IFRS - Conceptual framework

International Financial Reporting Standards
The views expressed in this presentation are those of the presenter,
not necessarily those of the IASB or IFRS Foundation.
July 25, 2013
Conceptual Framework
for Financial Reporting
A Discussion session with SBOTS 18
@
National Institute of Banking & Finance (NIBAF)
KThe views expressed in this presentation are those of the
presenter, not necessarily those of the IASB or IFRS Foundation.
By:
Sajjad Ahmed
FCA (Eng & Wales), PMP, MBA (Harvard Business
School), BS (University of Oxford)

Sajjad Ahmed, FCA (Eng & Wales), MBA (Harvard Business School), BS
(University of Oxford), PMP
2Points to Ponder upon… ‘The Direction’
What is Financial Reporting????
How does the Financial Reporting impact the stakeholders and
in-turn the business itself???
Need for Regulator in Financial reporting ‘business’ ????
Globalization of businesses and its relevance to the Financial Reporting
mechanism????
Relevance to your job????

Role of the Conceptual Framework
• Conceptual Framework sets out agreed concepts that
underlie financial reporting
– objective, qualitative characteristics, element definitions, …
• IASB uses Conceptual Framework to set standards
– enhances consistency across standards
– enhances consistency over time as Board members change
– provides benchmark for judgments
• Preparers use Conceptual Framework to develop
accounting policies in the absence of specific standard or
interpretation
3

4
Does the Framework help me understand
IFRSs? 4
• Yes, the starting point for understanding all IFRS information is
the objective and the concepts that flow logically from that
objective:
– IASB uses Framework to set IFRSs
– Teachers/Trainers use Framework-based teaching to
prepare students to make judgements that are necessary to
apply IFRSs
– Preparers use Framework to make the judgements that are
necessary to apply IFRSs
– Auditors and regulators assess those judgements
– Investors, lenders and others consider those judgements
when using IFRS financial information to inform their
decisions

55Objective of financial reporting
“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”
Note:
• other aspects of the Conceptual Framework flow
logically from the objective (CF.OB1)
• Conceptual Framework sets out the concepts that
underlie IFRS financial statements and assist the
IASB in the development of future IFRSs and in its
review of existing IFRSs (CF.Purpose and Status)

• Investors’, lenders’ and other creditors’ expectations
about returns depend on their assessment of the
amount, timing and uncertainty of (the prospects
for) future net cash inflows to the entity.
– Decisions by investors about buying, selling or holding equity
and debt instruments depend on the returns that they expect
from an investment in those instruments, eg dividends,
principal and interest payments or market price increases.
– Decisions by lenders about providing or settling loans and
other forms of credit depend on the principal and interest
payments or other returns that they expect.

• To assess an entity’s prospects for future net cash
inflows, existing and potential investors, lenders and
other creditors need information about:
– the resources of the entity;
– claims against the entity; and
– how efficiently and effectively the entity's management
and governing board have discharged their
responsibilities to use the entity's resources
– eg protecting the entity's resources from
unfavourable effects of economic factors such as
price and technological changes

88Qualitative characteristics
• If financial information is to be useful, it must be
relevant and faithfully represent what it purports to
represent (ie fundamental qualities).
– Financial information without both relevance and faithful
representation is not useful, and it cannot be made useful by
being more comparable, verifiable, timely or understandable.
• The usefulness of financial information is enhanced
if it is comparable, verifiable, timely and
understandable (ie enhancing qualities—less critical
but still highly desirable)
– Financial information that is relevant and faithfully
represented may still be useful even if it does not have any of
the enhancing qualitative characteristics.

99Fundamental qualitative characteristics
• Relevance: capable of making a difference in users’
decisions
– predictive value
– confirmatory value
– materiality (entity-specific)
• Faithful representation: faithfully represents the
phenomena it purports to represent
– completeness (depiction including numbers and words)
– neutrality (unbiased)
– free from error (ideally)
Note: faithful representation replaces reliability

1010Enhancing Qualitative Characteristics
• Comparability: like things look alike; different things look
different
• Verifiability: knowledgeable and independent observers
could reach consensus, but not necessarily complete
agreement, that a depiction is a faithful representation
• Timeliness: having information available to decision-makers
in time to be capable of influencing their decisions
• Understandability: Classify, characterize, and present
information clearly and concisely

111111Pervasive constraint
• Reporting financial information imposes costs, and it is
important that those costs are justified by the benefits of
reporting that information.
• Benefits include more efficient functioning of capital markets and a
lower cost of capital for the economy.
• Costs include collecting, processing, verifying and disseminating
financial information and the costs of analysing and interpreting the
information provided.
• In applying the cost constraint, the IASB assesses whether
the benefits of reporting particular information are likely to
justify the costs incurred to provide and use that information.
Those assessments are usually based on a combination of
quantitative and qualitative information.

