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

2. 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., Ch 1

3. 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

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

5. 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

6. 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

7. 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

8. 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., Ch 1

9. 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., Ch 1

10. 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

11. 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

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

13. 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

14. 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

15. 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., Ch 1

16. © 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)
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17. © 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., Ch 1

18. 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

19. 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

20. 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

21. 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

22. 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., Ch 1

23. © 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

24. Prepayments and accruals
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25. © 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

26. © 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

27. 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

28. Statement of Cash Flows
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29. © 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

30. 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

31. © 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