CFAP FAFR Study Text

7/25/2019 CFAP FAFR Study Text

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2016

ADVANCED ACCOUNTING AND

FINANCIAL REPORTING

STUDY SUPPORT MATERIAL


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ICAPAdvanced accounting and

financial reporting


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Emile Woolf International ii The Institute of Chartered Accountants of Pakistan

First edition published byEmile Woolf InternationalBracknell Enterprise & Innovation HubOcean House, 12th Floor, The RingBracknell, Berkshire, RG12 1AX United KingdomEmail: [email protected]

Emile Woolf International, May 2016

All rights reserved. No part of this publication may be reproduced, stored in a retrievalsystem, or transmitted, in any form or by any means, electronic, mechanical, photocopying,recording, scanning or otherwise, without the prior permission in writing of Emile WoolfInternational, or as expressly permitted by law, or under the terms agreed with theappropriate reprographics rights organisation.

You must not circulate this book in any other binding or cover and you must impose thesame condition on any acquirer.

NoticeEmile Woolf International has made every effort to ensure that at the time of writing thecontents of this study text are accurate, but neither Emile Woolf International nor its directorsor employees shall be under any liability whatsoever for any inaccurate or misleadinginformation this work could contain.


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Emile Woolf International iii The Institute of Chartered Accountants of Pakistan

Certified Finance and Accounting ProfessionalAdvanced accounting and financial reporting

CContents

Page

Syllabus objective and learning outcomes v

Chapter

1 Regulatory framework 1

2 Accounting and reporting concepts 25

3 Presentation of financial statements(IAS 1, IAS 34, IAS 24, IFRS 8, IAS 10) 53

4 IAS 8: Accounting policies, changes in accounting estimatesand errors 81

5 IFRS 15: Revenue from contracts with customers 103

6 IAS 16: Property, plant and equipment 117

7 Non-current assets: sundry standards(IAS 23, IAS 20 and IAS 40) 149

8 IAS 38: Intangible assets 173

9 IAS 36: Impairment of assets 195

10 IFRS 5: Non-current assets held for sale and discontinuedoperations 213

11 IFRS 16: Leases 235

12 IAS 37: Provisions, contingent liabilities and contingent assets 292

13 IAS 19: Employee benefits 323

14 IFRS 2: Share based payments 349

15 Financial instruments: Recognition and measurement 395

16 Financial instruments: Presentation and disclosure 457


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Advanced accounting and financial reporting

Emile Woolf International iv The Institute of Chartered Accountants of Pakistan

Page

17 IFRS 13: Fair value measurement 475

18 IAS 12: Income taxes 493

19 Business combinations and consolidation 53520 Consolidated statements of profit or loss and other

comprehensive income 577

21 Associates and joint ventures 589

22 Business combinations achieved in stages 607

23 Complex groups 625

24 Disposal of subsidiaries 659

25 Other group standards (IAS 27 and IFRS 12) 68726 Foreign currency 697

27 IAS 7: Statements of cash flows 729

28 IAS 33: Earnings per share 771

29 Analysis and interpretation of financial statements 811

30 Sundry standards and interpretations(IAS 2, IAS 41, IFRS 6, IFRS 14, IFRIC 12, SIC 7) 853

31 IFRS 1: First time adoption of IFRS 879

32 Specialised financial statements 891

33 International public sector accounting standards (IPSAS) 933

34 Accounting for hyperinflation 949

35 Islamic accounting standards 963

36 Ethical issues in financial reporting 977

Index 995


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Emile Woolf International v The Institute of Chartered Accountants of Pakistan


SSyllabus objective

and learning outcomes

CERTIFIED FINANCE AND ACCOUNTING PROFESSIONAL

ADVANCED ACCOUNTING AND FINANCIAL REPORTING

Objective

To develop an in-depth understanding of, and the ability to apply the requirements of

international pronouncements, the Companies Ordinance, 1984, and other applicableregulatory requirements in respect of financial reporting and the presentation of financial

statements.

Learning Outcome

On the successful completion of this paper candidates will be able to:

1 prepare financial statements in accordance with the international pronouncements

and under the Companies Ordinance, 1984.

2 evaluate and analyse financial data in order to arrive at firm decisions on theaccounting treatment and reporting of the same.

3 exercise professional judgment and act in an ethical manner (that is in the best

interest of society and the profession).

4 prepare financial statements of specialized entities (including small and medium

sized entities in accordance with the Companies Ordinance, 1984 and the

applicable reporting framework, retirement benefit funds in accordance with

international pronouncements) and be able to demonstrate an understanding of

reporting requirements under the laws specific to insurance, banking companies

and mutual funds.


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Emile Woolf International vi The Institute of Chartered Accountants of Pakistan

Grid Weighting

A Presentation of financial statements including public

sector accounting

30-35

B Financial reporting (including ethics) 50- 60

C Specialized financial statements 10-15

Total 100

Contents Chapter

A Presentation of financial statements including public sector

accounting

1 Presentation of financial statements (IAS 1, IAS 7 and Companies

Ordinance 1984)

2, 3, 25

2 IAS 27: Separate financial statements 23

3 IFRS 10: Consolidated financial statements 18, 19, 22

4 IAS 28: Accounting for associates and joint ventures 20

5 IFRS 11: Joint arrangements 20

6 IFRS 12: Disclosure of interests in other entities 22

7 IAS 34: Interim financial reporting 3

8 IAS 29: Financial Reporting in Hyperinflationary Economies 33

9 IFRS 5: Non-current assets held for sale and discontinued

operations

10, 22

10 IFRS 8: Operating segments 3

11 Overview of IPSASs and the conceptual framework for general

purpose financial reporting by public sector entities

32

12 IPSAS 1 Presentation of financial statements 32

13 IPSAS Financial reporting under the cash basis of accounting (this

IPSAS has not been given any number).

