What is the IFRS Conceptual Framework?

The IFRS Conceptual Framework for Financial Reporting is the foundational document for International Financial Reporting Standards (IFRS). It is not an accounting standard itself but provides the underlying principles used by the International Accounting Standards Board (IASB) to develop consistent standards. This consistency promotes the comparable treatment of economic events across different companies.

The Framework also serves as a reference for companies when creating accounting policies for transactions or events not covered by an existing IFRS Standard. In these situations, management uses its judgment, guided by the Framework’s principles, to develop a policy that provides relevant and reliable information. The revised version became effective for annual periods starting on or after January 1, 2020.

Objective of General Purpose Financial Reporting

The objective of general purpose financial reporting is to provide financial information useful to an entity’s primary users: existing and potential investors, lenders, and other creditors. This information helps them make decisions about providing resources to the entity, which includes buying, selling, or holding equity and debt instruments, as well as providing loans. To make these assessments, users need to evaluate the entity’s prospects for future net cash inflows, as their potential return is tied to the entity’s ability to generate cash.

Financial reports provide information about an entity’s economic resources (assets), the claims against it (liabilities and equity), and the transactions that change them. Information about financial performance, especially profitability, is an indicator of future cash-generating ability.

These reports do not show the entity’s total value but provide data to help users make their own valuation. They also allow users to assess management’s stewardship, which is how efficiently and effectively the entity’s resources have been used.

Qualitative Characteristics of Useful Financial Information

For financial information to be useful, it must possess qualitative characteristics, divided into fundamental and enhancing categories.

Fundamental Characteristics

The fundamental characteristics are relevance and faithful representation. Information is relevant if it is capable of making a difference in users’ decisions, meaning it has predictive value, confirmatory value, or both. Materiality is an entity-specific aspect of relevance; information is material if its omission, misstatement, or obscurity could reasonably influence the decisions of primary users.

Faithful representation means the information accurately depicts the economic phenomena it purports to represent. To achieve this, a depiction must be complete, neutral, and free from error. A complete depiction includes all necessary descriptions and explanations for a user to understand the event, while a neutral depiction is not biased. Freedom from error means there are no errors in the description or process, though this does not require perfect accuracy due to the use of estimates.

Enhancing Characteristics

Enhancing characteristics improve the usefulness of information that is already relevant and faithfully represented. They are:

• Comparability: Enables users to identify and understand similarities and differences among items.
• Verifiability: Assures users that information faithfully represents economic events, meaning different knowledgeable observers could reach a consensus on its accuracy.
• Timeliness: Means having information available to decision-makers in time to influence their decisions.
• Understandability: Requires that financial information be classified and presented clearly and concisely.

These characteristics are subject to a cost constraint. The benefits of reporting information should justify the costs incurred to provide and use it.

The Elements of Financial Statements

The Conceptual Framework defines five elements that are the building blocks of financial statements: assets, liabilities, equity, income, and expenses.

An asset is a present economic resource controlled by the entity as a result of a past event. An economic resource is a right that has the potential to produce economic benefits. For example, a company’s cash balance is an asset because it can be used to acquire other resources, and a factory building is an asset because it is used to produce goods that will generate revenue.

A liability is a present obligation of the entity to transfer an economic resource as a result of a past event. An obligation is a duty that the entity has no practical ability to avoid, such as a bank loan that creates an obligation for repayment. Another example is accounts payable, which represents the obligation to pay suppliers for goods or services already received.

Equity is the residual interest in the assets of the entity after deducting all its liabilities. It is affected by owner contributions, distributions to owners, and the period’s income and expenses, as shown by the equation: Assets – Liabilities = Equity.

Income is increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from owners. Income includes both revenue from ordinary activities (like sales) and other gains.

Expenses are decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to owners. Expenses include those from ordinary activities (like wages) and other losses.

These elements are presented for a reporting entity, which is an entity that prepares financial statements. The reporting entity’s boundary determines which resources and obligations are included.

Recognition and Measurement Principles

Recognition and measurement principles determine when elements are included in financial statements and at what amount. Recognition is the process of including an item that meets an element’s definition. An asset or liability is recognized only if it provides users with useful information, meaning it is relevant and provides a faithful representation. An item may not be recognized if there is significant uncertainty about its existence or a low probability of an inflow or outflow of economic benefits.

Derecognition is the removal of a recognized asset or liability. An asset is derecognized when the entity loses control of it, and a liability is derecognized when the entity no longer has a present obligation.

Measurement determines the monetary amounts for recognized elements. The two primary bases are historical cost and current value. Historical cost measures an asset at the price paid to acquire it, plus transaction costs. For a liability, historical cost is the consideration received to incur it, minus transaction costs. It is updated over time for consumption, such as depreciation or impairment.

Current value measures use information updated to reflect conditions at the measurement date. Types of current value include:

• Fair value: The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.
• Value in use: The present value of the cash flows an entity expects to derive from an asset’s use and ultimate disposal.
• Fulfilment value: The present value of the cash an entity expects to be obliged to transfer as it fulfils a liability.
• Current cost: The cost of an equivalent asset at the measurement date, including transaction costs that would be incurred.

Concepts of Presentation and Disclosure

The Conceptual Framework also addresses how financial information is presented and disclosed in financial statements to make it more useful.

A primary principle is classification, which involves sorting assets, liabilities, and equity into groups based on shared characteristics. For example, assets and liabilities are commonly classified as either current or non-current to help users assess the entity’s liquidity and solvency. Different classes of equity, such as paid-in capital and retained earnings, are also presented separately.

Aggregation involves adding together items with shared characteristics into summary line items, such as “Revenue” or “Property, Plant, and Equipment.” This process summarizes a large volume of transactions to make information more concise, but aggregation should not obscure material details.

The Framework also discusses concepts of capital and capital maintenance, which influence how profit is measured. Under financial capital maintenance, used by most entities, profit is earned if the financial amount of net assets increases during a period, excluding owner transactions. Under physical capital maintenance, profit is earned only if the entity’s physical productive capacity increases.