Accounting for Assets BCM 2104

Introduction to A.S. Conceptual framework for financial reporting. Accounting for Cash and receivables [IAS 7: Statement of cash flows]. Accounting for Inventories [IAS 2: Inventories]. Accounting For Property, Plant and Equipment Assets [IAS 16: Property, Plant and Equipment]. Accounting for Intangible Assets [IAS 38: Intangible assets]. Impairment of assets [IAS 36: Impairment of Assets] Accounting for Long term construction contracts [IAS 11: Construction Contracts]. Accounting for Investments [IAS 40: Investment Property]. Accounting for Agriculture [IAS 41: Agriculture]. 11/21/2019 MIS Notes

Framework for the Preparation and Presentation of Financial Statements Session One

Learning objectives The objectives of this session are to enable the learner: Understand the conceptual framework for financial reporting; Apply the requirements of the CF for FR in various accounting practices,

What is the Conceptual Framework? A practical tool that assists Board Preparers to develop Standards to understand and interpret Standards to develop consistent accounting policies All Addresses fundamental issues What is the objective of financial reporting? What makes financial information useful? What are assets, liabilities, equity, income and expenses, when should they be recognised and how should they be measured, presented and disclosed?

Purpose and status of the FW The Framework sets out the concepts that underlie the preparation and presentation of financial statements for external users. The purpose of the Framework is to: (a) assist the Board of IASB in the development of future International Accounting Standards and in its review of existing International Accounting Standards; (b) assist national standard-setting bodies in developing national standards;

Purpose and status (c) assist the Board of IASC in promoting harmonisation of regulations, accounting standards and procedures relating to the presentation of financial statements (d) assist preparers of financial statements in applying International Accounting Standards and in dealing with topics that have yet to form the subject of an International Accounting Standard; (e) assist auditors in forming an opinion as to whether financial statements conform with International Accounting Standards;

Purpose and status (f) assist users of financial statements in interpreting the information contained in financial statements prepared in conformity with International Accounting Standards; and (g) provide those who are interested in the work of IASC with information about its approach to the formulation of International Accounting Standards.

Users and their information needs The users of financial statements include: present and potential investors, employees, lenders, suppliers and other trade creditors, customers, governments and their agencies and the public. They use financial statements in order to satisfy some of their different needs for information.

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

Objective of FSs cont’d… However, financial statements do not provide all the information that users may need to make economic decisions. Financial statements also show the results of the stewardship of management, or the accountability of management for the resources entrusted to it. Ref. to the agency theory.

Financial position The financial position of an entity is affected by: the economic resources it controls, its financial structure, its liquidity and solvency, and its capacity to adapt to changes in the environment in which it operates.

Financial performance The performance of an entity, in particular its profitability, is required in order to assess potential changes in the economic resources that it is likely to control in the future. How do we measure the profitability of an entity? Information about variability of performance is important in this respect for example: PW Limited Income statement for the year ended 31 March 2011 (Financial perf. for the last 4 years) 2008 2009 2010 2011 Sh. 'million' Net profit before tax 5,800 5,985 8,452 9,632 Tax (1,740) (1,796) (2,536) (2,890) Net profit after tax 4,060 4,190 5,916 6,742

Changes in financial performance Information concerning changes in the financial position of an entity is useful in order to assess its: investing, financing and operating activities during the reporting period.

Review Underlying assumptions, Qualitative characteristics of financial statements, Constraints on relevant and reliable information, The elements of financial statements

Review: contents Underlying assumptions, Accrual basis and going concern. Qualitative characteristics of financial statements, Understandability; Relevance-Materiality; Reliability-Faithful representation, Substance over form, Neutrality, Prudence, Completeness; Comparability Constraints on relevant and reliable information, Timeliness; Balance between benefit and cost; Balance between qualitative characteristics The elements of financial statements: Assets, liabilities, equity, income, expenses.

Capital maintenance adjustments The revaluation or restatement of assets and liabilities gives rise to increases or decreases in equity. Concepts of capital maintenance:

Financial capital maintenance Under this concept a profit is earned only if the financial (or money) amount of the net assets at the end of the period exceeds the financial (or money) amount of net assets at the beginning of the period. i.e., Closing net assets - Opening net assets = Profit earned. This is after excluding any distributions to, and contributions from, owners during the period.