32

B Financial reporting and ethics

a Financial reporting

1 The Conceptual Framework for the preparation and presentation of

financial statements

2

2 IFRS 1: First-time adoption of international financial reporting

standards

30

3 IFRS 2: Share-based payment 15

4 IFRS 3: Business combinations 18, 19, 21

5 IFRS 4: Insurance contracts 31

6 IFRS 6: Exploration for and evaluation of mineral resources 29


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Syllabus objective and learning outcomes

Emile Woolf International vii The Institute of Chartered Accountants of Pakistan

Contents Chapter

B Financial reporting and ethics (continued)

a Financial reporting (continued)7 IFRS 7: Financial instruments: disclosures 17

8 IFRS 9: Financial Instruments 16

9 IFRS 13: Fair value measurement 2, 16

10 IFRS 14: Regulatory deferral accounts 29

11 IFRS 15: Revenue from contracts with customers 5

12 IAS 2: Inventories 29

13 IAS 8: Accounting policies, changes in accounting estimates and

errors

4

14 IAS 10: Events after the reporting date 3

15 IAS 11: Construction contracts 5

16 IAS 12: Income Taxes 13

17 IAS 16: Property, plant and equipment 6

18 IFRS 16: Leases 11

19 IAS 18: Revenue 5

20 IAS 19: Employee benefits 14

21 IAS 20: Accounting for government grants and disclosure ofgovernment assistance

7

22 IAS 21: The effects of changes in foreign exchange rates 24

23 IAS 23: Borrowing costs 7

24 IAS 24: Related party disclosures 3

25 IAS 32: Financial instruments: Presentation 17

26 IAS 33: Earnings per share 26

27 IAS 36: Impairment of assets 9

28 IAS 37: Provisions, contingent liabilities and contingent assets 12

29 IAS 38: Intangible assets 8

30 IAS 39: Financial instruments: recognition and measurement 16

31 IAS 40: Investment property 7

32 IAS 41: Agriculture 29

33 IFRIC 1: Changes in existing decommissioning, restoration and

similar liabilities

6

34 IFRIC 2: Membersshares in co-operative entities and similar

instruments

17


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Emile Woolf International viii The Institute of Chartered Accountants of Pakistan

Contents Chapter


a Financial reporting (continued)35 IFRIC 4: Determining whether an arrangement contains a lease 11

36 IFRIC 5: Rights to interests arising from decommissioning, restoration

and environmental rehabilitation funds

12

37 IFRIC 6: Liabilities arising from participating in a specific market

waste electrical and electronic equipment

12

38 IFRIC 7: Applying the restatement approach under IAS 29 financial

reporting in hyperinflationary economies

33

39 IFRIC 10: Interim financial reporting and impairment 9

40 IFRIC 12: Service concession arrangements 29

41 IFRIC 13: Customer loyalty programmes 5

42 IFRIC 14: IAS 19The limit on a defined benefit asset, minimum

funding requirements and their interaction

14

43 IFRIC 15: Agreements for the construction of real estate 5

44 IFRIC 16: Hedges of a net investment in a foreign operation 16

45 IFRIC 17: Distributions of non-cash assets to owners 17

46 IFRIC 18: Transfers of assets from customers 5

47 IFRIC 19: Extinguishing financial liabilities with equity instruments 17

48 IFRIC 20: Stripping costs in the production phase of a surface mine 6

49 IFRIC 21: Levies 21

50 SIC 7: Introduction of the euro 29

51 SIC 10: Government assistanceno specific relation to operating

activities

7

52 SIC 15: Operating leasesincentives 11

53 SIC 25: Income taxeschanges in the tax status of an enterprise or

its shareholders

13

54 SIC 27: Evaluating the substance of transactions in the legal form of a

lease

11

55 SIC 29: Disclosureservice concession arrangements 29

56 SIC 31: Revenuebarter transactions involving advertising services 5

57 SIC 32: Intangible Assetsweb site costs 8


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Syllabus objective and learning outcomes

Emile Woolf International ix The Institute of Chartered Accountants of Pakistan

Contents Chapter


b Ethics1 Professional misconduct under the Chartered Accountants Ordinance

1961

35

2 Code of Ethics issued by the Institute of Chartered Accountants of

Pakistan

35

C Specialised financial statements

1 Small and medium sized entities 31

2 Banks 31

3 Mutual funds 31

4 Insurance companies 31

5 IAS 26: Accounting and reporting by retirement benefit plans 31

6 Overview of Islamic accounting standard issued by ICAP 34


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Emile Woolf International x The Institute of Chartered Accountants of Pakistan


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Emile Woolf International 1 The Institute of Chartered Accountants of Pakistan


CHA

P

T

E

R

1Regulatory framework

Contents

1 Regulatory framework for accounting in Pakistan

2 Companies Ordinance 1984: Fourth Schedule

3 Companies Ordinance 1984: Fifth Schedule


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INTRODUCTION

Objective

To develop an in-depth understanding of, and the ability to apply the requirements ofinternational pronouncements, the Companies Ordinance, 1984, and other applicable

regulatory requirements in respect of financial reporting and the presentation of financialstatements.

Learning outcomes

LO 1 Prepare financial statements in accordance with internationalpronouncements and under the Companies Ordinance, 1984.

PRESENTATION OF FINANCIAL STATEMENTS INCLUDING PUBLIC SECTORACCOUNTING

A 1 Presentation of financial statements (Companies Ordinance 1984)


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Chapter 1: Regulatory framework


1 REGULATORY FRAMEWORK FOR ACCOUNTING IN PAKISTAN

Section overview

Accounting regulation in Pakistan

Companies Ordinance 1984: Introduction to accounting requirements

Companies Ordinance 1984: Introduction to the fourth and fifth schedules

Applicability of accounting standards in Pakistan

Accounting standards: Three tier approach

International Financial Reporting Standards

1.1 Accounting regulation in Pakistan

The objective of financial statements is to provide information about the financialposition (balance sheet), financial performance (profit and loss) and cash flows of

an entity that is useful to a wide range of users in making economic decisions.The Securities and Exchange Commission of Pakistan

The Securities and Exchange Commission of Pakistan (SECP) was establishedby the Securities and Exchange Commission of Pakistan Act, 1997 and becameoperational in 1999.

It is the corporate and capital market regulatory authority in Pakistan. Its statedmission is To develop a fair, efficient and transparent regulatory framework,based on international legal standards and best practices, for the protection ofinvestors and mitigation of systemic risk aimed at fostering growth of a robustcorporate sector and broad based capital market in Pakistan(SECP website).

One of the roles of the SECP is to decide on accounting rules that must beapplied by companies in Pakistan.

Companies must prepare financial statements in accordance with accountingstandards approved as applicable and notified in the official gazette by theSecurities and Exchange Commission of Pakistan (SECP) and in accordancewith rules in the Companies Ordinance 1984.

The Institute of Chartered Accountants in Pakistan (ICAP)

ICAP regulates the Chartered Accountancy profession. It is the body responsiblefor recommending accounting standards for notification by the Securities andExchange Commission of Pakistan. The process is explained later.

1.2 Companies Ordinance 1984: Introduction to accounting requirements

The Companies Ordinance 1984 is the primary source of company law inPakistan. Amongst other things it establishes the requirements for financialreporting by all companies in Pakistan.

General requirements

Every company must prepare annual accounts (financial statements) that providea true and fair view on the performance and activities of the company during theyear.

