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IFRS Conceptual Framework
Prof. Roberto Di PietraDepartment of Business and Social
Studies
University of Siena
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Pre-requisites and learning objectives Pre-requisites
Basic financial accounting and reporting concepts Introductory
accounting course
Learning objectives Understand the purpose of the IASB Framework
Describe the primary group of users Identify the qualities that
make Financial Statements
(FS) useful Define the basic elements of FS
f.gaushiya.01Typewritten
texthttp://www.disas.unisi.it/mat_did/dipietra/732/3%29_IFRS_Conceptual_Framework.pdf
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IASB Framework
Some historical notes The IASC (predecessor of IASB) has issued
in
1989 the Framework for the preparation and presentation of
Financial Statements (as part of the Comparability project)
This Framework in 2001 was re-adopted by the IASB
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Purpose and status of the IASB Framework The Framework
describes the basic concepts that underlie FS prepared under the
IFRSs
Serves as a guide to the IASB in developing accounting standards
resolving accounting issues that are not
addressed directly in a IFRS Is not itself an IASB standard
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Purpose and status of the IASB Framework The Framework
Defines the objective of FS Identifies the qualitative
characteristics that make
information in FS useful Defines the basic elements of FS and
the concepts for
recognising and measuring them in FS IAS 8 (2003) on Accounting
policies has introduced a
hierarchy of sources by which an entity would choose its
accounting policies In the absence of a specific standard
addressing an
issue, an entity is required to look to the IASB Framework
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Purpose and status of the IASB Framework The Framework has a
variety of uses:
The Framework guides the IASB and IFRIC members in deliberating
and establishing IFRS and interpretations of those standards
The Framework helps to ensure that the body of standards is
internally consistent
Preparers and Auditors of FS use the Framework as a point of
reference to resolve an accounting question in the absence of a
standard or interpretation that specifically deals with the
question
The Framework establishes precise terminology by which people
can discuss accounting questions
The Framework reduces the volume of standards (without the F.,
each accounting question would have to be answered ad hoc)
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Purpose and status of the IASB Framework The Framework has a
variety of uses:
The Framework makes it more likely that the standards will be
principles based rather than detailed rules that try to cover every
conceivable potential situation
The Framework reduces the need for interpretations and other
detailed implementation guidance
The Framework enhances public confidence in financial
reports
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Purpose and status of the IASB Framework Authority of the
Framework
IASB Preface to IFRS (2002) IFRSs are based on the Framework,
which
addresses the concepts underlying the information presented in
general purpose FS. The objective of the Framework is to facilitate
the consistent and logical formulation of IFRSs. The Framework also
provides a basis for the use of judgement in resolving accounting
issues ( 8)
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Purpose and status of the IASB Framework Authority of the
Framework
The IASB Preface also describes a due process steps that have to
be followed in developing IFRS
Step 1: the Staff are asked to identify and review all of the
issues associated with the topic and to consider the application of
the Framework to the issues
An identical Step 1 is set out in the due process followed by
IFRIC in developing its interpretations
Step 2: see 10 and 11 of IAS 8 (2003). IAS 8 is an
authoritative, binding standard, and it states that the Framework
is the first place to which a preparer or auditor must look in the
absence of a specific standard or interpretation
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General purpose of FSs Definition
The Framework addresses general purpose FS, which are the
financial statements that an entity prepares and presents at least
annually to meet the common information needs of a wide range of
usersexternal to the entity
Therefore the Framework does not necessarily apply to special
purpose FS such as reports to tax authorities, report to government
regulatory authorities, prospectus prepared in connection with
securities offerings, and reports prepared in connection with
proposed business combinations, etc.
