The Accounting Framework

Financial statements are structured reports that communicate an entity's financial performance and financial position to users. The IASB Conceptual Framework for Financial Reporting (2018) states that 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 about providing resources to the entity."

These decisions involve buying, selling, or holding equity and debt instruments, and providing or settling loans and other forms of credit. To make such decisions, users need information about:

• The entity's economic resources (assets) and claims against those resources (liabilities and equity)
• Changes in resources and claims arising from the entity's financial performance and other events
• How efficiently and effectively management has discharged its stewardship responsibilities over the entity's resources

A complete set of financial statements under IAS 1 Presentation of Financial Statements comprises:

1. Statement of financial position (SoFP) — shows assets, liabilities, and equity at a point in time
2. Statement of profit or loss and other comprehensive income (SoPL & OCI) — reports the entity's financial performance over a period
3. Statement of changes in equity (SoCIE) — reconciles opening to closing equity balances
4. Statement of cash flows (SCF) — summarises cash inflows and outflows classified by operating, investing, and financing activities
5. Notes to the financial statements — provide additional detail, accounting policies, and explanations

General-purpose financial statements are not designed to provide all the information every user may need — for example, they do not include forward-looking projections. They are, however, the primary vehicle through which entities communicate financial information to external parties.

The IASB published the revised Conceptual Framework for Financial Reporting in March 2018, replacing the previous 2010 version. The Framework is not an accounting standard — it cannot override any specific IFRS. Its purposes are to:

• Assist the IASB in developing and revising standards based on consistent concepts
• Help preparers develop consistent accounting policies when no standard or interpretation applies to a particular transaction
• Help all parties understand and interpret IFRS standards

The Framework covers:

1. The objective of general-purpose financial reporting
2. Qualitative characteristics of useful financial information
3. Financial statements and the reporting entity
4. The elements of financial statements
5. Recognition and derecognition
6. Measurement
7. Presentation and disclosure
8. Concepts of capital and capital maintenance

Fundamental Qualitative Characteristics

Enhancing Qualitative Characteristics

The Conceptual Framework defines five elements that relate to the measurement of financial position (SoFP) and financial performance (SoPL):

Key change in 2018: The revised definition of an asset no longer requires that future economic benefits be "expected" (i.e., probable). The 2018 wording is a right that has the potential to produce economic benefits. This is a lower threshold than the old definition. Similarly, a liability is now a "present obligation" rather than requiring that an outflow is "expected." The question of probability has moved from the definition to the recognition stage.

An obligation can be legal (enforceable by law) or constructive (the entity has created a valid expectation through an established pattern of practice, published policies, or a specific current statement that it will accept certain responsibilities).

Recognition is the process of incorporating an item into the financial statements — either the SoFP or the SoPL. Under the 2018 Framework, an item that meets the definition of an element is recognised when doing so provides users with:

• Relevant information about the asset, liability, income, or expense, AND
• A faithful representation of that item

Relevance and faithful representation are assessed on a case-by-case basis. Factors that may result in non-recognition include:

• Low probability of an inflow or outflow of economic benefits — recognition may not provide relevant information
• Measurement uncertainty — if no measure can produce a faithful representation

Note: the 2018 Framework removed the previous explicit "probable" threshold for recognition. Probability now feeds into the assessment of whether recognition provides relevant information — it is a factor, not a binary test.

Derecognition occurs when an item no longer meets the definition of an asset or liability. For assets, this typically happens when the entity loses control of the economic resource (e.g., sells the asset, it is consumed, or the right expires). For liabilities, it happens when the entity is released from the obligation (e.g., by performance, cancellation, or expiry). Derecognition should faithfully represent both the assets/liabilities retained after the transaction and the change resulting from it.

Measurement assigns a monetary amount to the elements recognised in the financial statements. The Conceptual Framework identifies two broad categories of measurement basis:

A. Historical Cost

• Assets: the consideration paid to acquire the asset (transaction price), plus transaction costs. Subsequently carried at cost less accumulated depreciation (for depreciable assets) and accumulated impairment losses.
• Liabilities: the value of the consideration received to assume the obligation, or the consideration expected to be paid to fulfil the obligation (in a non-market transaction), less transaction costs.
• Advantages: objective, verifiable, simple to apply, widely understood.
• Disadvantages: may become outdated over time and not reflect current economic conditions. Does not capture unrealised gains.