The financial statements comprise:

a balance sheet (statement of financial position): a structuredrepresentation of the financial position of an entity;


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an income statement (statement of comprehensive income): a structuredrepresentation of the financial performance of an entity.

a statement of changes in equity;

a cash flow statement;

notes to the accounts which contain a summary of significant accountingpolicies and other information that sets out explanations of figures in themain statements and provides supplementary information.

Section 234

Section 234 requires that every balance sheet (statement of financial position)must give a true and fair view of the state of affairs of the company as at the endof its financial year, and every profit and loss account or income and expenditureaccount of a company must give a true and fair view of the profit and loss of thecompany for the financial year.

All items of expenditure must be recognised in the profit or loss account unless itmay be fairly charged over several years. In such cases the whole amount must

be stated with the reasons why only part is charged against the income of thefinancial year.

Other requirements

Assets and liabilities must be classified under headings appropriate to thecompany's business.

The period reported on in the accounts is called the financial year.

1.3 Companies Ordinance 1984: Introduction to the fourth and fifth schedules

The Companies Ordinance 1984 contains a series of appendices calledscheduleswhich set out detailed requirements in certain areas.

The fourth schedule to the Companies Ordinance 1984

This schedule sets out the detailed requirements that must be complied with inrespect of the balance sheet and profit and loss account of a listed company. Italso applies to private and non-listed public companies that are a subsidiary of alisted company.

The schedule specifies that listed companies must follow International FinancialReporting Standards as notified for this purpose in the Official Gazette.

The fifth schedule to the Companies Ordinance 1984

This schedule applies to the balance sheets and profit and loss accounts of allother companies.

This schedule defines and applies to public interest companies, medium sizedcompanies and small sized companies. These categories determine whichaccounting standards are followed. The three categories are defined in the nextsection.

1.4 Applicability of accounting standards in Pakistan

Listed companies are subject to the requirements of the fourth schedule whichspecifies the use of International Financial Reporting Standards as notified forthis purpose in the Official Gazette.


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The requirements of the fifth schedule that apply to other companies are morecomplicated. The fifth schedule identifies different classes of companies and thenspecifies the standards which must be applied by each class. The classes are asfollows:

Public interest companies which are non-listed companies which are either

A public sector company as defined in the Public Sector Companies(Corporate Governance) Rules 2013; or

A public utility or similar company carrying on the business ofessential public service; or

A company that holds assets in a fiduciary capacity for a broad groupof outsiders (this class includes banks, insurance companies, pensionfunds and mutual funds). (Note that accounting rules in addition tothose set out in the fourth and fifth schedules might apply to suchcompanies. This is covered in a later chapter).

Large sized companies which are non-listed companies which have:

paid-up capital of Rs. 200 million or more: or

turnover of Rs. 1 billion or more.

Medium sized companies which are non-listed companies which are not:

a public interest company; or

a large sized company; or

small sized company (other than a non-listed public company).

Small sized companies which are non-listed companies (other than a non-listed public company) which have:

paid-up capital not exceeding Rs. 25 million: or

turnover not exceeding Rs. 100 million.

Accounting standards apply to these classes as follows.

Class Criteria

Public interest companies IFRS as approved and notified by SECP

Large sized companies IFRS as approved and notified by SECP

Medium sized companies IFRS for Small and Medium Entities as adopted inPakistan by council of ICAP (or IFRS as approvedand notified by SECP if they elect to do so).

Small sized companies Revised Accounting and Financial ReportingStandards for Small-Sized Entities (AFRS forSSEs) as approved by the council of ICAP (orIFRS as approved and notified by SECP if theyelect to do so).

All other companies including foreign companies which do not fall into any of theabove categories must follow Full IFRS as approved and notified by SECP.

The SECP may upon application made to it, grant an exemption to any companyor class of company from compliance with all or any of the requirements of the

standards.


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The SECP encourages medium sized companies and small sized companies tofollow IFRS as approved and notified by SECP.

Specific rules apply to companies formed under section 42 of the CompaniesOrdinance (associations not for profit) and section 43 of the CompaniesOrdinance (companies limited by guarantee). This guidance is not in the syllabus

but IFRS as approved and notified by SECPwould apply to many of thesecompanies.

1.5 Accounting standards: Three tier approach

As can be seen from the above, the regulatory framework in Pakistan uses athree tier approach to specify which accounting standards must be followed by anorganisation.

Tier 1: Publically accountable entities

This includes:

Any entity that has filed, or is in the process of filing, its financial statements

with the Securities and Exchange Commission of Pakistan. Public interest companies;

Large sized companies.

Any entity in this category must apply IFRSas approved as applicable andnotified in the official gazette by the Securities and Exchange Commission ofPakistan.

For clarity:

A listed company must follow the fourth schedule and apply IFRS (asspecified and notified by the SECP).

Unlisted public interest companies and large sized companies must followthe fifth schedule and apply IFRS (as specified and notified by theSECP).

If there is a conflict betweenIFRSand any SECP guidance or decision the SECPview must be applied.

Tier 2: Medium Sized Companies

Any company in this category must apply the IFRS for SMEsas adopted inPakistan by council of ICAP and follow the requirements of the fifth schedule.

Tier 3: Small Sized Companies

Any company in this category must apply the RevisedAccounting andFinancial Reporting Standards for Small-Sized Entities(a single documentdrafted and issued by ICAP) and follow the requirements of the fifth schedule.

TheAFRSis not examinable.

1.6 International Financial Reporting Standards

The International Accounting Standards Committee (IASC)was establishedin 1973 to develop international accounting standards with the aim ofharmonising accounting procedures throughout the world.

The first International Accounting Standards(IASs)were issued in 1975. Thework of theIASC was supported by another body called the StandingInterpretation Committee. This body issued interpretations of rules in standards


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when there was divergence in practice. These interpretations were calledStanding Interpretation Committee Pronouncementsor SICs.

In 2001 the constitution of the IASCwas changed leading to the replacement oftheIASCand the SIC by new bodies called the International AccountingStandards Board (IASB)and the International Financial Reporting

Interpretations Committee (IFRIC).The IASBadopted all IASsand SICsthat were extant at the time but said thatstandards written from that time were to be called International FinancialReporting Standards (IFRS). Interpretations are known as IFRICs.

The term IFRS is also used to refer to the whole body of rules (i.e., IASand IFRSin total).

Thus IFRSis made up as follows:

Published by the IASC(up to 2001)

Published by the IASB(from 2001)

Accounting standards IASs IFRSsInterpretations SICs IFRICs

Note that many IASsand SICshave been replaced or amended by the IASBsince 2001.