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General purpose of FSs
The Framework focuses on the FS of business entities, which
would include both privately owned and state-owned business
entities The entities does not necessarily apply to the
FS of governments, government non-business units, or other
not-for-profit entities, although most of the concepts in the
Framework would seem to be equally relevant to those types of
entities
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General purpose of FSs The Framework acknowledges that some
parties who
use the general purpose FSs of an entity may have the power to
obtain information in addition to that contained in the FSs Many
present and potential investors, creditors,
vendors, and other who seek financial information about the
entity do not have the same power as the major lender to get
special information
They must rely on the general purpose FSs to meet their
information needs
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Users and their information needs The Framework identifies the
principal
classes of users of general purpose FSs as Present and potential
investors (and their
advisers) Lenders Suppliers and other trade creditors Employees
(and their representative groups) Customers Governments (and their
agencies) The general public
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Users and their information needs All of these 7 categories of
users rely on FSs
to help them in making various kinds of economic and public
policy decisions The Framework also concludes that
Because investors are providers of risk capital to the entity,
FSs that meet their needs will also meet most of the general
financial information needs of the other classes of FS users
Common to all of these user groups is their interest in the
ability of an entity to generate cash and cash equivalents, and the
timing and certainty of those future cash flows
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Users and their information needs The Framework regards
investors as the
primary, overriding user group The Framework notes that FSs
cannot provide
all the information that users may need to make economic
decisions
FSs show the financial effects of past events and transactions,
whereas the decisions that most users of FSs have to make relate to
future
The information in FSs helps users to make their own
forecasts
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Responsibility for FSs
The management of an entity has the primary responsibility for
preparing and presenting the entitys FSs This responsibility is
noted in the auditors
report in most countries Some countries require that company
management include, as part of the FSs, an explicit statement of
managements responsibility for the FSs
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Responsibility for FSs The auditors responsibility is to form
and express an
opinion as to whether the FSs are prepared in accordance with
IFRS or some other identified financial-reporting framework
The fact that FSs are audited does not relieve management of its
fundamental responsibility
In a converse case this could show a sort of conflict of
interest that could affect the expression of an independent opinion
ISA 700 on the Auditors Report on FSs requires that
the auditors report include a statement that the FSsare the
responsibility of the entitys management
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The objective of FSs Objective of FSs is
To provide information about the financial position, performance
and changes in financial position of an entity that is useful to a
wide range of users in making economic decisions
Decision usefulness is an objective of FSs(this has been subject
of heated debate)
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The objective of FSs From one hand the objective as set out in
the IASB
Framework is to help people to make decision From the other hand
large part of the decisions are
future-oriented Some disagree with this objective They argue
that the FSs is strictly to be a scorecard of
the past (stewardship objective of FSs) The IASB Framework does
not reject this objective, but
it says that people want to know about the past (stewardship)
not merely out of curiosity, but because they want to use the
information about the past to help them in making future-oriented
economic decisions
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The objective of FSs
Information from the past
Decision as a predictive processTime series
Actualized Values
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The objective of FSs Financial position
The financial position of an entity is affected by economic
resources
its controls, its financial structure, its liquidity and
solvency and Its capacity to adapt to changes in the
environment in which it operates The Balance sheet presents this
kind of
information
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The objective of FSs Performance
Performance is the ability of an entity to earn a profit on the
resources that have been invested in it
Information about the amount and variability of profits helps in
forecasting future cash flows from the entitys existing resources
and in forecasting potential additional cash flows from additional
resources that might be invested in the entity
Information about performance is primarily provided in an Income
statement (or statement of profit and loss, or statement of
financial performance)
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The objective of FSs Performance
IAS 1 added a fourth basic financial statement: The statement
showing the changes in equity
It is important to look to both the income statement and the
equity statement in assessing performance because several IFRS
provide that certain items if income and expense should be reported
directly in equity (thereby by passing the income statement)
permanently or temporarily
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The objective of FSs Performance
Some examples Changes in FV of available-for-sale financial
assets are
reported directly in equity until financial asset is sold Major
classes of property, plant and equipment are re-
measured to FV at each BS, with the change in FV reported in a
revaluation reserve directly in equity
Foreign currency translation adjustment arising when the FSsof a
foreign operation are translated from the foreign currency into the
