 Hello and welcome to the session. This is Professor Farhad and this session we're going to be looking at the AISB conceptual framework or also known. Hello and welcome to the session. This is Professor Farhad and this session we're going to be looking at the AISB conceptual framework also known as the framework. This topic is covered in an international accounting course and it's starting to be covered on the CPA exam, the FAR section. As always, I would like to remind you my viewers to connect with me on a professional level via LinkedIn. If you don't have a LinkedIn account, you should create one. It's very good for your professional image and networking ability. YouTube is where I house all my lectures. You want to subscribe to my YouTube, please like the videos, share them, put them in playlists, let the world know about them. If you're benefiting from my lectures, there are other people my benefit as well, so please share the wealth. This is my Instagram account. Please follow me on Instagram as I'm trying to grow my following. This is my Facebook ID and I do have a Gumroad account with few CPA lessons and this is my website. We're going to be talking today about the conceptual framework. What is the conceptual framework and why does it exist? What's the reason? Why do we have a conceptual framework? Well, the reason is to develop accounting standard systematically. What does systematically means in an organized way in some sort of a way that is consistent with what we're going to be establishing for ourselves. Otherwise, we don't create those standard haphazardly. There's a way that we follow. Basically, there's a theory. There's an underlying theory in preparing the financial statements and an underlying theory that's going to help us establish the IFRS. If there are concepts, think of them theories underlying the preparation and presentation of the IFRS-based financial statements. Every time we need to set a new standard, every time we need to create a new IFRS, we want to make sure the new standard does not violate our conceptions, our theory of what we think accounting standard should be. The framework helps the IASP in developing future standards. When we develop a standard, we want to make sure we are looking at the framework and we're not violating anything in the framework and if we need to revise existing standards, so it will help IASP in creating new standards and revising new ones and revising old ones, sorry, not new ones. It assists the preparers of financial statements. So let's assume you are a company and you are trying to see how should I recognize a transaction. The IFRS does not have a clear guidance. Let's assume that's the case. Well, you could look at the framework. You could look at the framework and see this is how the framework might interpret this. So assist preparers in dealing with topics that are not yet addressed in the IFRS. So if there's something new that's not yet addressed, you could look at the framework and we talked about this framework in the prior session when we talked about IFRS-1. We said first kind of in a hierarchy first is the IFRS. Then after the IFRS, we could look at the framework if there is no true IFRS. So the framework is something we could look at when there is no existing IFRS to deal with a certain issue. It was first developed in 1989 by the IASC before the IASP was created and was reaffirmed by the newly formed IASP in 2001. And we're going to look at it from a four different perspective. It covered four different areas. Now in the real world, the framework is composed, I believe, of eight different chapters. So if you look at the actual framework, if you go to the IASP website or if you download the framework, it's basically it's eight chapters, but we're going to be taking those chapters and combine them into four different areas. The first one is the objective of financial statements and underlying assumptions. Kind of we talked about this one. We looked at IFRS-1. The qualitative characteristics that affect the usefulness of financial statements, basically they clearly spell out what type of characteristics specifically qualitative characteristic that are useful, that are good when we prepare financial statements. Those are very general definitions, but they apply in almost all situations. We're also going to look at definitions, recognition, and measurement of financial statement elements. What are the elements? Basically what constitute the financial statements, assets, liabilities, equity, revenues, and expenses. How do we define? How do we recognize? How do we measure those elements? We're going to look at it here, and at the end we would look at the concept of financial capital and physical capital maintenance. As usual, once I have a list, I'm going to go over this list in detail, so we'll cover each concept separately. The first one, as I talked about, kind of we covered already the objective of financial statements and the underlying assumption. First of all, what are the objective of financial statements? Why do we prepare financial statements? Well, we prepare financial statements to provide information to the users, useful information to the decision-making, the users. Now, who are the decision-making? Now, the decision-making could be anyone, creditors, investors, government, suppliers, citizens, anyone that uses the financial statements as a potential user. But specifically what we focus on is our investors. So basically, those are like the main group. Why? Because they commit capital, they commit their money, they risk their money when they invest in a company. Therefore, when we prepare information, we need to address their concern. Okay? So to meet the objective of decision usefulness, financial statements must be prepared on a cruel basis. So that's