financial information they need. Consequently, they are the primary users to whom
general purpose financial reports are directed. [CF 1.5]. Moreover, financial reports are
prepared for users with a reasonable knowledge of business and economic activities
who can review and analyse the information diligently. [CF 2.36].
Other parties, such as regulators and members of the public, may also find general
purpose financial reports useful. However, those reports are not primarily directed to
these other groups. [CF 1.10]. This draws out an interesting facet of the Board’s objective
for financial reporting being restricted to the information needs of those providing
resources to a reporting entity. It excludes other common uses of financial information,
notably the levying of corporation taxes and restrictions on distribution to members.
These two very important areas of corporate activity will typically take as a starting
point a measure of profit as reported in the entity’s financial reports. Self-evidently, if
these uses are not considered in the development of accounting requirements, there is
a risk that financial statements will be less suitable for these purposes.
The decisions described in the objective depend on the returns that existing and potential
investors, lenders and other creditors expect, for example, dividends, principal and interest
payments or market price increases. 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 and on their assessment of management’s
stewardship of the entity’s economic resources. Existing and potential investors, lenders and
other creditors need information to help them make those assessments. [CF 1.3].
The IASB’s Conceptual Framework
47
In doing so, users need information about: [CF 1.4]
• the economic resources of the entity, claims against the entity and changes in those
resources and claims (see 4.2 below); and
• how efficiently and effectively the entity’s management and governing board
have discharged their responsibilities to use the entity’s economic resources
(see 4.2.3 below).
4.1.2 Limitations
The Framework acknowledges that general purpose financial reports do not, and
cannot, provide all of the information needed by providers of capital. Users of financial
reports need to consider other pertinent information, such as general economic and
political conditions, and industry and company outlooks. Moreover, general purpose
financial reports are not designed to show the value of a reporting entity, but to provide
information to allow users to estimate it for themselves. [CF 1.6, 1.7].
General purpose financial reports are focused on meeting the needs of the
maximum number of primary users, who may have different, and possibly
conflicting, needs for information. However, this does not preclude a reporting
entity from including additional information that is most useful to a particular
subset of primary users. [CF 1.8]. It should be noted, however, that IAS 1 –
Presentation of Financial Statements – contains the requirement that the
understandability of financial statements should not be reduced by obscuring
material information with immaterial information. [IAS 1.30A]. Management of an
entity need not rely on general purpose financial reports, since the relevant
information can be obtained internally. [CF 1.9].
The IASB notes that, 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. The concepts should
be seen as a goal which the IASB and preparers should strive towards, but are unlikely
to achieve in full, at least in the short term, because it takes time to understand, accept
and implement new ways of analysing transactions and other events. Nevertheless, the
IASB believes that setting such a goal is essential if financial reporting is to evolve so as
to improve its usefulness. [CF 1.11].
4.2
Information about the economic resources of an entity and the
use made of them, claims against the entity, and changes in
resources and claims
General purpose financial reports provide information about:
• the financial position of a reporting entity (the economic resources of, and claims
against, the entity) – see 4.2.1 below; and
• the effects of transactions and other events that change the economic resources
of, and claims against, the entity – see 4.2 below.
Both types of information provide useful input for decisions about providing resources
to an entity. [CF 1.12].
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4.2.1
Economic resources and claims
Information about the nature and amounts of a reporting entity’s economic resources
and claims can help users to:
• identify the entity’s financial strengths and weaknesses;
• assess the entity’s liquidity and solvency, its needs for additional financing and how
successful it is likely to be in obtaining that financing; and
• assess management’s stewardship of the entity’s economic resources.
Information about the priorities and payment requirements of existing claims helps
users to predict how future cash flows will be distributed among lenders and creditors.
[CF 1.13].
Different types of economic resources affect a user’s assessment of the entity’s
prospects for future cash flows in different ways. Some future cash flows result directly
from existing economic resources, such as accounts receivable. Other cash flows result
from the entity using several resources in combination to produce and market goods or
services to customers. Although those cash flows cannot be identified with individual
economic resources (or claims), users need to know the nature and amount of the
resources available for use in an entity’s operations. [CF 1.14].