reporting companys currency are reported directly in equity
Companies have an option of reporting actuarial gains and losses
on their pension funds directly in equity when they arise
This value changes are part of an entitys performance, but under
existing IFRSs they are not reported in the IS; They show up in the
Equity statement; In assessing performance, both of those FSs must
be considered
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The objective of FSs Changes in financial position
Users of FSs seek information about the sources and users of an
entitys cash and cash equivalents such as bank deposits during the
reporting period
Cash comes into and goes out of an entity from 3 broad
categories of activity
Its operations (producing and selling its goods and
services)
Its investing activities (buying and selling long-lived assets
and financial investments)
Its financing activities (raising and repaying debt and equity
capital)
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The objective of FSs Changes in financial position
The cash flow statement (CFS) provides this kind of
information
All investors, creditors, and other capital providers to an
entity want to get cash out of their investment
The cash flow statement helps them assess the prospects of
receiving cash from the entity
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The objective of FSs Notes and Supplementary schedules The FSs
also contain notes and supplementary
schedules and other information that Explain items in the
balance sheet and IS Explain any resources and obligations not
recognised
in the BS The notes also sometimes contain information that
meets disclosure requirements arising under national laws or
regulations
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Underlying assumptions
The Framework sets out the underlying assumptions of FSs There
are:
Accrual basis of accounting Going concern assumption
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Underlying assumptions Accrual basis
Accounting recognises the effects of transactions and other
events when they occur rather than only when cash (or its
equivalent) is received or paid and accounting reports these
effects in the FSs of the period to which they relate
The accrual basis recognises that a companys financial position
and performance can change without any cash changing hands
Accrual accounting recognises these changes when they occur
The cash basis is not consistent with IASB Framework
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Underlying assumptions Going concern
The FSs presume that an entity will continue in operation
indefinitely or disclosure and a different basis of reporting are
required
An entity that is not a going concern is likely to be liquidated
in the near term
The users of the FSs of such an entity will have a great
interest in the net amount of cash that can be generated from the
entitys assets in the very short term
IFRS are not necessarily designed to provide this kind of
information presume that entity will continue to operate for the
foreseeable
future and therefore will generate its cash flows from
operations rather than from liquidation sales
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Qualitative characteristics of FSs Attributes that make the
information in FSs
useful to investors, creditors, and others Four principal
qualitative characteristics
Understandability Relevance Reliability Comparability
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Qualitative characteristics of FSs Understandability
Information should be presented in a way that is readily
understandable by users
Who have a reasonable knowledge of business economic activities
and accounting
Who are willing to study the information diligently
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Qualitative characteristics of FSs Relevance
Information in FSs is relevant when it influences the economic
decisions of users
It can do that by Helping users to evaluate past, present or
future
events relating the entity Conforming or correcting past
evaluations users have
made There are sub-characteristics under the relevance:
Materiality Timeliness
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Qualitative characteristics of FSs Relevance
Materiality: is a component of relevance Information is material
if its omission or misstatement
could influence the economic decisions of users Conversely if
information does not have a bearing on
the economic decisions of users, it is immaterial Neither the
IASB Framework nor individual IFRS
provide quantified measures of materiality (some traces are in
IAS 14 and IAS 19)
Timeliness: is another component of relevance To be useful,
information must be provided to users
within the time period in which it is most likely to bear on
their decisions
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Qualitative characteristics of FSs Reliability
Information in FSs is reliable if it is free from material error
and bias and can be dependent on by users to represent events and
transactions faithfully
5 attributes that make information reliable Representational
faithfulness Substance over form Neutrality Prudence
Completeness
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Qualitative characteristics of FSs Reliability
Representational faithfulness To be reliable, information must
represent
accurately the transaction or other circumstance that the
information purports to present
Substance over form FSs should reflect the substance of
transactions
and not-necessarily their legal form
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Qualitative characteristics of FSs Reliability
Neutrality The Framework is clear that accounting
information
must be decision-neutral This means that information is not
designed in a way
that intentionally leads the users of that information to make
an economic decision that the preparer of the information would
like them to make
Saying that accounting information should be decision-neutral is
entirely consistent with saying that accounting information should
be relevant
Relevance requires that the information bear on the economic
decisions that users want to make
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Qualitative characteristics of FSs Reliability
Prudence: is the inclusion of a degree of caution in the
exercise of the judgements needed in making the estimates required
under conditions of uncertainty, such that