another thing we need to do is prepare financial statement not on cash basis, based on a cruel basis. Now, a cruel basis, the assumption is it's going to give us more information about the future. Why? Because we have accounts such as accounts payable, accounts receivable. Any accounts receivable tells us how much potential cash we could receive in the future. Accounts payable tell us how much potential cash we need to pay in the future as well. So the cruel basis is assumed to be superior in terms of predicting the future of the company. That's why we use a cruel basis. Therefore, the framework says we need to use a cruel basis. Okay? Also, the financial statements should also show the results of the management stewardship of the enterprise resources. But that's not the primary objective. But the financial statement should tell us how well management is handling the company's assets, managing the company's liability, managing the cash flow. How well are they, are they running the company in order to produce profit for the investors? So this is another underlying assumption. The other underlying assumption that we use is we have to assume that the company is a going concern. We prepare the financial statements assuming a going concern. What is a going concern? Going concern means we are preparing the financial statements under the assumption that the company will exist in the near future, in the future. So that's why when we do the appreciation, when we buy an asset, we assume we're going to depreciate this asset over seven years or over eight years or over 10 years. Why? Well, because we're going to be exist, we're going to exist in the future. Also, when we amortize a bond premium or a bond discount, well, what we're implying is we're going to exist. Therefore, we are amortizing, we are discounting the bond and amortizing the discount. So this is the objective in underlying assumptions. Again, this is I believe chapter one or chapter two. I believe this is mostly chapter one in the real framework. Qualitative characteristic. This I believe this will be chapter two. What are the qualitative characteristics? Basically, the framework spells out certain characteristics that the prepares of financial statements or the accounting standard setting institution should follow. There are four that makes the financial statements information useful. First is understandability. What does that mean? What does understandability mean? It means when you prepare financial statements, someone with reasonable knowledge of financial information should be able to understand it. So when you prepare an income statement, someone with minimal or reasonable financial knowledge should understand what revenue is, what expenses are, revenues minus expenses equal to profit. So understandability means they're not complicated. You don't need to hire someone in order to be able to understand them. As long as you have reasonable financial knowledge, you could always hire someone, but as long as you have reasonable financial knowledge, you should be able to manage or at least ask the right questions. The second characteristic that makes the financial statement useful is relevant. The information that you provide has to be relevant. Now what does relevant mean? Relevant means the information that you provide, it's going to help the users make predictions, help the users make prediction of the future specifically cash flow because what you're interested in in cash flow. For example, when we report a counter receivable, we report a counter receivable at the net realizable value, how much we expect to receive in the future. That's a relevant information. Why? Because you're telling me how much I sold on credit and how much I expect to receive in the future in terms of cash flow. So it's going to help me make a prediction. That's relevant information for me. Also, it's used to confirm expectation. Well, I predicted that I'm going to be receiving 90% of my receivable. At the end of the period, I look at my cash and I see that I received 92, or I received 88. It either confirmed my expectation or I'm going to adjust my expectation. Now the information has to be relevant and the nature of the information is important and materiality are a factor in relevancy. What does that mean? Let's talk about materiality first. Materiality, simply there's no really black and white definition for materiality, but simply put, if something is material, it means it's going to make a change. It's going to affect your decision. So you should not admit anything that is material. But if something is not material, it's okay if you don't clearly state it. And in-material items of the items are immaterial. You are allowed to aggregate those items if they are in immaterial, not material. Now, the nature of the item is important. What does the nature mean? Let's assume you are going to mistake a minimum figure. Let's assume it's $20,000. So your profit is going to be mistated by $20,000. So it's $20,000 material. Well, first it depends on your company. If you are making billions of dollars and you mistake the $20,000 in revenue, it's not a big deal. It's not a big deal because the amount is immaterial. Now, if you are making $300,000 in profit and you mistake the $20,000 to $25,000 in revenue, I would say that will be material. That's the materiality. But again, there is no clear cut. Materiality differ between users. So that's why you don't define it. But the nature of the figure is important. Let's assume you are going to borrow money from the bank and you are mistating your profit by $20,000. Maybe $20,000 is not a material number for your overall company because your company is making $6 million in profit. But that $20,000 took you from a profit, from a loss to a profit. So because you mistated that $20,000, it