4.2.2
Changes in economic resources and claims
Changes in a reporting entity’s economic resources and claims result from that entity’s
financial performance and from other events or transactions such as issuing debt or
equity instruments. In order to assess properly the prospects for future cash flows of the
entity and management’s stewardship of resources, users need to know the extent to
which the reporting entity has increased its available economic resources, and thus its
capacity for generating net cash inflows through its operations rather than by obtaining
additional resources directly from providers of capital. [CF 1.15, 1.18, 1.21].
Information about a reporting entity’s financial performance helps users to understand
the return that the entity has produced on its economic resources. Information about
the return can help users to assess management’s stewardship of the entity’s economic
resources. Information about the variability and components of that return is also
important, especially in assessing the uncertainty of future cash flows. Information
about a reporting entity’s past financial performance and how
its management
discharged its stewardship responsibilities is usually helpful in predicting the entity’s
future returns on its economic resources. [CF 1.16].
Financial performance is reflected by changes in the entity’s economic resources and
claims other than by obtaining additional resources directly from providers of capital.
[CF 1.15, 1.18]. This is sometimes described as a ‘balance sheet approach’ to recording
financial performance, whereby financial performance for a period is essentially
derived as part of the overall movement in the entity’s financial position during that
period. This is discussed more explicitly in the section of the Framework dealing with
the elements of financial statements (see 7 below).
The IASB’s Conceptual Framework
49
Consistent with this ‘balance sheet approach’, financial performance is based on accrual
accounting, which 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, even if the resulting cash receipts and payments occur in a
different period. This provides a better basis for assessing the entity’s past and future
performance than information based solely on cash flows. [CF 1.17].
Information about an entity’s financial performance may also indicate the extent to
which events such as changes in market prices or interest rates have changed the entity’s
economic resources and claims, thereby affecting the entity’s ability to generate net cash
inflows. [CF 1.19]. Nevertheless, information about an entity’s cash flows during a period
also helps users to assess the entity’s ability to generate future net cash inflows,
understand the entity’s operations, evaluate its financing and investing activities, assess
its liquidity or solvency, assess management stewardship and interpret other
information about financial performance. [CF 1.20].
4.2.3
Information about the use of economic resources (stewardship)
Management is responsible for the use of an entity’s economic resources – for example,
by protecting those resources from unfavourable effects of economic factors, such as
price and technological changes, and ensuring that the entity complies with applicable
laws, regulations and contractual provisions. [CF 1.23].
Information about how efficiently and effectively the reporting entity’s management has
discharged its responsibilities to use the entity’s economic resources helps users to
assess management’s stewardship of those resources. Such information is also useful for
predicting how efficiently and effectively management will use the entity’s economic
resources in future periods. Hence, it can be useful for assessing the entity’s prospects
for future net cash inflows. [CF 1.22].
5
CHAPTER 2: QUALITATIVE CHARACTERISTICS OF
USEFUL FINANCIAL INFORMATION
The Framework states that the types of information likely to be most useful to providers
of capital are identified by various qualitative characteristics, [CF 2.1], comprising:
• two ‘fundamental qualitative characteristics’ (see 5.1 below):
• relevance; and
• faithful representation; [CF 2.5] supplemented by
• four ‘enhancing qualitative characteristics’ (see 5.2 below):
• comparability;
• verifiability;
• timeliness; and
• understandability. [CF 2.23].
50 Chapter
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Chapter 3 of the Framework also notes the role of cost as a ‘pervasive constraint’ on a
reporting entity’s ability to provide useful financial information. [CF 2.39]. This is
discussed further at 5.3 below.