International accounting standards cannot be applied in any country without theapproval of the national regulators in that country. All jurisdictions have somekind of formal approval process which is followed before IFRScan be applied inthat jurisdiction.

Adoption process for IFRS in Pakistan

The previous sections refer to the approval of IFRSby the SECPand notificationof that approval in the Official Gazette

Adoption of an IFRSinvolves the following steps:

As a first step the IFRS/IASis considered by ICAPs AccountingStandards Committee (ASC), which identifies any issues that may ariseon adoption.

TheASCrefers the matter to the Professional Standards and TechnicalAdvisory Committee (PSTAC)of ICAP. This committee determines howthe adoption and implementation of the standard can be facilitated. Itconsiders issues like how long any transition period should be and whetheradoption of the standard would requires changes in regulations.

If the PSTACidentifies the need for changes to regulations it refers thematter to the Securities and Exchange Commission of Pakistan (SECP)(and/or the State Bank of Pakistan (SBP)for matters affecting banks andother financial institutions). This process is managed by the CoordinationCommittees of ICAPand SECP (SBP).

After the satisfactory resolution of issues the PSTACand the Councilreconsider the matter of adoption.

ICAPrecommends the adoption to the SECP (SBP)by decision of theCouncil. The decision to adopt the standard rests with the SECPand SBP.

IFRSsare adopted by the Securities and Exchange Commission ofPakistanby notification in the Official Gazette. When notified, the

standards have the authority of the law.A full list of all IFRSsis given in the preliminaries section of this text.


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2 COMPANIES ORDINANCE 1984: FOURTH SCHEDULE

Section overview

Fixed assets (non-current assets)

Long term investments

Long term loans and advances

Long term deposits and prepayments

Current assets

Share capital and reserves

Non-current liabilities

Current liabilities

Contingencies and commitments

Profit and loss account

Other disclosures

These requirements must be followed in addition to those in IFRS.

2.1 Fixed assets (non-current assets)

Fixed assets (other than investments) must be classified as follows:

property, plant and equipment:

land (distinguishing between freehold and leasehold);

buildings (distinguishing between building on freehold land and those

on leasehold land); plant and machinery;

furniture and fittings;

vehicles;

office equipment;

capital work in progress;

development property; and

others (to be specified)

intangible: goodwill;

brand names;

computer software;

licences and franchises;

patents, copyright, trademarks and designs;

intangible assets under development; and

others (to be specified).


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2.2 Long term investments

The aggregate amount (under separate sub-headings) in respect of the following:

investments in related parties; and

other investments.

The investments must be shown under the heading long term investments,indicating separately:

at cost;

using the equity method;

held to maturity investments, which are not due to mature within nexttwelve months; and

available for sale investments which are not intended to be sold within thenext 12 months.

This section introduces several terms which require further explanation. They are

covered in more detail in certain international accounting. However, theCompanies Ordinance 1984 is in your syllabus and refers to these. Therefore,they will be explained briefly.

Related parties

A related party is an entity or person with the ability to control the company orexercise significant influence over the company in making financial and operatingdecisions or an entity over which the company has ability to control or exercisesignificant influence.

IAS 24 Related Party Disclosuresincludes a list of related parties and specifiesdisclosures.

The equity method

The equity method is a method of accounting where an investment is initiallyrecognised at cost and the carrying amount is increased or decreased torecognise the investors share of the profit or loss of the investee after the date ofacquisition.

IAS 28: Investments in Associates and Joint Venturesspecifies the use of theequity method in accounting for associates and joint ventures.

Held to maturity investments

This is a type of asset defined in IAS 39: Financial Instruments: Recognition andMeasurement.

Held to maturity investments are financial assets with fixed or determinablepayments and fixed maturity that an entity has the positive intention and ability tohold to maturity.

They are measured at amortised cost. The amortised cost of a financial asset isthe amount invested initially plus interest recognised at the effective rate less anycash received in respect of the asset.

IAS 39 is not in your syllabus.


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Available for sale investment

This is also a type of asset defined in IAS 39: Financial Instruments: Recognitionand Measurement.

An available for sale investment is one that is not a loan or receivable, nor held tomaturity nor held for trading purposes.

IAS 39 requires that available for sale investments are remeasured to fair valueat each reporting date. Any difference is recognised as other comprehensiveincome (see chapter 2) and accumulated as a separate reserve in equity.

IAS 39 is not in your syllabus.

2.3 Long term loans and advances

The following must be shown (under separate sub-headings) distinguishingbetween considered good and considered bad or doubtful.

Loans and advances to related parties and disclosing:

Details of each borrower (name, amount, terms and details of securityheld if any);

Maximum amount outstanding since the later of the date ofincorporation or the date of the previous balance sheet.

Other loans and advances disclosing in respect of amounts to those otherthan suppliers the name of the borrower and the terms of repayment if theamount is material with particulars of security.

Illustration: Long term loans and advances

A disclosure note might look like this.

Statement of financial position (extract) 2013 2012

Non-current assetsRs.

Rs.

Loans and advances 237,900 158,750

Note to the accounts: 2013 2012

Rs. Rs.

To employees secured, considered good 197,026 167,952

To supplier unsecured, considered good 98,736 28,734

295,762 196,686

Less current portion shown under current assets (57,862) (37,936)

237,900 158,750

Loans to employees are interest free loans for the purpose of cars. Theyare repayable within 3 years and are secured on the vehicles. Themaximum amount of the loans during the year was Rs. 201,345 (2012:174,321).

The loan to supplier is an unsecured loan given to the TZ Electric Companyto fund the development of electrical supply infrastructure at our Lahoredepot. The loan is repayable in equal instalments over. Mark-up is chargedat 2% per annum.


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2.4 Long term deposits and prepayments

Long-term deposits and long-term prepayments must be stated separately.

Any material item must be disclosed separately.

2.5 Current assets

Current assets must be classified in a way appropriate to the company's affairs,including the following:

stores, spare parts and loose tools distinguishing each from the otherwhere practicable;

stock-in-trade, distinguishing between appropriate classifications (forexample, raw materials and components, work in progress, finishedproducts etc.).

trade debts (other than loans and advances) showing separately:

debts considered good and debts considered doubtful or bad must be

separately stated;

debts considered good must be distinguished between secured andunsecured;

the aggregate amount due from directors, chief executive andexecutives; and

the aggregate amount due from related parties with the names ofthose related parties.

loans and advances due for repayment within a period of twelve monthsfrom the reporting date showing separately:

loans and advances considered good and those considered doubtfulor bad;

the aggregate amount due from directors, chief executive andexecutives;

the aggregate amount due from related parties with the names ofthose related parties;

trade deposits and short term prepayments and current account balanceswith statutory authorities;

interest accrued;

other receivables specifying separately the materials items;

financial assets other than any included above showing separately:

the aggregate amount due from directors, chief executive andexecutives;

the aggregate amount due from related parties with the names ofthose related parties;

tax refunds due from the Government, showing separately different types oftax;

cash and bank balances, distinguishing between current and depositaccounts.