assets or income are not overstated and liabilities or expenses
are not understated
While there is noting wrong with healthy scepticism, prudence
has sometimes been used to justify the deliberate overstatement of
liabilities or expenses, or the deliberate understatement of assets
or income
When this happens, the FSs measurements lose their
reliability
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Qualitative characteristics of FSs Reliability
Completeness Reliability requires that the FSs must report what
they
purport to report completely, subject to constraints of cost and
materiality
Omissions make FSs just as wrong as unreliable or irrelevant
information
Balance between benefit and cost The benefits that users of FSs
derive from information
should exceed the cost of providing that information The
evaluation of benefits and costs is a difficult
judgemental process (costs of providing information should
include direct and indirect costs for its preparation)
Trade-off between relevance and reliability
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Qualitative characteristics of FSs Comparability
User must be able to compare the FSs of an entity over time so
that they can identify trends in its financial position and
performance
Users must also be able to compare the FSsto different entities
to make decisions about where to invest their capital and at what
price
Disclosure of accounting policies is essential for
comparability
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Qualitative characteristics of FSs
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The elements of FSs FSs portray the financial effects of
transactions and
other events by grouping them into broad classes according to
their economic characteristics The elements directly related to
financial position (BS)
are: Assets Liabilities Equity
The elements directly related to performance (IS) are: Income
Expenses
The CFS reflects both IS elements and changes in BS elements
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The elements of FSs Definitions of the elements relating to
financial
position Asset
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 A present obligation of the entity arising from
past
events, the settlement of which is expected to result in an
outflow from the entity of resources embodying economic
benefits
Equity The residual interest in the assets of the entity
after
deducting all its liabilities
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The elements of FSs
Definitions of the elements relating to financial position
Economic benefits means future flows of
cash or other assets An assets is expected to help generate
cash
or other assets coming into the entity, and a liability is
expected to result in cash or other assets flowing out of the
entity
Both the Asset and Liability definitions refer to past
events
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The elements of FSs Definitions of the elements relating to
performance
Income Increases in economic benefits during the accounting
period in the form of inflows or enhancements of assets or
decreases of liabilities that result in increases in equity, other
than those relating to contributions from equity participants
Expense Decreases in economic benefits during the accounting
period in the form of outflows or depletions of assets, or the
incurrence of liabilities that result in decreases in equity other
than those relating to distributions to equity participants
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The elements of FSs Definitions of the elements relating to
performance
The definition of income encompasses both revenue and gains
Revenue arises in the course of the normal operating activities
of the entity
Gains represent other items that meet the definition of income
but that do not reflect from the normal sales of goods and services
produced by the entities
The definition of expenses encompasses expenses and losses
Expenses arise in the course of the ordinary activities of an
entity (cost of sales, wages, marketing costs, administrative
costs, depreciation)
Losses represent other items that meets the definition of
expenses and may or may not arise in the course of the ordinary
activities of the entity
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Recognition of the elements of FSs Recognition:
is the process of incorporating in the BS an item that meets the
definition of an element and satisfies both the following criteria
for recognition
Probable economic benefits It is probable that any future
economic benefit
associated with the item will flow to or from the entity
Measurement reliability
The items cost or value can be measured reliably All items that
satisfy these recognition criteria
should be recognised in the BS or IS
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Recognition of the elements of FSs The recognition criteria for
the elements of FSs under
the Framework are as follows: An asset is recognised in the BS
when it is probable
that the future economic benefits will flow to the entity and
the asset has a cost or value that can be measured reliably
A liability is recognised in the BS when it is probable that an
outflow of resources embodying economic benefits will result from
the settlement of a present obligation and the amount at which the
settlement will take place can be measured reliably
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Recognition of the elements of FSs The recognition criteria for
the elements of FSs under
the Framework are as follows: Income is recognised in the IS
when an increase in
future economic benefits related to an increase in an asset or a
decrease in a liability has arisen that can be measured
reliably
Expenses are recognised when a decrease in future economic
benefits related to a decrease in an asset or an increase in a
liability has arisen that can be measured reliably
Because equity is the arithmetic difference between assets and
liabilities, a separate recognition criterion for equity is not
needed
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Recognition of the elements of FSs Recognition of revenue from
the sale of goods
This revenue should be recognised when all of the following
criteria have been satisfied
The seller has transferred to the buyer the significant risks
and rewards of ownership
The seller retains neither continuing managerial involvement to
the degree usually associated with ownership nor effective control
