The understanding was reached during the current round of talks here between Menon and his designated Chinese counterpart Dai Bingguo.
"Dai and I agreed on a common understanding on discussions on the framework for a boundary settlement," Menon told media here on Tuesday.
Menon and Dai, the Special Representatives for the boundary talks, held three rounds of parleys yesterday spanning about six hours.
Elaborating, Menon said the border talks are currently in the second stage of a three-stage process which had been agreed in the beginning.
The first stage was to work out the guiding principles. It resulted in the 2005 agreement on the political parameters and guiding principles for boundary settlement.
The second stage is aimed at working out a framework for boundary settlement.
"Once we have a framework we will proceed to actual business of drawing boundary that is fair, reasonable and mutually acceptable," he said.
"We are in the middle of the second stage. What we try to do in the common understanding which we prepared was to say where we are today," he said.
"Overall when we looked at our relationship and when we looked at the boundary that we have actually made considerable progress and we handled the relationship well. The border is peaceful and we made progress towards settlement," he added.
"There is work still to be done. Both sides recognise that," Menon said, adding they have not allowed the boundary issue to prevent all-round development of relations.
The two countries launched the mechanism of meetings between Special Representatives on border issues in 2003.
Dai, who would be retiring in March, has remained China's Special Representative in all the 15 rounds so far.
India asserts that the dispute covered about 4,000 km, while China claims that it is confined to about 2000 km to the area of Arunachal Pradesh, which it refers to as Southern Tibet.
Menon, who also met Foreign Minister Yang Jiechi yesterday, wound up his visit today after calling on Wu Bangguo, the number two in the outgoing leadership of the ruling Communist Party, ranked next to President Hu Jintao.
His meeting with Wu, also the Chairman of China's national legislature, the National People's Congress, was an anti-climax as he had not met any members of the all-powerful new seven-member Standing Committee of the CPC.
Menon's visit was partly aimed at establishing contacts with the new leadership headed by CPC General Secretary Xi Jinping.
Earlier, he was expected to meet Vice Premier Li Keqiang, who is to replace Chinese Premier Wen Jiabao.
Menon is the first foreign dignitary to visit China after the leadership change at the 18th Congress of the ruling Communist Party of China last month.
On his part, Menon said he was not disappointed.
"Not at all. I actually got bumped up. I got to meet the Chairman of the NPC," he said answering a question.
But at the same time, he said he extended a message from Prime Minister Manmohan Singh to new CPC leader Xi, greeting him on his election.
Xi, in turn, conveyed a message back welcoming Singh's good wishes.
"We conveyed our message and they conveyed theirs. We expect this relationship to continue to develop and deepen. It is in our objective interest and theirs. Frankly, it is a relationship which is getting important to the region and the world," he said.
Menon also refuted a report in the Indian media that claimed the two sides were far from resolving the vexed issue, saying it was factually untrue, speculative and misleading.
He said he and Dai reached a common understanding which would be reported to the leadership of the two countries.
Asked whether the two countries had differences over the 2005 agreement on guiding principles, Menon said, "We moved beyond 2005 agreement. We both have an understanding of it, we might have had differences on bits and pieces."
"Basically we moved on that and when I say common understanding... That means we have moved beyond. Important thing is that we sat together and went over this and confirmed. Now we will tell our leadership," he said.
"Until you get the agreement, there will always be differences. The two sides are in the process of reducing differences.... Today we cannot say we are at the final point. It is complex, it is an issue that has been there (for) sometime and it is politically sensitive for both sides. We will have to work our way through that. We have increased the understanding between us steadily, thanks to the Special Representatives process," he said.
Menon's function to release a book on Chinese translation of the works of Prof. PC Bagchi, regarded as India's most eminent scholar on Chinese culture, as well as scheduled address on India-China relations at the Indian embassy today was cancelled as a mark of respect for former Prime Minister IK Gujral, who passed away on Nov 30.
Menon said during his talks here, the Chinese leaders maintained that India will continue to be on high priority in China's foreign policy.
The leaders whom he met "described the outcomes of the 18th party Congress, especially in terms of foreign policy lines and the areas they concentrate on", he said. "All three emphasised that India is and will remain a high priority and (that they) look forward to smoothing development and deepening of relationship," he said.
Menon said the two countries had a series of engagements which included the Special Economic Dialogue held last month in New Delhi.
"So many things are changing, including World economy. We need enabling environment for development and how we can carry the relationship forward," he said.
"It is useful, good and timely. We go home satisfied. On the substance common understanding we have to tell the leaders first," he said about his visit here.
About Navy Chief Admiral DK Joshi's remarks that Indian Navy will operate in South China Sea, Menon said they were misinterpreted.
The reporting on Joshi's remarks amounted to stretching the truth, he said.
Asked whether the Chinese side raised Joshi's remarks with him, Menon said no.
"They recognise that media plays a role. In the past they complained," he said, adding that media should reflect realities of what India and China are doing with each other.
"When you look at the range of India-China engagement, when you look at the fact how peaceful that border is, the progress achieved in the boundary settlement, the congruence the two had on several international issues, you get a more balanced picture of the relationship, its potential."