The relationship between the objective, fundamental characteristics, enhancing
characteristics and the pervasive cost constraint can be represented diagrammatically:
Figure 2.1
Components of the Conceptual Framework
Provide useful information to existing and future
Objective
investors, lenders and other creditors
Fundamental
Relevance
Faithful representation
characteristics
• Predictive value
• Completeness
• Confirmatory value
• Neutrality
• Entity-specific materiality
• Free from error
Enhancing
Comparability
Verifiability
Timeliness
Understandability
characteristics
Pervasive
Cost
constraint
Monetary amounts in financial reports will not always be observed directly and must
instead be estimated; in such cases measurement uncertainty arises. The use of
reasonable estimates is an essential part of the preparation of financial information and
does not undermine the usefulness of the information if the estimates are clearly and
accurately described and explained. Even a high level of measurement uncertainty does
not necessarily prevent such an estimate from providing useful information. This is
discussed further at 5.1.3 below. [CF 2.19].
Financial reports provide information about the reporting entity’s economic resources,
claims against the reporting entity and the effects of transactions and other events and
conditions that change those resources and claims (collectively referred to in the
Framework as ‘the economic phenomena’). Some financial reports also include
explanatory material about management’s expectations and strategies for the reporting
entity, and other types of forward-looking information. [CF 2.2]. The IASB’s work on
management reports is discussed at 12 below.
The qualitative characteristics of useful financial information apply to all financial
information, whether provided in financial statements or in other ways. All financial
information is also subject to a pervasive cost constraint on the reporting entity’s ability
to provide useful financial information. However, the considerations in applying the
qualitative characteristics and the cost constraint may be different for different types of
information. For example, applying them to forward-looking information may be
The IASB’s Conceptual Framework
51
different from applying them to information about existing economic resources and
claims and to changes in those resources and claims. [CF 2.3].
5.1
Fundamental qualitative characteristics
In order to be useful, financial information must be relevant (see 5.1.1 below) and
faithfully represent what it purports to represent (see 5.1.2 below). [CF 2.4].
5.1.1
Relevance (including materiality)
Relevant financial information is that which is capable of making a difference to the
decisions made by users, irrespective of whether some users choose not to take advantage
of it or are already aware of it from other sources. Financial information is capable of making
a difference in decisions if it has predictive value, confirmatory value or both. [CF 2.6, 2.7].
Financial information has predictive value if it can be used as an input to processes
employed by users to predict futu
re outcomes. Financial information with predictive
value need not itself be a prediction or forecast, but is employed by users in making
their own predictions. Financial information has confirmatory value if it confirms or
changes previous evaluations. [CF 2.8, 2.9].
The predictive value and confirmatory value of financial information are interrelated.
For example, information on revenue for the current year can be used both as the basis
for predicting revenues in future years, and as a point of comparison with predictions
made in prior years of revenue for the current year. The results of those comparisons
can help a user to correct and improve the processes that were used to make those
previous predictions. [CF 2.10].
The Framework refers to materiality as ‘an entity-specific aspect of relevance based on
the nature or magnitude, or both, of the items to which the information relates in the
context of an individual entity’s financial report’. In other words, information is material
(and therefore relevant) if omitting or misstating it could influence the decisions of users
of financial information about a specific reporting entity. Because of the specificity of
materiality to a particular reporting entity, the IASB cannot specify a uniform
quantitative threshold for materiality or predetermine what could be material in a
particular situation. [CF 2.11].
5.1.2 Faithful
representation
The Framework observes that financial reports represent economic phenomena in
words and numbers. To be useful, financial information must not only represent
relevant phenomena, but it must also faithfully represent the substance of the
phenomena that it purports to represent. In many circumstances, the substance of an
economic phenomenon and its legal form are the same. If they are not the same,
providing information only about the legal form would not faithfully represent the
economic phenomenon (see 7.1.3 below). [CF 2.12].
A perfectly faithful representation would be:
• complete,
• neutral, and
• free from error.
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The IASB’s objective is to maximise those qualities to the extent possible, while
acknowledging that perfection is seldom, if ever, achievable. [CF 2.13].
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