B. Current Value Measures — these reflect conditions at the measurement date:

1. Fair value (IFRS 13)

The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is a market-based (exit price) measure, not entity-specific. It is the same for all entities holding the same asset.

2. Value in use (for assets) / Fulfilment value (for liabilities)

The present value of the cash flows that the entity expects to derive from continuing use of the asset and its eventual disposal (value in use), or the present value of the cash flows the entity expects to incur in fulfilling the liability (fulfilment value). These are entity-specific measures — they reflect the entity's own expectations, not those of market participants. They include transaction costs on disposal/settlement.

3. Current cost

The cost of an equivalent asset at the measurement date (replacement cost). For liabilities, the consideration that would be received for an equivalent liability. Unlike fair value (which is an exit/selling price), current cost is an entry/buying price.

The choice of measurement basis depends on the relevance and faithful representation of the information it provides, balanced against its cost. Historical cost and fair value are the most commonly used bases in practice.

The accruals basis (accrual accounting) is the fundamental basis of accounting required by the IASB Conceptual Framework and IAS 1. It recognises the effects of transactions and other events when they occur — not when cash is received or paid — and reports them in the financial statements of the periods to which they relate.

Key features of accrual accounting:

• Revenue is recognised when the performance obligation is satisfied (goods delivered, services rendered, control transferred), regardless of when cash is received
• Expenses are recognised when incurred — when the resource is consumed or the obligation arises — regardless of when cash is paid
• At each period end, adjustments are required to reflect economic reality:

The cash basis recognises transactions only when cash is received or paid. It is simpler but provides an incomplete picture — it ignores amounts owed and owing, and does not match income with the expenses incurred to generate it. Most entities above a trivial size are required to use the accruals basis. The statement of cash flows, however, provides useful cash-basis supplementary information.

Example: An entity provides consulting services to a client throughout December 2024, invoicing £15,000 on 31 December 2024. The client pays on 20 January 2025.

• Accruals basis: Revenue of £15,000 recognised in December 2024 (when services were provided). Trade receivable of £15,000 shown on the SoFP at 31 December 2024.
• Cash basis: Income of £15,000 recognised in January 2025 (when cash is received). Nothing shown in December 2024.

The accruals basis gives a more faithful representation because the economic event (earning the fee) occurred in December.

The going concern assumption means that the entity is assumed to continue in operation for the foreseeable future — conventionally at least 12 months from the date the financial statements are authorised for issue. The entity has neither the intention nor the necessity to liquidate or curtail materially the scale of its operations.

This assumption is fundamental because it underpins how financial statements are prepared:

• Non-current assets are carried at cost less depreciation, reflecting their use over time — not at forced-sale or break-up values
• Liabilities are classified between current and non-current based on expected settlement in the normal course of business
• Prepayments and accruals are recognised on the basis that the entity will continue to operate and receive/deliver future benefits
• Deferred tax and other long-term provisions are recognised on the assumption of ongoing operations

If the entity is not a going concern (or the going concern assumption is inappropriate), the financial statements must be prepared on a break-up (liquidation) basis:

• Assets are stated at net realisable (break-up) values
• All liabilities become current (payable immediately)
• Additional provisions may be needed (e.g., redundancy costs, lease termination penalties)
• Disclosure is required about the basis of preparation and the reasons why the entity is not considered a going concern

Indicators of potential going concern doubts include:

• Recurring operating losses or negative operating cash flows
• Net current liabilities (current liabilities exceeding current assets)
• Inability to pay debts as they fall due or to comply with loan covenants
• Loss of a major customer, supplier, or key management personnel
• Pending litigation or regulatory action that could result in claims the entity cannot meet
• Withdrawal of financial support by a parent company or key lender

Under IAS 1, management must assess the entity's ability to continue as a going concern when preparing financial statements. If there are material uncertainties related to going concern, they must be disclosed. The auditor also has specific responsibilities under ISA 570 to evaluate going concern.