Part 1 Conceptual Framework and Regulatory Framework for Financial Reporting Topic 1 The IASB framework of financial reporting The framework for the preparation and presentation of financial statements sets out the concepts that underlie the preparation and presentation of financial statements. The framework document is also the IASB’s conceptual framework identifying the principles upon which accounting standards are to be developed. The Framework is a non-mandatory statement, it is not an IAS and nothing in the Framework overrides the specific requirements of any particular IAS or IFRS. 5-1

Topic 1 The IASB framework of financial reporting Objectives of Framework Defines the objective of financial statement Identifies the qualitative characteristics that make information in financial statements useful; and Defines the basic elements of financial statements and the concepts for recognizing and measuring them in financial statements. 5-2

Topic 1 The IASB framework of financial reporting Objectives of Financial Statement The objective of financial statements is to provide information about the reporting entity that is useful to existing and potential investors,lenders and other creditors in making decisions about providing rescources to the entity. 5-3

Topic 1 The IASB framework of financial reporting Underlying Assumptions The framework sets out the underlying assumptions of financial statements: Accrual Basis: The effects of transactions and other events are recognized when they occur, rather than when cash or its equivalent is received or paid, and they are reported in the financial statements of the periods to which they relate. 5-4

Topic 1 The IASB framework of financial reporting Underlying Assumptions The framework sets out the underlying assumptions of financial statements: Going Concern: The financial statements presume that an enterprise will continue in operation indefinitely or, if that presumption is not valid, disclosure and a different basis of reporting are required. 5-5

Topic 1 The IASB framework of financial reporting Qualitative characteristics of financial statements The Conceptual Framework distinguishes between fundamental and enhancing qualitative characteristics, for analysis purposes. Fundamental qualitative characteristics distinguish useful financial reporting information from information that is not useful or misleading. Enhancing qualitative characteristics distinguish more useful information from less useful information. 5-6

Topic 1 The IASB framework of financial reporting Qualitative characteristics of financial statements The two fundamental qualitative characteristics are relevance and faithful representation. 5-7

Relevance Relevant information is capable of making a difference in the decisions made by users. It is capable of making a difference in decisions if it has predictive value, confirmatory value or both. The relevance of information is affected by its nature and its materiality. Materiality. Information is material if omitting it or misstating it could influence decisions that users make on the basis of financial information about a specific reporting entity.

Faithful representation Financial reports represent economic phenomena in words and numbers. To be useful, financial information must not only represent relevant phenomena but must faithfully represent the phenomena that it purports to represent. To be a faithful representation information must be complete, neutral and free from error.

Substance over form This is not a separate qualitative characteristic under the Conceptual Framework. The IASB says that to do so would be redundant because it is implied in faithful representation. Faithful representation of a transaction is only possible if it is accounted for according to its substance and economic reality

Enhancing qualitative characteristics Comparability Comparability is the qualitative characteristic that enables users to identify and understand similarities in, and differences among, items. Information about a reporting entity is more useful if it can be compared with similar information about other entities and with similar information about the same entity for another period or date.

Consistency, although related to comparability, is not the same Consistency, although related to comparability, is not the same. It refers to the use of the same methods for the same items (i.e. consistency of treatment) either from period to period within a reporting entity or in a single period across entities. The disclosure of accounting policies is particularly important here. Users must be able to distinguish between different accounting policies in order to be able to make a valid comparison of similar items in the accounts of different entities. Comparability is not the same as uniformity. Entities should change accounting policies if those policies become inappropriate.

Verifiability Verifiability helps assure users that information faithfully represents the economic phenomena it purports to represent. It means that different knowledgeable and independent observers could reach consensus that a particular depiction is a faithful representation. Information that can be independently verified is generally more decision-useful than information that cannot.

Timeliness Timeliness means having information available to decision-makers in time to be capable of influencing their decisions. Generally, the older information is the less useful it is. Information may become less useful if there is a delay in reporting it. There is a balance between timeliness and the provision of reliable information. If information is reported on a timely basis when not all aspects of the transaction are known, it may not be complete or free from error.