Physical capital maintenance Under this concept a profit is earned only if the physical productive capacity (or operating capability) of the entity (or the resources or funds needed to achieve that capacity) at the end of the period exceeds the physical productive capacity at the beginning of the period i.e., Ending physical productivity – Beginning physical productivity = Profit earned this is after excluding any distributions to, and contributions from, owners during the period.

Recognition of the elements of financial statements Criteria for recognition: An item that meets the definition of an element should be recognised if: (a) it is probable that any future economic benefit associated with the item will flow into or from the entity; and (b) the item has a cost or value that can be measured with reliability.

Measurement of the elements of financial statements The measurement bases used are: (a) Historical cost. Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. (b) 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. May also refer to the ‘fair value’

Measurement Bases cont’d… (c) Realisable (settlement) value. Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.

Measurement bases cont’d… (d) Present value. Assets are carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of the future net cash outflows that are expected to be required to settle the liabilities in the normal course of business.

The concept of discounting and compounding Discounting is the determination of the present value, Compounding is the determination of the future value A discount rate is required in both cases. The discount rate is made up of the risk free rate plus a compensation for the risk inherent in the investment. Ri = Rf + Rp

Present value computations (1) Example 1: Assume that the future value of Sh.10,000 five years from now is at 8% per annum, what is the present value? Example 2: Given an interest rate of 10% per annum, what will be the PV of Sh. 1,000,000: One year from now? Two years from now? Five years from now? Ten years from now?

Present value computations (2) Example 3: Given the following amounts, determine the total present value: Year 1: Sh. 100,000 Year 2: Sh. 120,000 Year 3: Sh. 150,000 Year 4: Sh. 115,000 Year 5: Sh. 90,000 Use a discount rate of 10% per annum.

Present value computations (3) Annuity: an annuity is a series of similar payments over a given time period. Example 4: Determine the PV of the following cash flows: Years 1-5: Sh. 100,000 (meaning Sh. 100,000 each year). Use a discount rate of 10% per annum.

Present value: Practice problems Assume a discount rate of 10% in all cases, except where indicated: Q1: What is the PV of Sh. 120,000 received 6 years from now? – 1 mark. Q2: Determine the PV of the following cash flows: Year 1-3: Sh. 10,000, Year 4-5: Sh. 12,000. – 5 marks Q3: Using the following table, determine the PV: -10 marks   Year 1 Year 2 Year 3 Year 4 Year 5 Cash inflow 100,000 120,000 130,000 140,000 150,000 Cash out flow 75,000 40,000 10,000

Future value computations (1) Example 1: Determine the future value of Sh. 10,000 deposited today in a bank account earning 10% interest in 5 years time. Example 2: Determine the future value of the following cash flows: Year 1: Sh. 10,000; Year 2: Sh. 12,000 and Year 3: Sh. 20,000 Example 3: An individual deposits Sh.10,000 at the beginning of each of the next 10 years, starting today, into an account paying 9% interest compounded annually. The amount of money in the account of the end of 10 years will be closest to:

Future value computations (2) Example 4: Determine the FV of the following cash flows. Years 1-5: Sh. 100,000 Assume a discount rate of 10% per annum. For practice: Q: Using the following table, compute the FV of the cash flows. Assume a discount rate of 12% per annum   Year 1 Year 2 Year 3 Year 4 Year 5 Cash inflow 100,000 120,000 130,000 140,000 150,000 Cash out flow 75,000 40,000 10,000

PV and FV Using the cash flows below, compute the PV and FV assuming a discount rate of 8% per annum. Time Period Cash Flow 1 Sh. 1,000,000 2 Sh. 1,500,000 3 Sh. 2,000,000 4 Sh. 500,000 5 Sh. 3,000,000 PV = Sh. 6,208,860. FV (period 5) = Sh. 9,122,860

Review: The accounting cycle Adjustments to Financial Statements Adjustments to the Trial Balance End-Year Financial Statement Preparation Trial Balance Preparation (summary of balances) Posting (to the ledgers) Journalization (day books/journals, cash books) Recording Transactions (from source documents)

Q & A 11/21/2019 MIS Notes