Financial Reporting and

Conceptual Framework
Wiley: Chapter 1 & 2

1
LO1: Describe and explain the sources and authorities of
GAAP in HK

LO2: Define the objectives of FSs

LO3: Explain the underlying assumptions in preparation of

FSs

LO4: Identify and explain the qualitative characteristics that

make information provided in FSs useful to users

2
LO5: Define the elements of the FSs and the concepts for
recognizing and measuring them in the FSs

LO6: Describe and explain the application of fundamental

accounting assumptions and principles of accounting

3
1. Introduction
2. Sources and authorities of GAAP in HK
3. HKICPA’s Conceptual Framework
4. Fundamental assumptions and principles of accounting

4
5
 Financing activities
 Investing activities
 Operating activities

6
Activities that result in changes in the:
 Size and Composition of equity capital and borrowings of
the entities

 Examples:
◦ Issue of new shares
◦ New loans from bank
◦ Loan repayments
◦ Issue of debentures

7
 Activities to obtain the resources or assets in order to
operate the business

 Examples:
 Acquisition of PPE for operation of the business
 Sales of PPE when they are no longer needed

8
 The principal revenue-producing activities of the
enterprise that are not investing or financing activities

 E.g. sales and purchases

9
 HKAS 1 (Revised) Presentation of Financial Statements
(effective for annual periods beginning on or after 1 Prior to HKAS 1 (Revised)
January 2009)
(a) a statement of financial position as at the end of the (a) a balance sheet as at the end of the
period; period;
(b) a statement of profit or loss and other comprehensive
income for the period; either:
- one single comprehensive statement, or
- two statements: a separate income statement and a (b) an income statement for the period;
second statement (statement of comprehensive
income) beginning with profit or loss and displaying
components of other comprehensive income
(c) a statement of changes in equity for the period; (c) a statement of changes in equity for
the period;
(d) a statement of cash flows for the period; (d) a cash flow statement for the
period; and
(e) notes, comprising a summary of significant accounting (e) notes, comprising a summary of
significant accounting policies and
policies and other explanatory information; and other explanatory notes.
(f) a statement of financial position as at the beginning of
the earliest comparative period when an entity applies
an accounting policy retrospectively or makes a
retrospective restatement of items in its financial
statements, or when it reclassifies items in its financial
statements. 10
11
 Financial statements are prepared in conformity with a
common set of standards, guidelines, and procedures called
generally accepted accounting principles (GAAP).

Why do we need GAAP?

 To meet the information need of users by providing
guidelines and limits for financial reporting
 To improve comparability of financial reporting among
different companies

12
 The Companies Ordinance
◦ the maintenance of accounting records,
◦ the content of financial statements, and
◦ the audit of company incorporated in HK
◦ Requires directors to present “true and fair “ accounts

 Hong Kong Financial Reporting Standards (HKFRSs) issued

by HKICPA
◦ Hong Kong Financial Reporting Standard (HKFRS),
◦ Hong Kong Accounting Standards (HKAS), and
◦ Interpretations

 Listing Rules
◦ for publicly listed companies on the Main Board and the GEM
issued by the Stock Exchange of Hong Kong

13
 HKICPA’s Framework

 Recent pronouncements by other standard-setting bodies

 Accounting Guidelines by the HKICPA

◦ are persuasive in intent and, whilst not mandatory, should
normally be followed
 Accounting Bulletins by the HKICPA
◦ intended to assist members of the HKICPA in dealing with
accounting issues and to stimulate debate on subjects of topical
interest

14
15
“Conceptual Framework for Financial Reporting”
 Set out the concepts that underlie the preparation and
presentation of FSs for external users

 It is not an accounting standard or guideline

 Does not define standards for any particular measurement

or disclosure issue

 Does not override any specific accounting standard or

guideline

16
 The objectives of FSs

 Qualitative characteristics of FSs

 Elements of FSs

 Recognition and Measurement of the elements of FSs

17
 The objective of general purpose financial reporting is to
provide financial information about the reporting entity
that is useful to existing and potential investors, lenders
and other creditors in making decisions about providing
resources to the entity

 Users are assumed to be knowledgeable

 Other users (e.g. management, government, customers,

and employees) are not considered primary users

18
 If financial information is to be useful, it must be relevant and
faithfully represents what it purports to represent. The
usefulness of financial information is enhanced if it is
comparable, verifiable, timely and understandable.