Topic 1 The IASB framework of financial reporting Understandability The information should be in a form that is understandable by user groups. Problem- Users have different levels of financial sophistication; also the very complexity of business transactions makes it difficult to provide adequate disclosure whilst maintaining simplicity. 5-15

Topic 1 The IASB framework of financial reporting The elements of financial statements Elements of financial statements Measurement of financial position in Statement of financial position Measurement of performance in Statement of profit or loss and other comprehensive income 5-16

Topic 1 The IASB framework of financial reporting The elements of financial statements The elements directly related to financial position (statement of financial position) are: Assets Liabilities Equity An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise. 5-17

Topic 1 The IASB framework of financial reporting The elements of financial statements A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits. Equity is the residual interest in the assets of the enterprise after deducting all its liabilities. 5-18

Attention! Asset: Liability: Transactions or events in the past give rise to assets; those expected to occur in the future do not in themselves give rise to assets. For example, an intention to purchase a noncurrent asset does not, in itself, meet the definition of an asset. Liability: It is important to distinguish between a present obligation and a future commitment. A management decision to purchase assets in the future does not, in itself, give rise to a present obligation. Is a provision a liability?

Topic 1 The IASB framework of financial reporting The elements directly related to performance (income statement) are: Income Expenses 5-20

Topic 1 The IASB framework of financial reporting The elements directly related to performance (income statement) are: Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increase in equity, other than those relating to contributions from equity participants. Both revenue and gains are included in the definition of income. Revenue arises in the course of ordinary activities of an entity. Gains. Increases in economic benefits. As such they are no different in nature from revenue. Gains include those arising on the disposal of non-current assets. The definition of income also includes unrealised gains, eg on revaluation of marketable securities. 5-21

Expenses are decrease in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. As with income, the definition of expenses includes losses as well as those expenses that arise in the course of ordinary activities of an entity. Losses. Decreases in economic benefits. As such they are no different in nature from other expenses. Losses will include those arising on the disposal of noncurrent assets. The definition of expenses will also include unrealised losses, eg the fall in value of an investment.

Question Consider the following situations. In each case, do we have an asset or liability within the definitions given by the Conceptual Framework? Give reasons for your answer. a) Pat Co has purchased a patent for $20,000. The patent gives the company sole use of a particular manufacturing process which will save $3,000 a year for the next five years. b) Baldwin Co paid Don Brennan $10,000 to set up a car repair shop, on condition that priority treatment is given to cars from the company's fleet. c) Deals on Wheels Co provides a warranty with every car sold

Recognition of the elements of financial statements Items which meet the definition of assets or liabilities may still not be recognised in financial statements because they must also meet certain recognition criteria. An item that meets the definition of an element and satisfies the following criteria for recognition: a) it is probable that any future economic benefit associated with the item will flow to or from the entity; and b) the item has a cost or value that can be measured with reliabilit

Topic 1 The IASB framework of financial reporting Measurement of the elements of financial statements Measurement. The process of determining the monetary amounts at which the elements of the financial statements are to be recognised and carried in the statement of financial position and statement of profit or loss and other comprehensive income. A number of different measurement bases are used in financial statements. They include – Historical cost – Current cost – Realisable (settlement) value – Present value of future cash flows 5-25

Topic 1 The IASB framework of financial reporting Measurement of the elements of financial statements Current cost Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently. 5-26

Realisable value. The amount of cash or cash equivalents that could currently be obtained by selling an asset in an orderly disposal. Present value. A current estimate of the present discounted value of the future net cash flows in the normal course of business.

Historical cost is the most commonly adopted measurement basis, but this is usually combined with other bases, eg inventory is carried at the lower of cost and net realisable value. Recent standards use the concept of fair value, which is defined by IFRS 13 as ‘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’

Topic 1 The IASB framework of financial reporting IAS 1 Presentation of Financial Statements Statement of Financial Position (P36) Statement of Comprehensive Income (P41) Statement of Change in Shareholders’ Equity (P49) 5-29

IAS 1 Example 10. Which of the following is not a purpose of IASB's conceptual framework? A. To assist IASB in the prepareration and review of IFRS B. To assist auditors in the forming an opinion on whether financial statements comply with IFRS C. To assist in determining the treatement of items not covered by an exisiting IFRS D. To be authoritative where a spcific IFRS confilic with the CF.

IAS 1 Example 19. Financial Statements represent transaction in words and numbers. To be useful financial imformation must represent faithfully theses transactions int erms of how they are report. Which of following accounting treatment would be an example of faithful representation? A. Charging an rental payments for an item of plant to the statement of profit and loss where the rental agreement meets the criteria for a finance lease B. Including a convertiable loan note in equity basis that the holders are likely to choose the equity option on conversion C. Deregonizing factored trade receivable sold without recourse D. Treating redeemable preference share as part of equity in the SFP.