121212Summary
• Reporting financial information that is relevant and faithfully
represents what it purports to represent helps users to make
decisions with more confidence (ie financial information must
possess the fundamental qualitative characteristics).
• IFRS requirements must be cost-beneficial
• Applying the enhancing qualitative characteristics is an
iterative process that does not follow a prescribed order.
Sometimes, one enhancing qualitative characteristic
may have to be diminished to maximise another
qualitative characteristic.

1313Elements
• Asset: Resource controlled as a result of past events and
from which future economic benefits are expected to flow
• Liability: Present obligation arising from past events, the
settlement of which is expected to result in outflow of
resources embodying economic benefits
• Equity: Assets minus liabilities
• Income (expense): Increases (decreases) in economic
benefits during period from inflows or enhancements
(outflows or depletions) of assets (liabilities) or decreases
(incurrences) of liabilities from in increases (decreases) in
equity, other than contributions from (distributions to) equity

14Elements, examples
• Asset?
• an oil explorer’s exploration rig
• a fish farmer’s breeding stock
• fish in the sea (from a fish harvester’s perspective)
• own shares held by an entity
• firm order to acquire gold, settle net in cash
• firm order to acquire gold, cannot settle net
• expenditure on major inspection (a condition of
continuing to operate an item of PPE)
• ‘right’ to recover past costs incurred increased future
prices in a rate regulated activity
14

• Liability?
• defending a lawsuit
• promise to make good environmental damage (no legal
obligation to do so)
• law requires smoke filters be fitted to factory
• lessee—short-term car rental agreement
• participant in a cap and trade emission trading scheme
15

• Liability or equity?
• issue ordinary share
• issue compulsorily redeemable debt (fixed interest,
fixed redemption)
• issue convertible debt instrument (holder has option to
convert)
• non-controlling interest
16

17Elements, examples 17
Liability or equity at 31/12/20X1?
• On 15/01/20X2 the shareholders of an entity approved the
distribution of USD 40,000 dividend for the year ended
31/12/20X1 (as proposed by management on 21 December
20X1.
– USD 18,000: minimum dividend required by law for the year ended 31
December 20X1
– USD 22,000: additional to required minimum dividends

18Classification
• Objective of financial reporting
• Financial statements portray financial effects of transactions
and events by:
– grouping into broad classes (the elements, eg asset)
– sub-classify elements (eg assets sub-classified by their nature or
function in the business)
• IAS 1
– application of IFRSs with additional disclosures when necessary
results in a fair presentation (faithful representation of transactions,
events and conditions)
– don’t offset assets & liabilities or income & expenses

19Classification - Assets & Claims
• Information about the nature and amounts of a reporting
entity’s economic resources and claims can help users to
identify the reporting entity’s financial strengths and
weaknesses.
• That information can help users to:
– assess the reporting entity’s liquidity and solvency
– its needs for additional financing and how successful it is
likely to be in obtaining that financing.
(CF.OB13)

20Classification - Claims
• Information about priorities and payment requirements of
existing claims helps users to predict how future cash flows
will be distributed among those with a claim against the
reporting entity (CF.OB13)

21Classification - Liability
• Examples
• obligation to pay current tax
• metered power used but not yet billed by supplier
• ‘normal’ warrantee obligation to make good
manufacturing defect
• warrantee obligation to compensate for manufacturing
defects by settling in compensation in cash
• extended warrantee obligation
21

22Classification, assets
• Different types of economic resources affect a user’s
assessment of the reporting entity's prospects for future cash
flows differently.
– Some future cash flows result directly from existing economic
resources (eg accounts receivable and investment property).
– Other cash flows result from using several resources in combination
to produce and market goods or services to customers (eg PPE and
intangible assets). Although those cash flows cannot be identified
with individual economic resources (or claims), users of financial
reports need to know the nature and amount of the resources
available for use in a reporting entity’s operations. (CF.OB14)