over the goods sold
The amount of revenue can be measured reliably It is probable
that the economic benefits associated
with the transaction will flow to the seller The costs incurred
or to be incurred in respect of the
transaction can be measured reliably
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Recognition of the elements of FSs Recognition of revenue from
the tendering of
services This revenue should be recognised when all of
the following criteria have been satisfied The amount of revenue
can be measured reliably It is probable that the economic benefits
will flow
to the seller The stage of completion at the BS date can be
measured reliably The costs incurred, or to be incurred, in
respect of
the transaction can be measured reliably
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Recognition of the elements of FSs Recognition of revenue from
interest,
royalties and dividends These revenues should be recognised
when
all of the following criteria have been satisfied Interest
should be recognised using the effective
interest method set out in IAS 39 ( 5) Royalties should be
recognised on an accrual
basis in accordance with the substance of the relevant
agreement
Dividends should be recognised when the shareholders right to
receive payment is established
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Measurement of the elements of FSs
Measurement involves assigning monetary amounts at which the
elements of the FSs are to be recognised and reported The Framework
acknowledges that a variety of
measurement bases are used to different degreesand in varying
combinations in FSs including:
Historical cost Current replacement cost Net realisable value
Present value (discounted expected future cash flow)
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Measurement of the elements of FSs
Historical cost: Is the measurement basis most commonly
used today, but it is usually combined with other measurement
bases
Net realisable value: Is an assets selling price or a
liabilitys
settlement amount
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Measurement of the elements of FSs
The Framework does not include concepts or principles for
selecting which measurement basis should be used for particular
elements of FSs or in particular circumstances After covering the
objective of FSs, qualitative
characteristics, and elements definitions, the Framework
addresses measurement in only three paragraphs
It is fair to say that this is a significant deficiency in the
Framework
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The IASBs current Conceptual Framework project Because the
Framework does not include concepts
for choosing the proper measurement attribute for various
elements, the IASB standards today result in what is called a mixed
attribute accounting model, with different measurement bases for
different types of assets, liabilities, income and expenses Some
members of the IASB have a tendency to favour
fair value measurements if at all possible Other members lean
towards cost-based measures
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The IASBs current Conceptual Framework project The IASB and US
FASB have worked a joint project
designed to update and align the two boardsConceptual Framework
Eight phases
Objectives and qualitative characteristics Elements: recognition
and measurement attributes Initial and subsequent measurement
Reporting entity Presentation and disclosure Status of Framework in
GAAP hierarchy Applicability to not-for-profit entities
Reconsideration of the entire Framework
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The IASBs current Conceptual Framework project Objective
The boards have tentatively concluded that financial reports
should aim to provide information to a wide range of users that
focus on the information needs of existing common shareholders
only
The objective is to provide information about the entity to the
external users who lack the power to prescribe the information they
require and therefore must rely on the information provided by an
entitys management
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The IASBs current Conceptual Framework project Qualitative
characteristics
The 2 boards have tentatively concluded to identify the
following 5 primary qualitative characteristics of accounting
information
Relevance: is an essential qualitative characteristics Faithful
representation of real-world economic
phenomena Comparability: is an important characteristics of
financial reporting information and should be included in the
converged conceptual framework
Understandability: is an essential characteristics of financial
reporting information and should be included in the converged
conceptual framework
Materiality: relates not only to relevance, but also to faithful
representation
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The IASBs current Conceptual Framework project Exposure Draft in
May 2008
The objective of Financial reporting Is to provide information
about the reporting entity that
is useful to present and potential equity investors, lenders and
other creditors in making decisions in their capacity as capital
providers
Information that is decision-useful to capital providers may
also be useful to other users of financial reporting who are not
capital providers
FSs should reflect the perspective of the entity rather than the
perspective of the entitys investors
The key users of FSs are capital providers Capital providers
require information that is decision-useful
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The IASBs current Conceptual Framework project Exposure Draft in
May 2008
The objective of Financial reporting For financial information
to be useful, it must possess 2
fundamental qualitative characteristics: Relevance Faithful
representation (a depiction of an economic phenomenon
have to be complete, neutral and free from material error) The
ED provides 4 enhancing qualitative characteristics
Comparability Verifiability Timeliness Understandability
This characteristics are complementary to the fundamental
characteristics
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The IASBs current Conceptual Framework project Next steps
The Convergence process between IASB and FASB on the Conceptual
Framework was paused
This project was paused until the IASB concludes its ongoing
deliberations about its future work plan (visit the Agenda
consultation project page for more information)