include, but are not limited to, the nature of the item, its role (or function) within the
business activities conducted by the entity, and how it is measured. [CF 7.7].
Classifying dissimilar assets, liabilities, equity, income or expenses together can obscure
relevant information, reduce understandability and comparability and may not provide
a faithful representation of what it purports to represent. [CF 7.8].
10.2.1
Classification of assets and liabilities
Classification is applied to the unit of account selected for an asset or liability (see 7.1.1
above). However, it may sometimes be appropriate to separate an asset or liability into
components that have different characteristics and to classify those components
separately. That would be appropriate when classifying those components separately
would enhance the usefulness of the resulting financial information. For example, it
could be appropriate to separate an asset or liability into current and non-current
components and to classify those components separately. [CF 7.9].
10.2.1.A Offsetting
Offsetting occurs when an entity recognises and measures both an asset and liability as
separate units of account, but groups them into a single net amount in the statement of
financial position. Offsetting classifies dissimilar items together and therefore is
generally not appropriate. [CF 7.10].
The IASB’s Conceptual Framework 101
Offsetting assets and liabilities differs from treating a set of rights and obligations as a
single unit of account (see 7.1.1 above). [CF 7.11].
10.2.2
Classification of equity
To provide useful information, it may be necessary to classify equity claims separately
if those equity claims have different characteristics (equity is discussed at 7.4 above).
[CF 7.12].
Similarly, to provide useful information, it may be necessary to classify components of
equity separately if some of those components are subject to particular legal, regulatory
or other requirements. For example, in some jurisdictions, an entity is permitted to
make distributions to holders of equity claims only if the entity has sufficient reserves
specified as distributable. Separate presentation or disclosure of those reserves may
provide useful information. [CF 7.13].
10.2.3
Classification of income and expenses
Classification is applied to:
• income and expenses resulting from the unit of account selected for an asset or
liability; or
• components of such income and expenses if those components have different
characteristics and are identified separately. For example, a change in the current
value of an asset can include the effects of value changes and the accrual of interest
(see Figure 2.3). It would be appropriate to classify those components separately if
doing so would enhance the usefulness of the resulting financial information.
[CF 7.14].
Recognised changes in equity during the reporting period comprise:
• income minus expenses recognised in the statement(s) of financial performance;
and
• contributions from, minus distributions to, holders of equity claims. [CF 5.3].
A particularly important facet of classification is determining whether items of financial
performance should be considered part of profit and loss or as other comprehensive income.
10.2.3.A
Profit or loss and other comprehensive income
Income and expenses are classified and included either:
• in the statement of profit or loss; or
• outside the statement of profit or loss, in other comprehensive income. [CF 7.15].
The statement of profit or loss is the primary source of information about an entity’s
financial performance for the reporting period. That statement contains a total for profit
or loss that provides a highly summarised depiction of the entity’s financial performance
for the period. Many users of financial statements incorporate that total in their analysis
either as a starting point for that analysis or as the main indicator of the entity’s financial
performance for the period. Nevertheless, understanding an entity’s financial
performance for the period requires an analysis of all recognised income and expenses,
including income and expenses included in other comprehensive income, as well as an
analysis of other information included in the financial statements. [CF 7.16].
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Because the statement of profit or loss is the primary source of information about an
entity’s financial performance for the period, all income and expenses are, in principle,
included in that statement. Indeed, the Board observes that its intention in establishing
this principle was to emphasise that the statement of profit or loss is the default location
for income and expenses. [CF 7.17, BC7.24].
However, in developing standards, the Board may decide in exceptional
circumstances that income or expenses arising from a change in the current value of
an asset or liability are to be included in other comprehensive income when doing
so would result in the statement of profit or loss providing more relevant
information, or providing a more faithful representation of the entity’s financial
performance for that period. [CF 7.17].
Income and expenses that arise on a historical cost measurement basis (see Figure 2.3)
are included in the statement of profit or loss. That is also the case when income and
expenses of that type are separately identified as a component of a change in the current
value of an asset or liability. For example, if a financial asset is measured at current value
and if interest income is identified separately from other changes in value, that interest
income is included in the statement of profit or loss. [CF 7.18]. This use of more than one
measurement basis is discussed at 9.3.5 above.