23Classification - Assets
• Examples
• investment in ordinary shares
• gold
• land
• land planted with plantation
• farm implements
• bird breeder’s birds
• birds in a zoological garden
• birds in a bird breeding zoo
• owner-occupied building held for sale
• owner-occupied building decided to abandon
23

24The Concepts: ‘Financial position’ 24
The concepts
• Information about the nature and amounts of an entity’s
economic resources and claims against the reporting entity help
users identify the reporting entity’s financial strengths and
weaknesses (OB12–OB14).
– help assess entity’s prospects for future cash flows, its
liquidity and solvency, its needs for additional financing and
how successful it is likely to be in obtaining financing.

25The Concepts: ‘Financial performance’ 25
• Financial performance during a period, reflected by changes in
its economic resources and claims (other than by obtaining
additional resources directly from investors and creditors), is
useful in assessing the entity’s past and future ability to
generate net cash inflows (OB18)
• Accrual basis of accounting (depicts the effects of transactions
and other events and circumstances on a reporting entity’s
economic resources and claims in the periods in which those
effects occur (see ¶OB17)

26Recognition
• Accrual basis of accounting
– recognise element (eg asset) when satisfy definition and
recognition criteria
• Recognise item that meets element definition when
– probable that benefits will flow to/from the entity
– has cost or value that can measured reliably

27Recognition
What does probable mean?
The meaning of probable is determined at the standards level.
Therefore, inconsistent use across IFRSs
What does measure reliably mean?
To a large extent, financial reports are based on estimates,
judgements and models rather than exact depictions.

28Recognition – Examples
• Recognise the asset?
• a hospital’s backup backup generator (expect never to
use it)
• an oil explorer’s exploration rig
• an oil extractor’s unproven reserves
• an oil extractor’s proven reserves
• advertising expenditure
• research and development expenditure
• internally generated brand
• lessee—short-term car rental agreement
• firm order to acquire gold, cannot settle net

29Measurement concepts
• Measurement is the process of determining monetary amounts
at which elements are recognised and carried. (CF.4.54)
• To a large extent, financial reports are based on estimates,
judgements and models rather than exact depictions. The
Framework establishes the concepts that underlie those
estimates, judgements and models (CF.OB11)
• IASB guided by objective and qualitative characteristics when
specifying measurements.
29

30Measurement ‘concepts’ 30
• Measurement part of Conceptual Framework is weak
• A number of different measurement bases are employed to
different degrees and in varying combinations in financial
statements, including
– historical cost
– current cost
– realisable (settlement) value
– present value (CF.4.55)
• IASB guided by objective and qualitative characteristics when
specifying measurements.

The concept, defined in IFRS 13
• Fair value is the price that would be received to sell an asset
or paid to transfer a liability (exit price) in an orderly
transaction (not a forced sale) between market participants
(market-based view) at the measurement date (current
price).
• Fair value is a market-based measurement (it is not an
entity-specific measurement)
• consequently, the entity’s intention to hold an asset or to
settle or otherwise fulfil a liability is not relevant when
measuring fair value.
31Fair value measurement concept

32Fair value measurement concept 32
• Information about an entity’s financial performance in a period,
reflected by changes in economic resources is useful in
assessing the entity’s past and future ability to generate net
cash inflows (see CF.OB18)
• Income (expenses) are increases (decreases) in economic
benefits during an accounting period in the form of
enhancements (depletions) of assets (CF.4.25)
• Measure element at fair value with changes in fair value
recognised as income or expense for the period in which it
arises

