Accounting Principles and Concepts: Framework and Conventions
This domain tests the conceptual framework: qualitative characteristics, underlying assumptions, and the conventions that decide when and how much to recognize. Exam questions usually describe a situation and ask which principle applies or which one is violated.
Core rules
- Fundamental qualitative characteristics: relevance and faithful representation. Enhancing characteristics: comparability, verifiability, timeliness, and understandability. Cost is the pervasive constraint.
- Underlying assumptions: going concern, accrual basis, stable measuring unit, and periodicity.
- Conventions: historical cost, revenue recognition, matching, prudence, consistency, materiality, and full disclosure.
- Prudence means neutral, cautious judgment under uncertainty, not deliberate understatement of assets or overstatement of liabilities.
Worked example
A retailer sells goods in December with a 12-month warranty and estimates the warranty cost at 2% of ₩50,000,000 sales, or ₩1,000,000. Under accrual and matching, the ₩1,000,000 warranty expense and provision are recognized in December, when the sale and the related obligation arise, even though no claim has been paid. Recognizing the cost only when a customer claims would match it against a later period and overstate December profit.
Traps
- Using conservatism to create hidden reserves; K-IFRS prohibits deliberate understatement.
- Treating materiality as a fixed percentage; it is judgment based on both size and nature.
- Reading consistency as never changing a policy; changes are permitted with disclosure and retrospective application where required.
- Confusing a change in estimate, applied prospectively, with a change in policy, applied retrospectively.