Claims
Financial reports deliver information about an entity's financial position, which consists of:
Economic Resources: Assets (resources owned by the entity).
Claims: Liabilities and equity (obligations and ownership interests).
The financial position illustrates the assets, liabilities, and equity at a specific point in time,
allowing users to assess liquidity and solvency.
Liquidity and Solvency
Liquidity: Availability of cash to meet short-term obligations.
Solvency: Ability to meet long-term financial commitments.
Changes in Economic Resources and Claims
Financial reports also provide insights into changes resulting from:
Financial performance (revenues, expenses, net income).
Transactions such as issuing debt or equity instruments.
Financial Performance
The performance of an entity is assessed through the income statement, which captures the
efficiency in using resources. Key components include:
Revenues
Expenses
Net income or loss
Accrual Accounting
Accrual accounting is crucial for accurately reflecting financial performance. It recognizes
effects of transactions in the periods they occur, rather than when cash is received or paid. This
method provides a clearer picture of an entity's economic performance.
Example Calculation
Consider a company that earns $10,000 in revenue from sales in December, but only receives
payment in January. Under accrual accounting, the revenue would be recorded in December,
reflecting that the income was earned at that time.
Limitations of Financial Reporting
1. Financial reports cannot provide all needed information; supplementary sources may be
necessary.
2. They are not designed to show an entity's value but to help estimate it.
3. Reports cater to common user needs and cannot meet every specific request.
4. Much of the information is based on estimates and judgments rather than precise figures.
Management Stewardship
Management stewardship refers to the responsibility of management to use economic resources
efficiently. Understanding this stewardship is crucial for predicting how management will utilize
resources in the future and assessing the entity's prospects for future net cash flows.
