Financial Accounting II Lecture 19

In July 1989 the International Accounting Standard Board (IASB) (then IASC) produced a document, called framework for the preparation and presentation of financial statements.

The Framework is, in fact, the conceptual framework upon which all IAS’s are based and hence which determines how financial statements are prepared and the information they contain.

The Framework consist of several sections, these sections are as follows: The Objective of Financial Statements. Underlying Assumptions. Qualitative Characteristics of Financial Statements.

The Elements of Financial Statements. Recognition of the Elements of Financial Statements. Measurement of the Elements of Financial Statements. Concepts of Capital and Capital Maintenance.

The objective of the financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a vide range of users in making economic decisions. Objectives of Financial Statements

Financial position, Performance, and Changes in financial position Objectives of Financial Statements

Financial position (balance sheet) shows the economic resources controlled (assets) by the enterprise, the financial structure (capital structure) and the liquidity and solvency (short and long term commitments and receivables). OBJECTIVES - Financial Position

Financial performance (profit and loss) shows the information particularly profitability. OBJECTIVES - Financial Performance

Changes in financial position (cash flow) is used to assess the entity’s investing (non current assets), financing (equity and long term liabilities) and operating activities. OBJECTIVES - Changes in Financial Position

Financial statements are prepared on the following assumptions. Accruals basis Going concern Underlying Assumptions

The effects of transactions and other events are recognised when they occur (and not at the time of receipt or payment). ASSUMPTIONS - Accrual

The concept implies that the business will continue to operate for the foreseeable future. It is assumed that the entity has neither the intention nor the need to liquidate or curtail its operations. ASSUMPTIONS - Going Concern

The affect of going concern assumption is that assets and liabilities of the business are meant to be held for till their maturity (or useful life to the business) and are therefore measured and reported at their cost. If the business is not considered to be a going concern then the assets and liabilities would have to be shown at their current market value. ASSUMPTIONS - Going Concern

The financial statements (or any information) should possess following qualitative characteristics: Understandability Relevance Materiality Reliability Faithful representation Substance over form Qualitative Characteristics

Neutrality Prudence Completeness Comparability Timeliness Balance between cost and benefit Balance between qualitative characteristics True and fair presentation Qualitative Characteristics

Example Items that are material in size, but not in nature The total carrying amount of the machinery is Rs. 500,000, and included therein is a particular machine A, with a carrying amount of Rs. 450,000. The total carrying amount of furniture is Rs. 300,000 and the total carrying amount of office equipment is Rs. 310,000. The company’s materiality limit is Rs. 300,000

Example Explain whether or not Machine A should be separately disclosed from the other material based on its material size, and The furniture and equipment should be disclosed as two separate categories based on the materiality of the size of the carrying amounts of each category relative to the company’s materiality limit.

Example Machine A and other machinery: Despite the fact that machine A is material in size, machine A should be separately disclosed since, with reference to most user’s need, this is not material in nature (a separate description of machine A would be information more of a technical than a financial nature and would thus mean very little to most user).

Example Furniture and Office Equipment: Similarly, despite the materiality of individual sizes of the carrying amounts involved, office furniture and equipment should be aggregated due to their common nature.

Example Items that are material in nature, but not in size The total carrying amount of furniture is Rs. 200,000, and the total carrying amount of machinery is Rs. 250,000. The company’s materiality limit is Rs. 300,000. Explain whether or not furniture and machinery should be disclosed as two separate categories.

Example Furniture and machinery should be disclosed as two separate categories even though the carrying amount of each category is below the materiality limit because, as far as the user is concerned, there is a material difference in the nature between furniture and machinery.

Reliability – Information has a quality of reliability when it is free from material error and bias. Qualitative Characteristics