Intermediate Accounting — Conceptual Framework and Presentation: Qualitative Characteristics, Recognition, Measurement, Capital Maintenance

Intermediate accounting works through the individual standards one by one. Before that, this chapter sets out the framework they all rely on: the Conceptual Framework for Financial Reporting and the general principles of K-IFRS 1001 Presentation of Financial Statements (IAS 1). The definitions seen in principles of accounting are rebuilt here to exam level (see Principles of Accounting chapter 1).

1. Status and purpose of the Conceptual Framework

The Conceptual Framework is not a standard. Where it conflicts with an individual standard, the standard prevails. It helps the IASB develop consistent standards and gives entities a basis for developing accounting policies when no standard applies (K-IFRS 1008, IAS 8).

The objective of general purpose financial reporting is to provide information useful to existing and potential investors, lenders and other creditors in deciding whether to provide resources to the entity. These primary users cannot demand information directly from the entity and so rely on financial reports. Regulators and the general public may use them too, but they are not primary users.

2. Qualitative characteristics of useful financial information

Information lacking the fundamental characteristics is not useful no matter how many enhancing characteristics it has. And because all information costs something to provide, cost constrains the scope of reporting.

The 2018 revision reintroduced “prudence”. This does not permit understating assets and income or overstating liabilities and expenses; it means exercising caution when judgements are uncertain. Asymmetric conservatism undermines neutrality.

3. Recognition and measurement

A. Recognition criteria

The 2018 Framework removed the old threshold of “recognize if probable and reliably measurable”. Instead, recognition is judged by whether it provides relevant information and a faithful representation. Where existence is uncertain, the probability of inflows is low or measurement uncertainty is very high, not recognizing may be more useful. The individual standards turn this principle into their own specific recognition requirements.

B. Measurement bases

Which basis to choose depends on how the asset or liability contributes to future cash flows and on measurement uncertainty. When an asset generates cash in combination with other assets rather than by being sold, historical cost is often relevant.

4. Capital maintenance and profit

Profit is what remains after maintaining opening capital. What counts as “capital to be maintained” changes profit.

A company buys 100 units of goods with ₩10 million of cash at the start of the period. At the end, it sells them all for ₩13 million. Meanwhile the general price index rose by 10%, and the cost of buying the same 100 units again became ₩12 million.

K-IFRS financial statements mostly assume nominal financial capital maintenance. Entities in hyperinflationary economies adjust for purchasing power under a separate standard (K-IFRS 1029, IAS 29).

5. General principles of presentation

K-IFRS 1001 sets out the following principles.

• Fair presentation and compliance with K-IFRS: an entity may state compliance only if it has complied with all of K-IFRS.
• Going concern: management assesses the entity’s ability to continue as a going concern for at least twelve months from the end of the reporting period, and discloses material uncertainties.
• Accrual basis: statements other than cash flow information are prepared on the accrual basis.
• Materiality and aggregation: items dissimilar in nature or function are presented separately, but immaterial items may be aggregated.
• No offsetting: assets and liabilities, income and expenses are not offset unless a standard requires or permits it.
• Comparative information: comparative information for the preceding period is presented for all current amounts. When a policy is applied retrospectively or items are reclassified, an additional opening statement of financial position for the preceding period is also presented.

Check your understanding

At the start of the period, company J uses net assets of ₩20 million to buy 200 tonnes of raw materials; by year-end, after processing and selling them, its net assets are ₩26 million. General prices rose 5% during the period, and the current cost of 200 tonnes of raw materials at year-end is ₩23 million. What is profit under nominal financial capital maintenance, constant purchasing power financial capital maintenance and physical capital maintenance?

Under nominal financial capital maintenance, profit is $2{,}600 - 2{,}000 = 600$ (₩10,000), i.e. ₩6 million. Under constant purchasing power, capital to be maintained is $2{,}000 \times 1.05 = 2{,}100$, so profit is ₩5 million. Under physical capital maintenance, capital to be maintained is the current cost of ₩23 million, so profit is ₩3 million. Raw material prices rose faster than general prices, so profit in physical terms is the smallest.

References

• Korea Accounting Standards Board, Conceptual Framework for Financial Reporting (revised 2018)
• Korea Accounting Standards Board, K-IFRS 1001 Presentation of Financial Statements
• Donald Kieso, Jerry Weygandt and Terry Warfield, Intermediate Accounting: IFRS Edition, ch. 2