Any provision made for a fall in value of any current asset is shown as adeduction from the gross amount of that asset.


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Definition

Executive: An employee, other than the chief executive and directors, whose basicsalary exceeds five hundred thousand rupees in a financial year.

Illustration: Stock in trade



Current assets Rs. Rs.

Stock in trade 547,132 523,890


Rs. Rs.

Raw materials 139,950 153,856

Work in progress 178,434 163,433

Finished goods 179,100 162,121

Goods purchased for sale 51,962 48,261

549,446 527,671

Less: Provision for slow moving items (2,314) (3,781)

547,132 523,890

Illustration: Trade debts



Current assets Rs. Rs.

Trade debts 493,657 472,010


Rs. Rs.

Considered good secured 19,247 15,652

Considered good unsecured 474,410 456,358

Considered doubtful unsecured 10,192 8,763

503,849 480,773

Less: Provision for doubtful debts (10,192) (8,763)

493,657 472,010

The considered good unsecured trade debts include Rs. 47, 438 (2012Rs. 26,342) from X Limited, a related party.


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2.6 Share capital and reserves

Share capital and reserves must be classified under the following sub-heads:

issued, subscribed and paid up capital, distinguishing in respect of eachclass between:

shares allotted for consideration paid in cash; shares allotted for consideration other than cash; and

shares allotted as bonus shares; and

reserves (distinguishing between capital reserves and revenue reserves).

Definition

Capital reserve: A reserve not regarded free for distribution by way of dividend.(Includes capital redemption reserve, capital repurchase reserve account, sharepremium account, profit prior to incorporation).

Revenue reserve: A reserve that is normally regarded as available for distribution.

Illustration: Share capital



Rs. 000 Rs. 000

Issued subscribed and paid-up capital(Ordinary shares of Rs. 10 each) 41,800 38,000

Note to the accounts: 2013 2012 2013 2012

Rs. 000 Rs. 000 Number ofshares

Number

of shares

Authorised sharecapital (Ordinaryshares of Rs. 10each) 50,000 50,000 5,000,000 5,000,000

Issued subscribedand paid-up capital(Ordinary shares of

Rs. 10 each)Fully paid in cash 35,000 35,000 3,500,000 3,500,000

Fully paid forconsideration otherthan cash 3,000 3,000 300,000 300,000

Bonus issue 3,800 nil 380,000 nil

41,800 38,000 4,180,000 3,800,000


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2.7 Non-current liabilities

Non-current liabilities must be classified under the following sub-headings:

long term financing;

debentures;

liabilities against assets subject to finance lease;

long term murabaha;

long term deposits; and

deferred liabilities.

Long term loans must be classified as secured and unsecured, and the followingmust be shown separately under each class:

loans from banking companies and other financial institutions, other thanthose as specified below;

loans from related parties; and

other loans.

Long-term deposits must be classified according to their nature.

2.8 Current liabilities

Current liabilities and provisions must be classified under the following sub-headings:

trade and other payables, which shall be classified as:

creditors;

murabaha; accrued liabilities;

advance payments;

payable to employee retirement benefit funds;

unpaid and unclaimed dividend; and

others ( to be specified, if material);

interest, profit, return or mark-up accrued on loans and other payables;

short term borrowings which shall be classified as:

short-term borrowings, distinguishing between secured andunsecured and between loans taken from:

banking companies and other financial institutions other thanrelated parties;

related parties; and

others;

short-term running finance, distinguishing between secured andunsecured;

current portion of long term borrowings;

current portion of long term murabaha; and

provision for taxation, showing separately income tax and other taxes.


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Illustration: Trade and other payables



Current liabilities Rs. Rs.

Trade and other payables 316,715 268,803


Rs.

Rs.

Trade creditors 275,102 228,869

Accrued liabilities 13,610 14,599

Advance payments 23,457 22,222

Others 4,546 3,113

316,715 268,803

2.9 Contingencies and commitments

The following must be shown separately as a footnote to the balance-sheet:

the aggregate amount of any guarantees given by the company on behalfof any related party and where practicable, the general nature of theguarantee;

where practicable the aggregate amount or estimated amount, if it ismaterial, of contracts for capital expenditure, so far as not provided for or astatement that such an estimate cannot be made; and

any other commitment, if the amount is material, indicating the generalnature of the commitment.

2.10 Profit and loss account

The profit and loss account must disclose separately the manufacturing, tradingand operating results.

A manufacturing concern must show the cost of goods manufactured.

The profit and loss account must disclose all material items of income andexpenses including the following:

The turnover (sales) showing the gross sales figure with trade discount andsales tax as a deduction.

Expenses, classified according to their function under the following sub-heads (along with additional information on their nature):

cost of sales;

distribution cost;

administrative expenses;

other operating expenses; and

finance cost.


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Other operating income:

income from financial assets;

income from investments in and debts, loans, advances andreceivables to each related party; and

income from assets other than financial assets. Finance cost must show separately the amount of interest on borrowings

from related parties (if any).

Other information:

debts written off as irrecoverable distinguishing between trade debts,loans, advances and other receivables; and

provisions for doubtful or bad debts distinguishing between tradedebts, loans, advances and other receivables.

In each case the company must disclose:

debts due by directors, chief executive, and executives of thecompany and any of them severally or jointly with any otherperson; and

debts due by other related parties.

The aggregate amount of auditors remuneration, showing separately fees,expenses and other remuneration for services rendered as auditors and forservices rendered in any other capacity and stating the nature of such otherservices. (Amounts must be shown separately for joint auditors).

If a donation is made and any director or his spouse has interest in thedonee, the company must disclose the names of such directors, their

interest in the donee and the names and address of all donees.

Illustration: Turnover


Profit and loss account (extract) 2013 2012

Rs. Rs.

Turnover 578,554 533,991

Note to the

accounts: 2013

2012

Rs. Rs.

Gross sales 673,669 611,670

Less:

Sales tax (83,839) (74,566)

Trade discounts (11,276) (3,113)

578,554 533,991


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Payments to senior management

A company must disclose the aggregate amount charged in the financialstatements in respect of the directors, chief executive and executives by thecompany as fees, remuneration, allowances, commission, perquisites or benefitsor in any other form or manner and for any services rendered.

