© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

Constructing Financial Reports: IFRS and the Framework of Accounting CHAPTER 4 Constructing Financial Reports: IFRS and the Framework of Accounting © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 © 2009 John Wiley & Sons, Ltd, Accounting for Managers, 3rd ed., 9780470777640 Ch 1

Learning Objectives What is management’s basic responsibility regarding a company’s financial statements? What parties are generally considered to be the external users of a company’s financial statements? What are the objectives, elements, and qualitative characteristics of financial statements? How is accrual accounting applied in the recording of prepayments accruals, provisions, and depreciation? © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 Accounting provides an explanation or report in financial terms about the transactions of an organization to satisfy stakeholders Financial statements or reports (Company’s Accounts) Income Statement Balance Sheet Cash Flow Statement International Financial Reporting Standards (IFRS) applicable to public entities Accounting Standards for Private Entities (ASPE) applies to private companies © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

Management’s Responsibility for Fair Presentation Financial reports must present fairly the financial position, financial performance, and cash flows of an entity be prepared according to generally accepted accounting principles (GAAP) be audited or reviewed to ensure that this is the case © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

International Financial Reporting Standards (IFRS) Global harmonization of standards Excluding US International Accounting Standards Board (IASB) responsible for developing “a single set of high-quality, understandable, enforceable and globally accepted international financial reporting standards” Accounting standards are principles based © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

International Financial Reporting Standards (IFRS) IFRS Objectives Promote the use and rigorous application of those standards Take account of the financial reporting needs of emerging economies and small and medium-sized entities (SMEs) Bring about convergence of national accounting standards and IFRSs to high-quality solutions IFRS and ASPE set out recognition, measurement, presentation, and disclosure requirements dealing with transactions and events that are important in general-purpose financial statements (directed toward the common information needs of a wide range of users) © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

Conceptual Framework for Financial Reporting Seeks to harmonize regulations, accounting standards, and procedures relating to the preparation and presentation of financial statements The Conceptual Framework deals with The objectives of financial reporting The qualitative characteristics of useful financial information The definition, recognition, and measurement of the elements from which financial statements are constructed © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 © 2009 John Wiley & Sons, Ltd, Accounting for Managers, 3rd ed., 9780470777640 Ch 1

Conceptual Framework for Financial Reporting A complete set of financial statements or reports includes Statement of Financial Position Statement of Comprehensive Income Statement of Changes in Shareholders’ Equity Statement of Cash Flows Notes to the financial statements © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 © 2009 John Wiley & Sons, Ltd, Accounting for Managers, 3rd ed., 9780470777640 Ch 1

Objectives of Financial Statement To provide financial information about the reporting entity that is helpful to the users in making decisions about providing resources to the entity decision usefulness © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

Qualitative Characteristics of Financial Statements Relevance Predictive and confirmatory value Affected by materiality Faithful representation Comparability Verifiability Timeliness Understandability © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

Elements of Financial Statements Assets Liabilities Equity Income Revenues Gains Expenses Losses © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

Elements of Financial Statements Recognition Incorporating in the Statement of Financial Position or Statement of Comprehensive Income items in words and monetary measurement that meets the definition of an element Element should be recognized if both of the following are true: 1. It is probable that any future economic benefit associated with the item will flow to or from the entity 2. The item has a cost or value that can be measured with reliability © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

Elements of Financial Statements Measurement The process of determining the monetary amount at which elements are recognised in the Statement of Financial Position or Statement of Comprehensive Income Four bases of measurement: 1. Historical cost 2. Current cost 3. Realizable value 4. Present value © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

Reporting Profitability: The Statement of Comprehensive Income Profit = Income - Expenses © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 © 2009 John Wiley & Sons, Ltd, Accounting for Managers, 3rd ed., 9780470777640 Ch 1

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 Matching Principle Matching income with the expenses incurred in earning that income Income Revenue (sales, fees, interest, rent, etc.) Gains (disposal of non-current assets, revaluations) Expenses Expenses (salaries, advertising, etc.) Losses (fire & flood, sale of non-current assets) © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 Reporting Profitability: The Statement of Comprehensive Income - Extended Operating profit = Gross profit - Expenses © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 © 2009 John Wiley & Sons, Ltd, Accounting for Managers, 3rd ed., 9780470777640 Ch 1

Reporting Financial Position: The Statement of Financial Position Asset is classified as current asset when: Expected to realize the asset, or intends to sell or consume it in its normal operating cycle or within 12 months after the reporting period whichever is the longest It holds the asset primarily for the purpose of trading The asset is cash or a cash equivalent © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

Reporting Financial Position: The Statement of Financial Position Assets Current Money in Bank Accounts receivable Inventory Non current Tangible (Property, plant and equipment) Intangible (Patents, trademarks) © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

Reporting Financial Position: The Statement of Financial Position Liabilities Current Accounts payables Loans, taxes, etc. payable within 12 months Non current Loans repayable after 12 months Shareholders Equity (or Capital) Shareholders’ investment and retained profits © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

Reporting Financial Position: The Statement of Financial Position Net assets = Total assets – total liabilities (equal to equity) or Assets = liabilities + equity or Assets - liabilities = equity © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

Reporting Financial Position: The Statement of Financial Position © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 © 2009 John Wiley & Sons, Ltd, Accounting for Managers, 3rd ed., 9780470777640 Ch 1

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 Accrual Accounting Recognizes income when it is earned and expenses when they are incurred Cash versus accruals accounting Matching principle Adjustments for Prepayments Accruals Provisions Depreciation © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

Prepayments and accruals © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 Provisions Doubtful debts (Bad Debts) Inventory Depreciation The term “Amortization” is used for intangible assets, such as patents or copyrights) Each of the above items is a deduction from the its asset value in the Balance Sheet © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 Depreciation Depreciation is an expense that spreads the cost of the asset over its useful life © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

Reporting cash flow: The Statement of Cash Flows Movement in cash during a financial period From operations Depreciation Increases or decreases in working capital Interest receipts and payments Income tax paid Capital expenditure Dividends paid New borrowings or repayments of borrowings © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

Statement of Cash Flows © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 Cash Flow Statement Cash flow from operations: Operating Profit + depreciation (non-cash) +/- change in working capital - interest - income taxes - capital expenditure - dividends +/- new borrowings or repayment of borrowings = Net increase in Cash © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

Critical Perspective on Accounting Standards Continual changes in standards Practical implementation issues (e.g., Pension funds and stock options) Exclusion of US from IFRS Complexity Lobbying effect on standards (e.g., Enron) Standards can lead to more creativity Narrow accounting focus © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 Conclusion Financial Statements Statement of comprehensive income Statement of financial position Statement of cash flows IFRS and Conceptual Framework Accruals, prepayments, provisions Depreciation Critique of standards © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4