Chapter 6 - A Conceptual And Regulatory Framework

Question 1

The regulatory framework

Answer 1

To ensure users of financial statements receive a minimum amount of information that will enable them to make meaningful decisions regarding their interest in a reporting entity.

Principles based framework:

1. Based on a conceptual framework such as IASBs framework.
2. Accounting standards are set on the basis of the conceptual framework.

Rules based framework.

1. Cookbook approach.
2. Accounting standards are a set of rules which companies must follow.

Question 2

A conceptual framework

Answer 2

A coherent system of interrelated objectives and fundamental principles.

A framework which prescribes the nature, function and limits of financial accounting and financial statements.

Question 3

Why have a conceptual framework?

Answer 3

1. Enables accounting standards and generally accepted accounting practice (GAAP) to be developed in accordance with agreed principles.
2. Avoids ‘fire fighting’ where accounting standards are developed in a piecemeal way in response to specific problems or abuses.
   ‘Fire fighting’ can lead to inconsistencies between different standards and between accounting standards and legislation.
3. Lack of a conceptual framework may mean certain critical issues are not addressed.
4. As transactions become more complex and businesses become more sophisticated it helps preparers and auditors of accounts to deal with transactions which are not the subject of an accounting standard.
5. Accounting standards based on principles are ought to be harder to circumvent.
6. A conceptual framework strengthens the credibility of financial reporting and the accounting profession.
7. It makes it less likely that the standard setting process can be influenced by ‘vested interests’.

Question 4

Objective of financial reporting

Answer 4

To 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.

Question 5

Fundamental qualitative characteristics

Answer 5

1. Relevance
   Information is relevant if:
   - it has the ability to influence the economic decisions of users.
   - is provided in time to influence those decisions.
2. Qualities of relevance
   Information that is relevant has predictive, or confirmatory value.
   - predictive value enables users to evaluate or assess past, present or future events.
   - confirmatory value helps users to confirm or correct past evaluations and assessments.
3. Materiality
   An entity specific aspect of relevance and depends on the size of the item or error judged in the particular circumstances of its omission or misstatement.

A threshold quality is:

1. One that needs to be studied before considering the other qualities of that information.
2. A cut off point - any information which does not pass the test is not material and is not considered further.
3. Faithful representation
   If information is to represent faithfully, they must be accounted for and presented in accordance with their substance and economic reality and not merely their legal form.

Completeness:
To be understandable information must contain all the necessary descriptions and explanations.

Neutrality:
Information must be free from bias.
Financial statements are not neutral if by selection or presentation of information they influence the making of a decision or judgement in order to achieve a predetermined result or outcome.

Free from error:
Information must be free from error within the bounds of materiality.
A material error or an omission can cause the financial statements to be false or misleading and thus unreliable and deficient in terms of their relevance.

Question 6

Enhancing qualitative characteristics

Answer 6

1. Comparability
   - compare the financial statements of an entity over time to identify trends in the financial position and performance.
   - compare the financial statements of different entities to evaluate their relative financial performance and financial position.
2. Verifiability
   Can be direct or indirect.
   Direct verification means verifying an amount or other representation through direct observation.
   Indirect verification means checking the inputs using the same methodology.
3. Timeliness
   Having information available to decision makers in time to be capable of influencing their decisions.
   The older the information, the less useful it becomes.
4. Understandability
   Depends on:
   - the way in which information is presented.
   - the capabilities of users.

Users have:

• a reasonable knowledge of business and economic activities.
• are willing to study the information provided with reasonable diligence.

Question 7

Elements of the financial statements

Answer 7

1. Assets
   - resources controlled by the entity.
   - as a result of past events.
   - from which future economic benefits are expected to flow to the entity.
2. Liabilities
   - an entity’s present obligations.
   - to transfer economic benefits.
   - as a result of past transactions or events.
3. Equity interest
   The residual amount found by deducting all liabilities of the entity from all of the entity’s assets.
4. Income
   - an increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases in liabilities.
   - transactions that result in increases in equity other than those relating to contributions from equity participants.
   - this definition follows a statement of financial position approach rather than the profit or loss approach to recognising income.
5. Expenses
   - decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or occurrences of liabilities.
   - transactions that result in decreases in equity other than those relating to distributions to equity participants.

Question 8

Recognition

Answer 8

1. Recognition
   The depiction of an element.
   In words and by monetary amount.
   In the financial statements.
2. Recognition of assets
   An asset will only be recognised if:
   - it gives rights or other access to future economic benefits as a result of past transactions or events.
   - it can be measured with sufficient reliability.
   - there is sufficient evidence of its existence.
3. Recognition of liabilities
   A liability will only be recognised if:
   - there is an obligation to transfer economic benefits as a result of past transactions or events.
   - it can be measured with sufficient liability.
   - there is sufficient evidence of its existence.
4. Recognition of income
   Income is recognised in profit or loss when:
   - an increase in future economic benefits arises from an increase in an asset (or a reduction in a liability) and
   - the increase can be measured reliably.
5. Recognition of expenses
   Expenses are recognised in profit or loss when:
   - a decrease in future economic benefits arises from a decrease in an asset or an increase in a liability and
   - can be measured reliably.
6. Financial position approach to recognition.
   - income is an increase in an asset/ decrease in a liability.
   - expenses are an increase in a liability/ decrease in an asset.

Question 9

IFRS Foundation

Answer 9

• The supervisory body for the IASB.
• Responsible for governance issues and ensuring each body is properly funded.

The objectives are:

• develop a set of high quality global accounting standards.
• promote using and applying these standards.
• bring about the convergence of national and international accounting standards.

Question 10

IASB

Answer 10

Solely responsible for using IFRSs

Intentions are:

• develop a single set of understandable and enforceable high quality worldwide standards
• IASB cannot enforce compliance with its standards as needs cooperation with national standard setters.

Question 11

IFRS Interpretations Committee (IFRS IC)

Answer 11

Issues rapid guidance on accounting matters where divergent interpretations of IFRSs have arisen.

Must be approved by the IASB.

The IFRIC addresses issues of reasonably widespread importance.

• newly identified financial reporting issues not specifically dealt with in IFRISs or
• issues where unsatisfactory or conflicting interpretations have developed.

Question 12

The IFRS Advisory Council (IFRS IC)

Answer 12

Provides a forum for the IASB to consult a wide range of interested parties affected by the IASBs work with the objective of:

• advising the board on agenda decisions and priorities.
• informing the Board of the views of the organisations and individuals on the Council on major standard setting projects.
• giving other advice to the Board or Trustees.