The company must give full particulars of the aggregate amounts separately forthe directors, chief executive and executives together with the number of suchdirectors and executives, under appropriate headings such as:

fees;

managerial remuneration;

commission or bonus, indicating their nature;

reimbursable expenses which are in the nature of a perquisite or benefit;

pension, gratuities, company's contribution to provident, superannuationand other staff funds, compensation for loss of office and in connection with

retirement from office; other perquisites and benefits in cash or in kind stating their nature and,

where practicable, their approximate money values; and

the amounts, if material, by which any items shown above are affected byany change in an accounting policy.

Illustration: Remuneration of chief executive, directors and executives

Note to the accounts Chiefe

xecutive

Executive

directors Executives

Rs.000 Rs.000 Rs.000

Fees 1,650 5,478

Managerial remuneration 11,225 33,675 323,280

Bonus 2,000 6,000 12,000

Retirement benefits 2,000 4,800 37,900

Housing 8,666

Transport 2,345 6,734 26,778

27,886 56,687 399,958

Number of persons 1 4 48

Sale of fixed assets

For sale of fixed assets where the book value of the asset or assets exceeds inaggregate fifty thousand rupees, a company must disclose particulars of theassets and in aggregate:

cost or valuation, as the case may be;

the book value;

the sale price and the mode of disposal (e.g. by tender or negotiation); and

particulars of the purchaser.


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2.11 Other disclosures

A company must disclose the following:

The general nature of any credit facilities available to the company underany contract (other than trade credit) and not used as at the date of thebalance sheet.

Any penalty imposed under any law by any authority.

The fact of any reduction, enhancement or waiver of a penalty.

Where any property or asset, acquired with the funds of the company, is not heldin the name of the company, or is not in the possession and control of thecompany, this fact must be disclosed together with a description and value of theproperty or asset and the person in whose name and possession or control it is.

Note:In the exam, you may be required to make any or all of these disclosurestherefore their knowledge and presentation is expected at this level.


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3 COMPANIES ORDINANCE 1984: FIFTH SCHEDULE

Section overview

Sundry requirements

Fixed assets (non-current assets)

Long term investments

Long term loans and advances

Long term deposits and prepayments

Current assets

Share capital and reserves

Non-current liabilities

Current liabilities

Contingencies and commitments

Profit and loss account

Other disclosures

3.1 Sundry requirements

The figures in the financial statements may be rounded to the thousands ofrupees.

Financial statements must disclose:

all material information necessary to make the financial years statementsclear and understandable;

any change in an accounting policy that has a material effect in the currentyear or may have a material effect in the subsequent year together withreasons for the change and the financial effect of the change, if material.

3.2 Fixed assets (non-current assets)

Fixed assets (other than investments) must be classified as follows:

property, plant and equipment:

land (distinguishing between free-hold and leasehold);

buildings (distinguishing between building on free-hold land and thoseon leasehold land);

plant and machinery;

furniture and fittings;

vehicles;

office equipment

capital work in progress:

development property; and

others (to be specified)


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intangible:

goodwill;

brand names;

computer software;

licences and franchises;

patents, copyright, trademarks and designs; and

others (to be specified).

3.3 Long term investments

The aggregate amount (under separate sub-headings) in respect of the following:

investments in related parties; and

other investments.

A company that is not a small sized company must also disclose investmentsunder the heading long term investments, indicating separately:

held to maturity investments, which are not due to mature within nexttwelve months; and

available for sale investments which are not intended to be sold within thenext 12 months.

market value of listed securities and book value of unlisted securities as pertheir latest available financial statements.

3.4 Long term loans and advances

The following must be shown (under separate sub-headings) distinguishingbetween considered good and considered bad or doubtful.

Loans and advances to related parties and disclosing:

Other loans and advances.

Any provision made for bad or doubtful loans and advances is shown as adeduction under each sub-heading above.

Information on terms and conditions, securities obtained and any other materialinformation must be disclosed.

3.5 Long term deposits and prepayments

Long-term deposits and long-term prepayments must be stated separately.

3.6 Current assets

Current assets must be classified in a way appropriate to the company's affairs,including the following:

stores, spare parts and loose tools distinguishing each from the otherwhere practicable;

stock-in-trade, distinguishing between appropriate classifications (forexample, raw materials and components, work in progress, finishedproducts etc.).


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trade debts (other than loans and advances) showing separately:

debts considered good and debts considered doubtful or bad must beseparately stated;

debts considered good must be distinguished between secured andunsecured;

the aggregate amount due from directors, chief executive andexecutives (does not apply to small sized companies); and

the aggregate amount due from related parties with the names ofthose related parties (does not apply to small sized companies).

loans and advances due for repayment within a period of twelve monthsfrom the reporting date showing separately:

loans and advances considered good and those considered doubtfulor bad;

the aggregate amount due from directors, chief executive and

executives (does not apply to small sized companies); the aggregate amount due from related parties with the names of

those related parties (does not apply to small sized companies);

trade deposits and short term prepayments and current account balanceswith statutory authorities;

interest accrued;

other receivables specifying separately the materials items;

financial assets other than any included above showing separately:

the aggregate amount due from directors, chief executive and

executives (does not apply to small sized companies);

the aggregate amount due from related parties with the names ofthose related parties (does not apply to small sized companies);

tax refunds due from the Government, showing separately different types oftax;

cash and bank balances, distinguishing between current and depositaccounts.

Any provision made for a fall in value of any current asset is shown as adeduction from the gross amount of that asset.

3.7 Share capital and reserves

Share capital and reserve must be classified under the following sub-heads:

issued, subscribed and paid up capital, distinguishing in respect of eachclass between:

shares allotted for consideration paid in cash;

shares allotted for consideration other than cash; and

shares allotted as bonus shares; and

reserves by distinguishing between capital reserves and revenue reserves.


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3.8 Non-current liabilities

A company which is not a small company must classify non-current liabilitiesunder the following sub-headings:

long term financing;

debentures; liabilities against assets subject to finance lease;

long term murabaha;

long term deposits; and

deferred liabilities.

Long term loans must be classified as secured and unsecured, and the followingmust be shown separately under each class:

loans from banking companies and other financial institutions, other thanthose as specified below;

loans from related parties; and

other loans.

Long-term deposits must be classified according to their nature.

