Chapter 1 The Financial Reporting Framework

Question 1

The conceptual framework for financial reporting

Answer 1

Objective:-
Provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.

Those decisions involve buying, selling or holding equity and debt instruments and providing or settling loans or other forms of credit.

Question 2

Qualitative characteristics of financial information

Answer 2

Fundamental qualitative characteristics

1. Relevance
2. Faithful representation

Enhancing qualitative characteristics

1. Comparability
2. Verifiability
3. Timeliness
4. Understandability

The cost constraint on useful financial reporting
1. Benefits of reporting information should justify the costs

Question 3

The elements of financial statements

Answer 3

1. Asset
   A resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity.
2. Liability
   A present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.
3. Equity
   The residual interest in the assets of an entity after deducting all its liabilities.
4. Income
   Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.
5. Expense
   Decreases in economic benefits during the accounting period in the form of outflows or depletion of assets or incurrences of liabilities that result in decreases in equity, other than those relating to equity participants.

Question 4

Recognition of the elements of the financial statements

Answer 4

1. Probable 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 measured with reliability.

Question 5

Current developments

Answer 5

In May 2015 the IASB issued an Exposure Draft (ED/2015/3) of the revised Conceptual Framework for Financial Reporting.

The Exposure Draft covers the following areas.

1. The objective of general purpose financial reporting.
2. Qualitative characteristics of financial statements.
3. Financial statements and the reporting entity.
4. The elements of financial statements.
5. Recognition and de recognition.
6. Measurement.
7. Presentation and disclosure.
8. Concepts of capital and capital maintenance.

Question 6

Revenue recognition (IFRS 15)

Answer 6

IFRS 15 requires an entity to recognise revenue by applying the five steps below:

1. Identify contract with the customer.
   The model applies where a contract (an agreement between two or more parties that creates enforceable rights and obligations) exists and all of the following criteria are met.

• parties have approved the contract (in writing or orally)
• entity can identify each party’s rights
• entity can identify payment terms
• contract has commercial substance (risk, timing or amount of future cash flows expected to change as result of contract)
• it is probable that entity will collect the consideration

2. Identify performance obligations
   At contract inception, an entity shall assess the goods and services promised in a contract with a customer and shall identify as a performance obligation each promise to transfer to the customer either:

• a good or service that is distinct or
• a series of distinct goods or services that are substantially the same and that have the same pattern to transfer to the customer

3. Determine transaction price
   The amount to which the entity expects to be entitled.

Includes variable consideration of highly probable that significant reversal of cumulative revenue will not occur. Measure variable consideration at:

• probability weighted expected value or
• most likely amount

Discounting not required where less than one year.

4. Allocate transaction price to performance obligations
   Multiple deliverables: transaction price allocated to each separate performance obligation in proportion to the stand alone selling price at contract inception of each performance obligation.
5. Recognise revenue when (or as) performance obligation satisfied
   When an entity transfers a promised or service to a customer.

Only considered transferred when (or as) the customer obtains control of that good or service.

Control of an asset refers to the ability to direct the use of and obtain substantially all of the remaining benefits from the asset.

Question 7

Transfer of control of a good or service

Answer 7

An entity transfers control of a good or service over time and therefore satisfies a performance obligation and recognises revenue over time if one of the following criteria is met:

1. The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs.
2. The entity’s performance creates or enhances an asset e.g. WIP that the customer controls as the asset is created or enhanced.
3. The entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date.

Question 8

Satisfaction of a performance obligation at a point in time

Answer 8

To determine the point in time when a customer obtains control of a promised asset and an entity satisfies a performance obligation, the entity would consider indicators of the transfer of control that include but are not limited to

1. The entity has a present right to payment for the asset.
2. The customer has legal title to the asset.
3. The entity has transferred physical possession of the asset.
4. The customer has the significant risks and rewards of ownership of the asset.
5. The customer has accepted the asset.

Question 9

Contract costs

Answer 9

Obtaining a contract
Incremental costs of obtaining a contract are recognised as an asset if the entity expects to recover them.

Fulfil a contract
If the costs to fulfil a contract are not within the scope of another Standard, they should be recognised as an asset only if they meet all of the following:

1. The costs relate directly to a contract or an anticipated contract that the entity can specifically identify.
2. The costs generate or enhance resources of the entity that will be used in satisfying (or continue to satisfy) performance obligations in the future.
3. The costs are expected to be recovered.

Question 10

Amortisation and impairment of costs recognised as an asset

Answer 10

The asset should be amortised to profit or loss on a systematic basis consistent wi the pattern of transfer of the goods or services to which the asset relates.

For the costs of obtaining a contract, if the amortisation period is estimated to be one year or less, the costs may be recognised as an expense when incurred.

An impairment loss should be recognised in profit or loss to the event the carrying amount exceeds:

1. The remaining amount of consideration that the entity expects to receive in exchange for the goods or services to which the asset relates less
2. The costs that relate directly to providing those goods or services that have not yet recognised as expenses.

Question 11

Presentation

Answer 11

When either party to a contract has performed, an entity shall present the contract in the SOFP as a contract asset (if entity transfers goods or services before customer pays) or as a contract liability (if customer pays before entity transfers goods or services).

Any unconditional rights to consideration should be shown separately as a receivable.

1. Sale with the right of return
   Recognise all of:
   - revenue for the transferred products in the amount of consideration to which the entity expects to be entitled (i.e. Revenue not recognised for products expected to be returned)

• a refund liability and
• an asset ( and corresponding adjustment to cost of sales) for its right to recover products from customers on settling the refund liability.

2. Warranties
   - If customer has option to purchase warranty separately, treat as separate performance obligation under IFRS 15.

• if customer does not have option to purchase warranty separately, account with IAS 37 Provisions, Contingent Liabilities and Contingent Assets.
• if warranty provides customer with a service in addition to the assurance that the product complies with agreed-upon specifications, the promised service is a performance obligation.

3. Principal versus agent
   - if the entity controls the specified goods or service before transfer to a customer, it is a principal
   Revenue = gross amount of consideration

• if the entity arranges for goods or services to be provided by the other party, it is an agent
  Revenue = fee or commission
• indicators that an entity controls the goods or service before transfers and therefore is a principal include:
  (a) the entity is primarily responsible for fulfilling the promise to provide the specified good or service.
  (b) the entity has inventory risk.
  (c) the entity has discretion in establishing the price for the specified good or service.

4. Non-refundable upfront fees
   - if it is an advance payment for future goods and services, recognise revenue when future goods and services provided.