In the view of the Board, if the statement of profit or loss is the primary source of
information about financial performance for a period, the cumulative amounts included
in that statement over time need to be as complete as possible. As a consequence,
income and expenses can only be excluded permanently from the statement of profit
or loss if there is a compelling reason in to do so in any particular case. [CF BC7.29]. In
principle, therefore, income and expenses included in other comprehensive income in
one period are reclassified from other comprehensive income into the statement of
profit or loss in a future period when doing so results in the statement of profit or loss
providing more relevant information, or providing a more faithful representation of the
entity’s financial performance for that future period.
However, if, for example, there is no clear basis for identifying the period in which
reclassification would have that result, or the amount that should be reclassified, the
Board may, in developing standards, decide that income and expenses included in other
comprehensive income are not to be subsequently reclassified. [CF 7.19].
10.3 Aggregation
Aggregation is the adding together of assets, liabilities, equity, income or expenses that
have shared characteristics and are included in the same classificat
ion. [CF 7.20].
Aggregation makes information more useful by summarising a large volume of detail.
However, aggregation conceals some of that detail. Hence, a balance needs to be found
so that relevant information is not obscured either by a large amount of insignificant
detail or by excessive aggregation. [CF 7.21].
Different levels of aggregation may be needed in different parts of the financial
statements. For example, typically, the statement of financial position and the
statement(s) of financial performance provide summarised information and more
detailed information is provided in the notes. [CF 7.22].
The IASB’s Conceptual Framework 103
11
CHAPTER 8: CONCEPTS OF CAPITAL AND CAPITAL
MAINTENANCE
The concept of capital maintenance is concerned with how an entity defines the capital
that it seeks to maintain. It is a prerequisite for distinguishing between an entity’s return
on capital (that is, profit) and its return of capital. In general terms, an entity has
maintained its capital if it has as much capital at the end of the period as it had at the
beginning of the period. Any amount over and above that required to maintain the
capital at the beginning of the period is profit. [CF 8.4, 8.6].
The Framework identifies two broad concepts of capital maintenance:
• financial capital maintenance (see 11.1 below); and
• physical capital maintenance (see 11.2 below).
The principal difference between the two concepts of capital maintenance is the
treatment of the effects of changes in the prices of assets and liabilities of the entity.
[CF 8.6]. The selection of the appropriate concept of capital by an entity should be based
on the needs of the users of its financial statements. [CF 8.2].
The concept of capital maintenance chosen by an entity will determine the accounting
model used in the preparation of its financial statements. Most entities adopt a financial
concept of capital. It is explained that different accounting models exhibit different
degrees of relevance and reliability, and it is for management to seek a balance between
relevance and reliability (see 5 above for a discussion of the qualitative characteristics
of useful financial information). [CF 8.9].This use in Chapter 8 of the Framework of the
term ‘reliability’ seems to be a drafting error – the term was used in the 1989 Framework
but was replaced in the 2010 Framework with the term ‘faithful representation’. As the
text concerned has been carried forward unchanged from the 1989 Framework to the
current one, the failure to update this reference seems to us to be an oversight. The
Framework notes that the IASB does not prescribe a particular model other than in
exceptional circumstances, such as in a hyperinflationary economy (see Chapter 16).
This intention will, however, be reviewed in the light of world developments. [CF 8.1, 8.9].
The Framework notes that the revaluation or restatement of assets and liabilities gives
rise to increases or decreases in equity that meet the definition of income and expenses,
but – under certain concepts of capital maintenance – are included in equity as capital
maintenance adjustments or revaluation reserves. [CF 8.10].
11.1 Financial
capital
maintenance
Under a financial concept of capital, such as invested money or invested purchasing
power, capital is synonymous with the net assets or equity of the entity. Under this
concept a profit is earned only if the financial (or money) amount of the net assets at the
end of the period exceeds the financial (or money) amount of net assets at the beginning
of the period, after excluding any distributions to, and contributions from, owners
during the period. [CF 8.1, 8.3(a)].
Financial capital maintenance can be measured in either nominal monetary units or units
of constant purchasing power. [CF 8.3(a)]. The financial capital maintenance concept does
not require a particular measurement basis to be used. Rather, the basis selected depends
upon the type of financial capital that the entity is seeking to maintain. [CF 8.5].