took you from a loss to a profit. And let's assume that bank only lend money for profitable companies. Simply put, the $20,000 is not material because it's a small amount because you're making you have $6 million in revenues. So $20,000 is not a big deal. But in this and under the circumstances, the nature of it, it took you from a loss that $20,000 put you into a profit. And in turn, what happened, the bank agreed to lend you money. Well, under those circumstances, you are not really providing relevant information. Therefore, materiality is important but also the nature of the materiality, the nature of the component. Another use, another information that makes the financial statement useful, another characteristic to be more specific, is reliability. And hopefully reliability is a self-explanatory. It means I can't rely on the information. What does it mean if I can't rely on the information? It means the information is truthful. It means the information has that faithful representation. It's really telling me what actually happened. Okay, it's given me the substance over the form. Also reliability means it's neutral. It's not favoring one party over the other. What does it mean favoring one party over the other? For example, if you have investors and creditors, investors are interested in profit because investors share in the profit of the company. Creditors on the other hand, they're not interested in the profit as much as they are interested in capital maintenance. And creditors, all what they want is they want to make sure you pay them back their money plus interest. They don't care if you make billions of dollars because they're not going to share into the profit. So when you provide information, the information that you provide has to be reliable and part of reliability has to be neutral, free of bias. It doesn't show a certain picture for a certain group over other. So that's what reliability is. Again, it has to be faithful representation. It's really telling you exactly what happened. Okay, economic substance over legal form. Substance means what really happened. Legal form is on paper. This is what happened. But what really happened behind the scene is or the heart of the transaction is different than what it looks like. Therefore, show me the substance that don't look at the form. Also another useful characteristic of financial information is comparability. Well, why is comparability important? Because when you analyze companies, you want to analyze companies over a period of time. And if the company is using different accounting method or applying different accounting standards from period to period, then I'm going to be comparing apples to oranges. So comparability means apply the same accounting method from period to period. Now, if you happen to change those methods, please disclose. Let me know that you changed them. Therefore, I will make the appropriate assumption. So if you're changing your depreciation method, if you're changing your inventory method, just let me know. Also, what is what is part of reliability is conservatism. Conservatism basically is measuring accounting element, conservatism in measuring accounting elements. What does that mean? It means if you have a doubt, whether to treat something as an asset or an expense, because every time you spend money, well, you have to decide, am I going to treat this transaction as an asset? Did I acquire an asset? Something that's going to benefit me in the future. We're going to talk about asset next. Or is this an expense? Expense means it's going to go on the income statement. And from a financial statement perspective, expense has no future value because I expense it. So if you have to choose between an expense and an asset, well, if you're conservative, you treat the expenditure as an expense. So this is what we might conservatism. If you have any doubt, if you have any doubt, you always take the conservative route. Now, you cannot create hidden reserve or excessive provisions to deliberately understand understate income. So what happened using this conservatism, what some companies or what some managers would do, if they have some good years, if they are making a lot of profit this year, what they try to do, they will try to create reserves or provisions for losses. So what they do is say, okay, since we have a lot of profit this year, let's debit an asset, debit a loss, create a liability as a provision for future losses, like bad debt expense or warranties. Why? What happened is when the following year kicks in and when that bad debt expense or that warranty does not materialize, they reverse it. And as they reverse it, they will reduce their expenses. So creating those hidden or excessive provisions is not acceptable under the concept of conservatism. Conservatism means if you have a doubt about the transaction, how to record it, take the conservative way, not only if you have a doubt, okay? Otherwise, if you are creating excessive reserve on purpose or hidden reserve, then that's basically misleading the financial users and that's not really quality of, it's not a quality of reliable bill. Next thing we're going to look at is definitions, recognition and measurement of financial statement elements. And this is important whether you are a introductory accounting students or you are an advanced accounting students, you want to make sure you understand the elements of financial statements and the elements of financial statements are assets, liabilities, revenues, expenses. So we want to make sure we understand how we measure them, how do we recognize them. Starting with assets. Assets are defined as resources controlled by an enterprise from which future economic benefit are expected to flow to the enterprise. So simply put you have something, whatever