3.9 Current liabilities

Current liabilities and provisions must be classified under the following sub-headings:

trade and other payables, which shall be classified as:

creditors;

murabaha;

accrued liabilities;

advance payments;

payable to employee retirement benefit funds;

unpaid and unclaimed dividend; and

others ( to be specified, if material);

interest, profit, return or mark-up accrued on loans and other payables;

short term borrowings which shall be classified as:

short-term borrowings, distinguishing between secured andunsecured and between loans taken from:

banking companies and other financial institutions other thanrelated parties;

related parties; and

others;

short-term running finance, distinguishing between secured andunsecured;

current portion of long term borrowings;

current portion of long term murabaha; and

provision for taxation, showing separately income tax and other taxes.


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3.10 Contingencies and commitments

The following must be shown separately as a footnote to the balance-sheet:

the aggregate amount of any guarantees given by the company on behalfof any related party and where practicable, the general nature of theguarantee;

where practicable the aggregate amount or estimated amount, if it ismaterial, of contracts for capital expenditure, so far as not provided for or astatement that such an estimate cannot be made; and

any other commitment, if the amount is material, indicating the generalnature of the commitment.

3.11 Profit and loss account

The profit and loss account must disclose separately the manufacturing, tradingand operating results.

A manufacturing concern must show the cost of goods manufactured.The profit and loss account must disclose all material items of income andexpenses including the following:

The turnover (sales) showing the gross sales figure with trade discount andsales tax as a deduction.

Expenses, classified according to their function under the following sub-heads (along with additional information on their nature):

cost of sales;

distribution cost;

administrative expenses; other operating expenses; and

finance cost.

Other operating income:

income from financial assets;

income from investments in and debts, loans, advances andreceivables to each related party; and

income from assets other than financial assets.

Finance cost must show separately the amount of interest on borrowings

from related parties (if any). This does not apply to a small sized company.

Other information:

debts written off as irrecoverable distinguishing between trade debts,loans, advances and other receivables; and

provisions for doubtful or bad debts distinguishing between tradedebts, loans, advances and other receivables.

In each case the company must disclose:

debts due by directors, chief executive, and executives of thecompany and any of them severally or jointly with any other

person; and

debts due by other related parties.


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Number of employees at the year-end and the average number ofemployees during the year.

Payments to senior management

This does not apply to a small sized company.

A company must disclose the aggregate amount charged in the financialstatements in respect of the directors, chief executive and executives by thecompany as fees, remuneration, allowances, commission, perquisites or benefitsor in any other form or manner and for any services rendered.

The company must give full particulars of the aggregate amounts separately forthe directors, chief executive and executives together with the number of suchdirectors and executives, under appropriate headings such as:

fees;

managerial remuneration;

commission or bonus, indicating their nature;

reimbursable expenses which are in the nature of a perquisite or benefit;

pension, gratuities, company's contribution to provident, superannuationand other staff funds, compensation for loss of office and in connection withretirement from office;

other perquisites and benefits in cash or in kind stating their nature and,where practicable, their approximate money values; and

the amounts, if material, by which any items shown above are affected byany change in an accounting policy.

3.12 Other disclosures

A company must disclose the following:

The general nature of any credit facilities available to the company underany contract (other than trade credit) and not used as at the date of thebalance sheet.

Any penalty imposed under any law by any authority.

The fact of any reduction, enhancement or waiver of a penalty.

Where any property or asset, acquired with the funds of the company, is not heldin the name of the company, or is not in the possession and control of thecompany, this fact must be disclosed together with a description and value of the

property or asset and the person in whose name and possession or control it is.If any loan or advance has been granted on terms softer than those generallyprevalent in trade or any relief allowed in matters of interest, repayment, securityor documentation, details with reasons for this must be disclosed along with thenature of interest of the company or its directors or other officers.

Note:In the exam, you may be required to make any or all of these disclosurestherefore their knowledge and presentation is expected at this level.


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Certified Finance and Accounting Professional


CHA

P

T

E

R

2Accounting and reporting concepts

Contents

1 A conceptual framework for financial reporting

2 The IASB Conceptual Framework3 Qualitative characteristics of useful financial

information

4 The elements of financial statements

5 Recognition in the financial statements

6 Accounting concepts

7 Measurement and capital maintenance

8 Fair presentation


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INTRODUCTION

Objective

To develop an in-depth understanding of, and the ability to apply the requirements of

international pronouncements, the Companies Ordinance, 1984, and other applicable

regulatory requirements in respect of financial reporting and the presentation of financial

statements.

Learning outcomes

LO 1 Prepare financial statements in accordance with the international

pronouncements and under the Companies Ordinance, 1984.

LO 2 Evaluate and analyse financial data in order to arrive at firm decisions

on the accounting treatment and reporting of the same.

FINANCIAL REPORTING AND ETHICS

Financial reporting

B (a) 1 The Conceptual Framework for the preparation and presentation of financial

statements

B (a) 9 IFRS 13: Fair value measurement


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Chapter 2:Accounting and reporting concepts


1 A CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

Section overview

The meaning of GAAP

The meaning of a conceptual framework

The purpose of a conceptual framework

The alternative to a conceptual framework

1.1 The meaning of GAAP

The preparation and presentation of financial statements is based on a large

number of concepts, principles and detailed rules. Some of these are contained

in law, and others are in financial reporting standards. Many of the most

fundamental concepts are not contained in any law or regulation or standard, butare simply accepted accounting principles and conventions.

All the concepts, principles, conventions, laws, rules and regulations that are

used to prepare and present financial statements are known as Generally

Accepted Accounting Principles or GAAP.

Generally accepted accounting principles vary from country to country, because

each country has its own legal and regulatory system. The way in which

businesses operate also differs from country to country. (For example, there is

US GAAP, UK GAAP and Pakistan GAAP).

Many countries have now adopted International Financial Reporting Standards orIFRSs, sometimes called international accounting standards. It is now fairly

common to refer to the totality of the rules as IFRS or IAS.

1.2 The meaning of a conceptual framework

A conceptual framework is a system of concepts and principles that underpin the

preparation of financial statements. These concepts and principles should be

consistent with one another.

The International Accounting Standards Committee (the predecessor of the

IASB) issued a conceptual framework document in 1989. This was called the

Framework for the Preparation and Presentation of Financial Statements andwas adopted by the IASB. It is comprised of the following sections:

The objective of financial statements (now replacedsee below)

Underlying assumptions of financial statements

Qualitative characteristics of financial statements (now replacedsee

below)

The elements of financial statements

Recognition of the elements of financial statements

Measurement of the elements of financial statements Concepts of capital and capital maintenance.


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The IASB has been working closely with FASB (the US standard setter) on a

wide range of projects with the aim of converging IFRS and US GAAP. One of

the projects has had the aim of producing a conceptual framework common to

each GAAP.