104 Chapter
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Where capital is defined in terms of nominal monetary units, profit represents the
increase in nominal money capital over the period. This has the implication that
increases in the prices of assets held over the period, conventionally referred to as
holding gains, are conceptually profits. They may not be recognised as such, however,
until the assets are disposed of in an exchange transaction. [CF 8.7].
When the concept of financial capital maintenance is defined in terms of constant
purchasing power units, profit represents the increase in invested purchasing power
over the period. Thus, only that part of the increase in the prices of assets that exceeds
the increase in the general level of prices is regarded as profit. The rest of the increase
is treated as a capital maintenance adjustment and, hence, as part of equity. [CF 8.7].
11.2 Physical capital maintenance
Under this concept a profit is earned only if the physical productive capacity (or
operating capability) of the entity (or the resources or funds needed to achieve that
capacity) at the end of the period exceeds the physical productive capacity at the
beginning of the period, after excluding any distributions to, and contributions from,
owners during the period. [CF 8.3(b)]. The physical capital maintenance concept requires
the current cost basis of measurement to be adopted. [CF 8.5].
Because capital is defined in terms of the physical productive capacity, profit represents
the increase in that capital over the period. Price changes affecting the assets and
liabilities of the entity are changes in the physical productive capacity of the entity,
which are therefore treated as capital maintenance adjustments within equity and not
as profit. [CF 8.8].
12 MANAGEMENT
COMMENTARY
Over a number of years, a number of individual countries have issued regulations or
guidance requiring or encouraging the preparation of narrative ‘management
commentary’ to accompany the financial statements.
In December 2010 the IASB published its first guidance on management commentary –
Management Commentary – A Framework for Presentation – as a non-binding ‘IFRS
Practice Statement’. The introduction to the Practice Statement clarifies that it is neither
an IFRS nor part of the Framework. However, it has been prepared on the basis that
management commentary meets the definition of other financial reporting in the
Preface to International Financial Reporting Standards, and is therefore within the
scope of the Framework. Consequently, the Statement should be read ‘in the context
of’ the Framework. [MC.IN2, IN4].
Management commentary is described as a narrative report that relates to financial
statements that have been prepared in accordance with IFRSs. Management
commentary provides users with historical explanations of the amounts presented in
the financial statements, specifically the entity’s financial position, financial
performance and cash flows. It also provides commentary on an entity’s prospects and
other information not presented in the financial
statements. Management commentary
also serves as a basis for understanding management’s objectives and its strategies for
achieving those objectives. [MC Appendix]. For many entities, management commentary is
The IASB’s Conceptual Framework 105
already an important element of their communication with the capital markets,
supplementing as well as complementing the financial statements. [MC.IN3].
The Practice Statement is intended to set out a broad framework for the preparation of
management commentaries, to be applied by management of individual reporting
entities to their own specific circumstances. [MC.IN5]. However, the IASB believes that
that all management commentary should:
• provide management’s view of the entity’s performance, position and progress; and
• supplement and complement information presented in the financial statements.
[MC.12].
Management commentary should include information that is forward-looking and has
the qualitative characteristics referred to in the Framework. [MC.13].
The IASB also envisages that any management commentary will include the following
elements:
• the nature of the business;
• management’s objectives and strategies for meeting those objectives;
• the entity’s most significant resources, risks and relationships;
• the results of operations and prospects; and
• the critical performance measures and indicators that management uses to
evaluate the entity’s performance against stated objectives. [MC.24].
106 Chapter
2
References
1 W. A. Paton and A. C. Littleton, An Introduction
Concepts and Standards for External Financial
to Corporate Accounting Standards, Monograph
Reports, Statement on Accounting Theory and
No. 3, American Accounting Association, 1940.
Theory Acceptance, 1977. The 1977 report
2
See, for example: American Accounting
concluded that closure on the debate was not
Association, Executive Committee, ‘A Tentative
feasible, which is perhaps indicative of the
Statement of Accounting Principles Affecting
complexity of the problem.
Corporate Reports’, Accounting Review, June
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 22
