1. Introduction
To understand the concepts and the essence of IFRS, it is very important to understand the Framework of Concepts of these standards, one of the most interesting changes are the new definitions of the elements of the Financial Statements such as Assets, Liabilities, Equity, Income and Expense. Thus, in this newsletter we will present the latest changes to the IFRS Framework of Concepts.
2. Background
The International Financial Reporting Standards Board (= IASB), began the review work of this document in 2010 and concluded the review work in March 2018.
3. Definition
The Conceptual Framework for Financial Reporting describes the objective and concepts for general purpose financial reporting. The conceptual framework is not a norm and therefore cannot override what is established by a norm.
The purpose of the Conceptual Framework is:
- Help the International Accounting Standards Board develop IFRS standards that are based on consistent concepts; Help preparers develop consistent accounting policies when no standard applies to a particular transaction or other event, or when a standard allows a choice accounting policy; y Help all interested parties understand and interpret IFRS.
4. Structure of the Framework of Concepts
The current Conceptual Framework structure is divided into 8 chapters.
- The Purpose of Financial Statements Qualitative characteristics that make financial information useful Financial Statements and the reporting entity The elements of Financial Statements Recognition of the elements of financial statements Measurement Presentation and exposure Concept of capital and capital maintenance
Below is a summary of each of these components.
4.1. The Purpose of General Purpose Financial Statements
The objective of general purpose financial reporting is the foundation of the conceptual framework. 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 regarding the provision of resources to the entity.
However, general purpose financial reports do not and cannot provide all the information that existing and potential investors, lenders, and other creditors need. Those users should consider pertinent information from other sources, such as general economic conditions and expectations, political events and political climate, and company and industry outlook.
General purpose financial reports are not designed to show the value of a reporting entity; but they provide information to help existing and potential investors, lenders and other creditors to estimate the value of the reporting entity.
Management of a reporting entity is also interested in financial information about the entity. However, management does not need to rely on general purpose financial reporting as it is able to obtain the financial information it needs internally.
Other parties, such as regulators and members of the public other than investors, lenders, and other creditors, may also find general-purpose financial reporting useful. However, those reports are not primarily directed at these other groups.
4.2. Qualitative characteristics that make Financial Information useful
For financial information to be useful, it must be relevant and faithfully represent what it purports to represent. The usefulness of financial information is improved if it is comparable, verifiable, timely and understandable.
The fundamental qualitative characteristics are Relevance and Faithful Representation.
Relevance
Financial information is relevant if it is capable of making a difference in the decisions of the users of the Financial Statements.
Financial information is capable of making a difference in decisions whether it has predictive value, confirmatory value, or both.
Faithful representation
Financial reports represent economic facts in the Financial Statements and their Notes. To be useful, financial information must not only represent relevant facts, but must also faithfully represent the substance of the facts that it purports to represent. In many circumstances, the substance of an economic event and its legal form are the same.
For the information presented to have a faithful representation, it must meet three characteristics: it must be complete, neutral and free of errors. The qualitative characteristics for improvement are comparability, verifiability, timeliness and understandability. These characteristics increase the usefulness of the information that is relevant and provides a faithful representation.
Comparability
Comparability is the qualitative characteristic that allows users to identify and understand similarities and differences between items. Unlike the other qualitative characteristics, comparability is not related to a single item. A comparison requires at least two items.
Verifiability
Verifiability helps assure users that the information faithfully represents the economic phenomena it purports to represent. Verifiability means that different knowledgeable and independent observers could reach a consensus, although not necessarily complete, that a particular representation is a faithful representation.
Financial reports are prepared for users who have reasonable knowledge of business and economic activities and who diligently review and analyze the information.
Opportunity
Opportunity refers to what financial information should be available at a time that may be able to influence your decisions.
Understandability
For financial information to be understandable, it must be properly classified and presented in a clear and concise manner. Some facts by their nature are inherently complex and cannot be easy to understand, however, they cannot be removed from Financial Reports.
4.3. Financial statements and the reporting entity
Financial statements provide information about the reporting entity's economic resources, claims against the entity, and changes in those resources and claims, which meet the definitions of the elements of financial statements.
The objective of financial statements is to provide financial information about the reporting entity's assets, liabilities, equity, income and expenses that is useful to users of financial statements in evaluating the prospects for future net cash inflows to the entity. entity that reports and in the evaluation of the management of the administration on the economic resources of the entity
It is important to mention that for the purposes of the Framework of Concepts, the Balance Sheet is called the Financial Situation Statements and the Profit and Loss Statement as the Financial Performance Statement.
Financial statements provide information about transactions and other events considered from the perspective of the reporting entity as a whole, not from the perspective of any particular group of existing or potential investors, lenders or other creditors of the entity.
Going concern hypothesis
Financial statements are normally prepared under the assumption that the reporting entity is a going concern and will continue in operation for the foreseeable future. Therefore, it is assumed that the entity has neither the intention nor the need to go into liquidation or cease its operation in the foreseeable future. If such an intention or need exists, the financial statements may have to be prepared on a different basis. If so, the financial statements should describe the basis used.