 Constraints on the usefulness of information

◦ Materiality
◦ Costs

19
 Relevance - information is capable of making a difference in the
decisions made by users

◦ Predictive value - can be used as an input to processes

employed by users to predict future outcomes

◦ Confirmatory value - provides feedback about (confirms or

changes) previous evaluations

20
 Faithful Representation - faithfully represent the economic
phenomena that it purports to represent

◦ Completeness - includes all information necessary for a user to

understand the phenomenon being depicted, including all
necessary descriptions and explanations

◦ Neutrality - without bias in the selection or presentation of

financial information

◦ Free from error - there are no errors or omissions in the

description of the phenomenon, and the process used to
produce the reported information has been selected and applied
with no errors in the process

21
 Comparability – Similar economic phenomena are reported in
the same manner, both across entities and across time.

 Verifiability - different knowledgeable and independent observers

could reach consensus, although not necessarily complete
agreement, that a particular depiction is a faithful representation.

 Timeliness - having information available to decision-makers in

time to be capable of influencing their decisions.

 Understandability - Classifying, characterizing and presenting

information clearly and concisely makes it understandable.

22
Elements for the measurement of financial position:
ASSETS = LIABILITIES + EQUITY
(resources) (obligations) (residual interest)

Elements for the measurement of profit:

INCOME － EXPENSES = NET PROFIT
(Revenues + Gains) (Expenses + Losses)
(↑in economic benefits) ( ↓in economic benefits)

23
 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.
 Liability is a present obligation of the entity to transfer
an economic resource as a result of past events.
 Equity is the residual interest in the assets of the entity
after deducting all its liabilities.
 Income is the increases in assets, or decreases in
liabilities, that result in increases in equity, other than
those relating to contributions from holders of equity
claims.

24
 Income is the increases in assets, or decreases in
liabilities, that result in increases in equity, other than
those relating to contributions from holders of equity
claims.
 Expense is the decreases in assets, or increases in
liabilities, that result in decreases in equity, other than
those relating to distributions to holders of equity claims.

25
 An item that meets the definition of an element should be
recognized if:
1. Probable economic benefits – flow to or from the entity; and
2. Measurement reliability – the item’s cost or value can be
measured reliably

 Measurement: the process of determining the monetary

amount at which the elements of the FSs are to be
recognized and reported

26
1. Historical Cost
• E.g. an asset - cash or cash equivalent paid or the fair value of the
consideration given to acquire it at acquisition date
2. Current Cost
• E.g. an asset – the amount of cash or cash equivalents that would be paid
if the same or equivalent asset was acquired currently
3. Realizable or settlement value
• E.g. an asset - the amount of cash or cash equivalents that could currently
be obtained by selling the asset in an orderly disposal.
4. Present value
• E.g. PV of an asset – discounted future cash flows

27
1. Economic entity assumption:
Company’s business activities should be separated from
owner’s personal activities.

2. Going concern assumption:

A company will continue operating unless there is an
evidence proving it will liquate soon.

28
3. Monetary unit assumption:
Accounting transactions are recorded and reported in
monetary units, assumed to be stable over time.

4. Time period assumption (Periodicity):

The economic life of a business can be divided into
artificial time periods for financial reporting.

2007 2008 2009

29
5. Accrual basis of accounting:
Under the accrual basis of accounting, transactions and
events are recognised when they occur (and not as cash
or its equivalent is received or paid) and they are
recorded in the accounting records and reported in the
financial statements of the periods to which they relate

30
 Measurement principles: “mixed-attributes” system
◦ Cost Principle: Assets and liabilities are held at their
acquisition price (historical cost), generally used when the
fair value of an asset cannot be reliably measured.

◦ Fair Value Principle: Assets and liabilities are held at fair

value, provided there is a liquid market for the asset or
liability. HKFRS 13 defines fair value 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.

31
2. Revenue recognition principle:
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.

Revenue Recognition

At end of At point
production of sale

During At time cash

production received

Revenue should be recognized in the

accounting period in which it is earned
(generally at point of sale).

32
3. Expense recognition principle:
Expenses are recognized in the income statement 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. Often expenses are
‘matched’ to revenues.

4. Full disclosure principle:

Any information that could affect decisions making
should be included in the FSs.

33
1. Materiality - if omitting it or misstating it
could influence decisions that users make
on the basis of financial information about
a specific reporting entity.

2. Cost Constraint - The costs of producing

information should not exceed the benefits
derived from using that information.

34
 True and fair view
 Substance over form
 Matching principle
 Conservatism principle
 Reliability

35
36