2. The conceptual framework for Financial Reporting Flashcards
What is the purpose of the IASB’s Conceptual Framework?
The purpose of the Conceptual Framework is:
a) to assist the IASB in the development of future IFRS and its review of existing IFRS;
b) to provide basis for reducing the number of alternative accounting treatments permitted by IFRS and thus assist the harmonisation and regulations, accounting standards and procedures related to financial reporting;
c) to assist national standard setting bodies in developing national standards;
d) to assist preparers of financial statements in applying IFRS and in dealing with topics that are not covered by a standard or where there is choice of accounting policy;
e) to assist auditors in forming an opinion as to whether financial statements comply with IFRS;
f) to assist users of financial statements in interpreting the financial
statements prepared in compliance with IFRS;
g) to provide those who are interested in the work of the IASB with
information about its approach to the formulation of IFRS.
Why is there a need for businesses to prepare financial statements for their users?
The key benefits of preparing financial statements for their users are listed below.
Investors: financial statements help investors to decide about buying or
selling shares by providing information about the level of dividend and
any changes in share price. It also helps investors to see the company’s
prospects, present liquidity position and how the company’s shares
compare with those of its competitors.
Employees and management: company performance is related to the
security of employment and future prospects for jobs in the company. The financial position and performance help management in managing the business.
Lenders: the information in the financial statements help lenders decide whether to lend to a company. This information is checked for adequacy of the value of security, ability to make interest and capital repayments and to ensure financial covenants have not been breached.
Suppliers: are interested in information to assess whether the company will be a good customer and pay its debts.
Customers: the company should be in a good financial position to be able to continue producing and supplying goods or services.
Government: is specifically concerned with compliance with tax and
company law, ability to pay tax and its general contribution to the
economy.
The public: All of the reasons stated above could be useful to the general public.
Briefly explain the meaning of the faithful represeantaion.
Briefly explain the meaning of faithful representation.
Faithful representation means that financial information must meet three criteria: completeness, neutrality and be free from error.
Completeness: all information that users need to understand the item is given.
Neutral or unbiased: there is no bias in the selection or presentation of information.
Free from error: there are no omissions, errors or inaccuracies in the
process to produce the information. The idea of ‘substance over form’ is key for the faithful representation of financial information. It may be necessary to override the legal form of a transaction to portray a true economic position.
Management commits to purchase assets in the future. Does this give
rise to a liability?
An essential characteristic of a liability is that the entity has a present obligation.
A liability is present obligation of the entity to transfer economic benefit as a result of past transactions or events. For example, a trade payable is a 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. It is rather a future commitment.
Explain how you would report a transaction that fails to satisfy the
recognition criteria.
Where an essential element is not recorded as an asset, liability, income or expense because it is unable to meet the criteria for recognition, it can be disclosed in the form of explanatory notes if the knowledge would be relevant to the users of the financial report in making and evaluating their decisions. The revised recognition criteria refer explicitly to the qualitative characteristics of useful information.
For example, an entity may be engaged in litigation in defence of a claim for a certain amount of damages. Although the claim may not meet the recognition criteria of a liability, such information may be considered to be relevant to the users of the financial report in making and evaluating their decisions.
Accordingly, it may warrant disclosure in the notes in the financial report.
Explain the most commonly used measurement in financial
statements.
Historical cost is the measurement basis most commonly used today. It is usually combined with other measurement bases. Examples of this include:
assets on finance leases are to be carried at the lower of:
– fair value at the date of its acquisition; or
– discounted value of the minimum lease payments at that date
construction contracts shall be carried at historical cost plus a proportion of the expected profit;
inventories are also measured as per IAS 2 at the lower of cost and net realisable value.
Consideration of different factors is likely to result in different measurement bases for different assets, liabilities, income and expenses. The factors to be considered when selecting a measurement basis are relevance and faithful representation, because the aim is to provide information that is useful to investors, lenders and other creditors.
What is a conceptual framework?
Statement of generally accounting theoretical principles which underpin the formulation of reporting standards.
Provide the basis for the development and evaluation of new and existing accounting standards
What is the purpose of the conceptual framework? (7 points)
IASBs HUBCAP
Harmonisation – makes it easier by reducing no. of alternative treatments
Users – helps them to compare and understand the information if its standardised
Bodies – national standard setting bodies gives them a starting point
Context – provides the background to standard setting
Audit – helps to form an opinion about compliance with IFRS
Preparers – gives them a standard to follow and guidance to apply when producing information
- Creating and developing new and existing IFRS
- Assist preparers in applying the standard
- Helps auditors to give an opinion on whether IFRS has complied with IFRS
- National body starting point to set standards
- Limit the amount of accounting treatments
- Standardisation and comparison between companies and countries
- Assist the users in interpreting IFRS
What does the IASB conceptual framework cover?
- the objectives of financial reporting;
- the underlying assumptions;
- the qualitative characteristics; *
- the elements of financial statements;
- the recognition (and derecognition) of the elements;
- the measurement of the elements; and
- the concepts of capital and capital maintenance.
What are the advantages of IFRS system?
Financial statements presented under IFRS make global comparisons easier.
Cross-border listing is facilitated, making it easier to raise funds and make investments abroad.
Multinational companies with subsidiaries in foreign countries have a common, company-wide accounting language.
Foreign companies can be more easily appraised for mergers and acquisitions.
Multinational companies benefit for the following reasons: – preparation of group financial statements may be easier; – a reduction in audit costs might be achieved; – management control would be improved; and – transfer of accounting knowledge and expertise across national borders would be easier
Disadvantages of IFRS?
The cost of implementing IFRS.
The lower level of detail in IFRS.
International Financial Reporting Standards are principles-based standards which require the application of judgement. Many do not favour this approach. For example, US GAAPs are more rules-based standards. US accountants are subject to a high degree of litigation and their defence is usually that they complied with the relevant sections of detailed standards which make up US GAAP. They fear that adoption of IFRS will remove this defence.
There are challenges in adopting IFRS in emerging economies, namely: – the economic environment; – incompatible legal and regulatory environments; – concern around SMEs; – level of preparedness; and – education needs of auditors