that something is, you control it, you can use it like a building, inventory, cash in the bank and that's going to possibly benefit your company. Not for sure, it's expected. Now you might have inventory but if you sell them at a loss, that's not benefit to you. Other detail definition of assets is the assets, you don't have to own it. For example, if you lease an asset, well, that's fine. If you lease a vehicle, a truck, a building, you can control the use of it. It's considered an asset. Asset should have a cost or a value that can be measured reliably. So every time you add an asset, you have to use a value. So I'm going to increase an asset and let's assume I'm paying cash or credit cash. So every time you put an asset on the books, it has to have a reliable measure. You have to measure it in terms of a dollar amount or whatever currency you are using. Now the way you measure it may be used on historical cost. For example, if you buy supply, you would use historical cost to measure it. You could use current cost. For example, IFRS allows you to use current cost for PPNE or fear value, realizable value. If you're using account receivable, you would use a realizable value. Sometimes you could use present value which is for notes receivable. So notice how you measure the asset. It used to be only historical cost. Then there is movements toward fear value measurement. So there's different measurement, how you measure your assets. How you measure your assets depends on different asset. Another element of the financial statements, important element is liabilities. What are liabilities? Liabilities are present obligation. You have an obligation right now arising from a past event because something happened in the past that expected to settle with an outflow of resources. Usually what's that outflow of resources? You have to pay cash. You have to pay cash in the future. If you have a liability, you have to pay cash. No obligation need not to be contractual to be treated as a liability. So you don't have to have a contract. Sometimes you might have to estimate a liability. Sometimes a liability is contingent upon future event. So it doesn't have to be written down contractual. Liability should be recognized when it's probable. Notice probable that an outflow of resources will be required to settle them and the amount can be measured reliably. So as long as you think you are going to pay for it and you know how much you're going to pay for it, guess what? You have a liability. And how do you measure liabilities? There are different ways to measure liabilities just like assets. You could measure liability at the amount proceeds received in exchange for the obligation. For example, you receive inventory and you have to pay $50,000 for it. Then that's your accounts payable. That's your liability measure at the exchange. How much you exchange your inventory with accounts payable, $50,000. The amount that would be required to settle an obligation currently, for example, the pension. The pension is measured at how much would you have to, how much would you have to pay the day if you have to settle it? That's the one way to measure liability. Undiscounted settlement value in the normal course of business. If you have a short-term loan, you would record it at the undiscounted settlement value because it has a very short period. Or liability can be recorded at the present value of a future cash flow. Like if you have a bond or a long-term note, how much do you record today? Well, I'm going to record today how much is the present value of the future cash flow. Okay, and we'll see this later on. But hopefully you know this information already. Other definitions for elements of financial statements, income and expenses are the two elements that constitute profit. So now we're moving to the little bit more to the income statement or to the equity side of things. What is income? What is income? Income encompasses both revenues and gains. And how do we define what's something revenue or gain if it increases in equity other than transaction from owners. So every time your equity increases, okay, other than the owner has given you money, then that's considered an income or either an income or a gain. Income should be recognized with the increase in an asset or a decrease in liability measured reliably. So how do you measure income? Well, you measure income, how much assets that you receive or sometime you don't increase asset. You just have to, as long as you reduce your liability, let's assume you owe me, you owe me $50 just to make it simple. I would say, okay, if you paint my home, if you paint my bedroom, I would relieve you from the debt. Well, you do so. Guess what? I have revenue. Why? Because you have revenue. I'm sorry, I don't have revenue. You have revenue. Why? Because it's as if I gave you $50 in revenue, then you gave it back to me. So if I reduce your liability, that's revenue to you. Expenses, including losses, are decreases in equity other than distribution to owners. So when is something considered an expense or a loss? Well, guess what? If I'm reducing, if my equity is going down, other than dividend, because dividend also reduces equity, but dividend is transaction with the owners. If my equity is going down with transaction, other than distribution to owners, then that's an expense. Expenses are recognized when the related decrease in asset or increase in liability. So when you incur an expense, either your assets will go down, like you pay it in cash, or you give something, like you give them inventory, you give them supplies, whatever you do, you give up some cash, some asset. Most of the time, you pay your expenses with cash. Or oftentimes, not oftentimes, the other possibility is you have an expense, but you're going to pay for it in the