4.4. Elements of the Financial Statements
The elements of the Financial Statements defined in the conceptual framework are:
- Assets, liabilities and equity that are related to the Statement of Financial Position; eIncome and expenses, which are related to the Statement of Financial Performance.
In this chapter the new Framework of Concepts establishes the new concepts of the elements of financial statements.
Active
A present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits.
passive
A present obligation of the entity to transfer an economic resource as a result of past events.
Heritage
The residual interest in the assets of the entity after deducting all its liabilities.
Income
Increases in assets, or decreases in liabilities, resulting in increases in equity, other than those related to the contributions of the holders of the assets by shares.
Expenses
Decreases in assets, or increases in liabilities, that result in a decrease in equity, other than those related to distributions to holders of equity rights.
4.5. Recognition of the Elements of Financial Statements
Recognition is the process of capturing for inclusion in the statement of financial position or in the statement of financial performance an item that meets the definition of one of the elements of the financial statements.
The statement of financial position and the statement (s) of financial performance represent the recognized assets, liabilities, equity, income and expenses of an entity in structured summaries that are designed to make financial information comparable and understandable. An important feature of the structures of these summaries is that the amounts recognized in a financial statement are included in the totals and, if applicable, in the subtotals that link the items recognized in that statement.
Revenue recognition occurs at the same time as:
- the initial recognition of an asset, or an increase in the carrying amount of an asset; low wave of a liability, or a decrease in the carrying amount of a liability.
The recognition of expenses occurs at the same time as:
- the initial recognition of a liability, or an increase in the carrying amount of a liability; a derecognition of an asset, or a decrease in the book value of an asset.
Only items that meet the definition of assets, liabilities or equity are recognized in the statement of financial position. Similarly, only items that meet the definition of income or expense are recognized in the statement (or statements) of financial performance. However, not all elements that meet the definition of one of those elements are recognized.
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Derecognition is the total or partial elimination of a recognized asset or liability from the entity's statement of financial position. Derecognition typically occurs when that item no longer meets the definition of an asset or liability:
- For an asset, derecognition normally occurs when the entity loses control of all or part of the recognized asset; y For a liability, derecognition typically occurs when the entity no longer has a present obligation for all or part of the recognized liability.
4.6. Measurement
Measurement is the process by which we assign a value related to a monetary unit to the different elements of financial statements.
The elements recognized in the financial statements are quantified in monetary terms. This requires the selection of a measurement basis. A measurement basis is an identified characteristic, for example historical cost, fair value or fulfillment value, of an item being measured. Applying a measurement basis to an asset or liability creates a measure for that asset or liability and for the related income and expenses.
The measurement bases mentioned in the Framework of Concepts are historical cost and present value.
Historical cost
Historical cost measures provide monetary information on assets, liabilities, and related income and expenses, using information derived, at least in part, from the transaction price or other event that originated them. Unlike current value, historical cost does not reflect changes in values, except to the extent that such changes are related to the impairment of an asset or a liability that becomes onerous.
The historical cost of an asset when it is acquired or created is the value of the costs incurred in the acquisition or creation of the asset, which includes the consideration paid to acquire or create the asset plus transaction costs. The historical cost of a liability when incurred or contracted is the value of the consideration received to incur or assume the liability less transaction costs.
Current value
Present value measures provide monetary information about assets, liabilities, and related income and expenses, using updated information to reflect conditions at the measurement date.
Current measurement bases include:
- Fair value Value in use for assets and fulfillment value for liabilities Current value
4.7. Presentation and disclosure
An entity communicates information about its assets, liabilities, equity, income and expenses by presenting and disclosing information in its financial statements
Effective communication of information in financial statements makes information more relevant and contributes to a faithful representation of an entity's assets, liabilities, equity, income and expenses. It also improves the understandability and comparability of information in financial statements.
To facilitate the effective communication of information in financial statements, when developing presentation and disclosure requirements in standards, a balance is needed between:
- give entities the flexibility to provide relevant information that faithfully represents the assets, liabilities, equity, income and expenses of the entity; and require information that is comparable, both from one period to another for a reporting entity and within a single reporting period between entities.
4.8. Concept of Capital and Capital Maintenance
The selection of the appropriate concept of capital by an entity should be based on the needs of the users of its financial statements. Therefore, a financial concept of capital should be adopted if users of financial statements are primarily concerned with maintaining the nominal capital invested or the purchasing power of the capital invested. However, if the primary concern of users is the operating capacity of the entity, a physical concept of capital should be used.
Most entities adopt a financial concept of capital when preparing their financial statements. Under a financial concept of capital, such as invested money or invested purchasing power, capital is synonymous with the net assets or equity of the entity.
Under a physical concept of capital, such as operating capacity, capital is considered as the productive capacity of the entity based, for example, of production units per day.
5. Conclusion
It is important to mention that this framework of concepts will come into effect from January 1, 2020, allowing its early application.
As you can see, the evolution and change in the development of business also means that the concepts that were had in the past, evolve as time goes by and that means that we must constantly relearn new concepts and accounting as the language of the businesses cannot close their eyes to these changes.