© 2010
IFRS
Found
ation.
30
Canno
n
Street
|
London
EC4M
6XH |
UK.
www.ia
sb.org
33
ASSET TYPE MEASUREMENT AT INITIAL
RECOGNITION
COST MODEL BASIS OF
IMPAIRMENT
TEST
IAS 2 Inventory Cost of purchase and/or conversion
costs and costs to get the item to the
location and condition for sale
Cost unless impaired Lower of cost
(initial recognition)
and net realisable
value
IAS 16 Property, Plant
and Equipment
Purchase costs + construction costs +
costs to bring to the location and
condition necessary to be capable of
operating in the manner intended by
management.
Accounting policy choice:
cost less accumulated
depreciation and
impairment, if any
Compare carrying
amount to
recoverable
amount.
Recoverable
amount is greater
of value in use
and fair value less
disposal costs
(IAS 36)
IAS 38 Intangibles
Assets
Purchase costs + development costs +
costs to bring to the location and
condition necessary to be capable of
operating as intended by management
Accounting policy choice:
amortisation (unless
indefinite life asset) and
amortisation, if any
IAS 40 Investment
Property
Cost including transaction costs Accounting policy choice:
depreciation (unless land)
and impairment (if any)
IFRS 9 Financial
Instruments
Fair value For particular business
models amortised cost
IAS 39 specifies
impairment rules

Presentation and disclosure
• Objective of financial reporting
• Presentation: financial statements portray financial effects of
transactions and events by:
– grouping into broad classes (the elements, eg asset)
– sub-classify elements (eg assets sub-classified by their nature or
function in the business)
• IAS 1
– application of IFRSs with additional disclosures when necessary
results in a fair presentation (faithful representation of transactions,
events and conditions)
– don’t offset assets & liabilities or income & expenses
34

35Derecognition of assets
• Derecognition of an asset refers to when an asset previously
recognised by an entity is removed from the entity’s statement
of financial position
– derecognition requirements are specified at the standards level.
– derecognition does not necessarily occur when the asset no longer
satisfies the conditions specified for its initial recognition (ie
derecognition does not necessarily coincide with the loss of control of
the asset )
• IASB guided by objective, qualitative characteristics and
elements
35

36
Framework-based understanding
provides… 36
• a cohesive understanding of IFRSs
– Framework facilitates consistent and logical formulation of
IFRSs
• a basis for judgement in applying IFRSs
– Framework established the concepts that underlie the
estimates, judgements and models on which IFRS financial
statements are based
• a basis for continuously updating IFRS knowledge and
IFRS competencies

37Framework’s role in applying IFRSs 37
Does the Framework help me apply IFRSs?
• Yes, Framework is in IAS 8 hierarchy (see next slide)
– Preparers use the Framework to make the judgements that
are necessary to apply IFRSs
– Auditors and regulators assess those judgements
– Investors, lenders and others consider those judgements
when using IFRS financial information to inform their
decisions

38If no specific IFRS requirement
• Use judgement to
– develop a policy that results in relevant information that
faithfully represents (i.e. complete, neutral and error
free)
– Hierarchy:
1st IFRS dealing with similar and related issue
2nd Framework definitions, recognition crit. etc
Can also in parallel refer to GAAPs with similar Framework
38

39In other words, if no IFRS requirement… 39
Framework-based approach would ask:
• What is the economics of the phenomenon (egg transaction or
event)?
• What relevant information using the accrual basis of accounting
faithfully present that economic phenomenon to inform
decisions of investors and lenders (potential and existing)?
• Is there anything in IFRSs that prevents me from providing that
information?

Common ‘conceptual’ misunderstandings
The Framework does not… Clarification—the Framework
includes
include a matching concept accrual basis of accounting—
recognise elements when satisfy
definition and recognition criteria
include prudence/conservatism
concept
neutrality concept
include an element other
comprehensive income (or a
concept for OCI)
only the following elements—asset,
liability, equity, income and expense
mention management intent or
business model
40

continued
Misunderstanding Clarification
Uniformity = comparability Comparability is achieved when like
things are accounted for in the same
way.
Comparability is not achieved when
accounting rules require unlike
things be accounted for in the same
way
41

continued
There is a clear concept for the
historical cost of an item
The Framework provides only a
vague description—assets are
recorded at the amount of cash or
cash equivalents paid or the fair
value of the consideration given to
acquire them at the time of their
acquisition.
What is cost when:
- advance/deferred payment?
- purchased option exercised?
- contingent purchase price?
42

continued
Principles are necessarily less
rigorous than rules
Rules are the tools of financial
engineers
There are few judgements and
estimates in cost-based
measurements
Inventory, eg allocate joint costs
and production overheads
PPE, eg costs to dismantle/restore
site, useful life, residual value,
depreciation method
Provisions, eg uncertain timing and
amount of expected future cash
flows
43

44
Questions or comments?
4444

IFRS - Conceptual framework

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