future. Then what's that going to do? It's going to increase your liability. It's going to increase your liability. So an expense is reflected by either decreasing cash or increasing liability, kind of the opposite of an asset. An asset, you're, I'm sorry, the opposite of a revenue. In a revenue situation, your asset goes up and your liability goes down. And how is equity defined? Well, equity defined is assets minus liability, asset minus liability. Remember, equity is increased by revenue reduced by expenses. Hopefully you know this. The last concept we're going to be covering is the financial capital maintenance concept and the physical capital maintenance concept. So let's take a look at the definition of financial capital maintenance. And hopefully I'm going to keep this very simple because many students find difficulty understanding this concept. Whatever, you know, for whatever reason you are watching this, if you're watching this for the CPA exam or for ACCA exam or whatever exam is, the topic is not covered heavily, but you have to know what it is. We're going to go through it anyhow. So how do we measure if it's a financial capital maintenance? We look at the profit as we look at, we look at the profit as the amount of the amount earned. Okay. Profit is the earned only of the amount of net asset. At the end of the period exceeds the amount at the beginning of the period, executing any inflow from or outflow to owners. That asset is basically equity. Okay. What does that mean? It means if I'm measuring my profit, I'm going to look at the net, the change in my net asset. If my net asset went up from the beginning of the period till the end of the period, then I have a profit. Okay. What does that mean? Let's assume I started my own company and I invested $100. Okay. So my cash went up. My common stock went up. So at the beginning of the period, I'm going to keep it simple. So how much equity do I have or net asset? Only $100. Okay. Asset minus liabilities equal to equity only have no liabilities. Let's assume I took this 40. I took 50. Let's make it $40. Let's assume I took $40 and I purchased inventory with it. So my cash now is 60. Okay. So I have cash of 60. Inventory of 40. I still have $100 in assets and I still have $100 of common stock, which is I'm still in the same position. Now, I bought this inventory. Let's assume I sold this inventory for $50. Okay. If I sold this inventory for $50, now my cash, my cash is 100. I sold all the inventory. Now, all what I have is cash 110 common stock of 100 and I'm going to keep this profit. I'm not going to pay it in dividend and retained earning. I'm going to close the profit to retained earning. I have $10 profit because I sold it for 10. So now, and let's assume that's the only thing that happened throughout the year. So notice I started the year with $100 in equity. I ended up with, sorry, 110. That's the whole purpose of to show you the increase. I end up the year with 110. So notice I started the year with 100 in cash, 100 in common stock. I ended up the year with 100 of equity, basically 110 in equity. From a financial capital maintenance perspective, I am better off. I have a profit of $10. So this is how we measure financial capital maintenance. Okay. Now, how do we measure? So the financial capital maintenance, although it's a fancy word, it's what you learned in financial accounting. This is what we do because it's easier to measure financial capital maintenance. If we are looking at physical capital maintenance after measuring the profit from a physical capital maintenance, it implies that a profit is earned only if the enterprise productive or operating capacity at the end of the period exceeds the capacity at the beginning of the period, including executing, obviously, we don't anything to do with owner's contribution or distribution from the owners. So let's use the same example. I started with $100. I bought some inventory. I sold it, I bought for inventory 450. I bought it for 40, sold it for 50. Now, I'm going to add a little bit more details here. Now, when I invested this $40, I bought 40 units of this inventory. What does that mean? It means I paid $1 per unit. So my cost was $1 per unit. Okay. Let's assume by the end of the year, I decided to buy this 40 units of inventory because I sold them. I made a $10 profit. Let's assume I need to rebuy that 40 units. Guess what? Now, if I need to buy 40 units, I have to pay $80. Why $80? Because the cost of each unit went up. So there was a huge price increase. The cost of my inventory doubled. So what happened to my productive capacity? My productive capacity went down. Now, if I have to buy the same 40 units, I have to invest $80. It means I really did not make any profit. Why? Because my productive capacity went down. So this is, if you are looking from a company from the physical capital maintenance, I did not really make a profit because my productive or operating capacity at the end of the period did not exceed. With the same asset, I could have bought 40 units. I can no longer do so. Now, if I want to invest $40 now, if I'm going to take my $40, if I'm going to take my $40, I can only buy 20 units with my $40. I can only buy 20 units. So my capacity, my operating capacity decreased. My operating capacity decreased. So this is the difference between financial capital maintenance and physical capital maintenance as a accountant. We look at financial capital maintenance. Again, Doris, you can talk about inflation here, but we're not going to go into this into more details other than this. But this is basically about the conceptual framework of the IASV. If you have any questions about this topic, please email me. If you happen to visit my website for additional lectures, please consider donating. Good luck and study hard.