The new conceptual framework is being developed on a chapter by chapter

basis. Each chapter is being released as an exposure draft and then, subject to

comments received, released as the final version. To date, two chapters have

been finalised and these replace the sections on The objective of financial

statementsand Qualitative characteristics of financial statementsfrom the

original document.

To avoid confusion the IASB has published a new document called The

conceptual framework for financial reportingwhich includes the new chapters

and those retained from the original framework.

The new document is made up of the following sections:

Chapter 1The objective of general purpose financial statements.

Chapter 2The reporting entity (to be addedcurrently in release as an

exposure draft).

Chapter 3Qualitative characteristics of financial information.

Chapter 4The Framework (1989): The remaining text (These sections

are unchanged as of yet).

Underlying assumptions of financial statements.

The elements of financial statements.

Recognition of the elements of financial statements.

Measurement of the elements of financial statements.

Concepts of capital and capital maintenance.

The original document was known as The Framework. This text will describe the

new document as The Conceptual Framework. Note that the changes are not

fundamental in terms of their impact on IFRS.

1.3 The purpose of a conceptual framework

Most preparers and users of financial statements recognise that there is a needfor a formal conceptual framework and that this can be useful in a number of

ways.

Where there is a formal conceptual framework for accounting, accounting

practice and accounting standards are based on this framework.

Lack of a formal framework often means that standards are developed randomly

or only to deal with particular problems. The result is that standards are

inconsistent with each other or with legislation.

Lack of a conceptual framework may also mean that accounting standards fail to

address important issues. For example, until the IASB developed its Framework,

there was no proper definition of terms such as asset, liability, income and

expenses.


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The business environment is becoming increasingly complex. It is unlikely that

accounting standards can cover all possible transactions. Where an entity enters

into an unusual transaction and there is no relevant accounting standard, it can

refer to the framework and apply the principles in it.

It can also be argued that a conceptual framework strengthens the credibility of

financial reporting and the accounting profession in general.

1.4 The alternative to a conceptual framework

The alternative to a system based on a conceptual framework is a system based

on detailed rules.

Accounting standards based on detailed rules are open to abuse. Creative

accountingis the name given to techniques which enable management to give a

biased impression (usually favourable) of the companys performance while still

complying with accounting standards and other regulations. During the 1980s

there were a number of scandals in which investors were misled by the financialstatements of apparently healthy companies which then collapsed. This was one

of the original reasons why the IASB and other standard setters developed their

conceptual frameworks. Principles are normally much harder to evade than rules.

Another disadvantage of a rule-based system is that standard setters are more

likely to be influenced by vested interests such as large companies or a

particular business sector. The existence of a conceptual framework is an

important safeguard against this kind of political pressure.

Despite these problems, some preparers and regulators still appear to favour rule

based standards. Standards based on principles may require management to

use its judgement (and to risk making a mistake), while rules simply need to be

followed. This can be important where management can face legal action if an

investor makes a poor decision based on the financial statements.

The use of a conceptual framework can lead to standards that are theoretical and

complex. They may give the right answer but be very difficult for the ordinary

preparer to understand and apply. However, a system of extremely detailed rules

can also be very difficult to apply.


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2 THE IASB CONCEPTUAL FRAMEWORK

Section overview

Introduction

Underlying assumption

Users and their information needs

Objective of general purpose financial statements

2.1 Introduction

Financial reports are based on estimates, judgements and models rather than

exact depictions. The Conceptual Framework establishes the concepts that

underlie those estimates, judgements and models.

The Conceptual Framework deals with:

the objective of financial reporting;

the qualitative characteristics of useful financial information;

the definition, recognition and measurement of the elements from which

financial statements are constructed; and

concepts of capital and capital maintenance.

The Conceptual Framework sets out the concepts that underlie the preparation

and presentation of financial statements for external users. Its purpose is:

to assist the IASB in the development of future IFRSs and in its review of

existing IFRSs;

to assist the IASB in promoting harmonisation of regulations, accounting

standards and procedures relating to the presentation of financial

statements by providing a basis for reducing the number of alternative

accounting treatments permitted by IFRSs;

to assist national standard-setting bodies in developing national standards;

to assist preparers of financial statements in applying IFRSs and in dealing

with topics that have yet to form the subject of an IFRS;

to assist auditors in forming an opinion on whether financial statements

comply with IFRSs;

to assist users of financial statements in interpreting the information

contained in financial statements prepared in compliance with IFRSs; and

to provide those who are interested in the work of the IASB with information

about its approach to the formulation of IFRSs.

This Conceptual Framework is not an IFRS and nothing in the Conceptual

Framework overrides any specific IFRS.


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On very rare occasions there may be a conflict between the Conceptual

Framework and an IFRS. In those cases, the requirements of the IFRS prevail

over those of the Conceptual Framework.

2.2 Underlying assumption

The going concern basis of accounting is the assumption in preparing thefinancial statements that the entity will continue to operate for the foreseeable

future, and does not intend to go into liquidation and will not be forced into

liquidation. The going concern assumption is particularly relevant for the

valuation of assets.

This is found in chapter 4 of The Conceptual Framework.

2.3 Users and their information needs

Many existing and potential investors, lenders and other creditors cannot require

reporting entities to provide information directly to them and must rely on generalpurpose financial reports for much of the financial information they need. These

are the primary users to whom general purpose financial reports are directed.

General purpose financial reports cannot provide all the information needed

and users also need to consider pertinent information from other sources.

General purpose financial reports do not show the value of a reporting

entity; but they provide information to help users estimate a value.

Individual primary users have different information needs. The aim of IFRSs

is to provide information that will meet the needs of the maximum number

of primary users.Other users

Regulators and members of the public other than investors, lenders and

other creditors may also find general purpose financial reports useful but

these reports are not primarily directed to these groups.

A companys management is interested in financial information but the

management does not need to rely on general purpose financial reports.

2.4 Objective of general purpose financial statements

The objective of general purpose financial reporting forms the foundation of the

Conceptual Framework. Other aspects of the Conceptual Framework flow

logically from the objective.

The objective

The objective of general purpose financial reporting is 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.

Those decisions involve buying, selling or holding equity and debt instruments,

and providing or settling loans and other forms of credit.


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In order to make these decisions the users need information to help them

assess the prospects for future net cash inflows to an entity.

In order to assess an entitys prospects for future net cash inflows, users

need information about:

the resources of the entity;

claims against the entity; and

how efficiently and effectively the entitys management have

discharged their responsibilities to use the entitys resources. (This

information is also useful for decisions by those who have the right to

vote on or otherwise influence management performance).

Information provided

General purpose financial statements provide information about:

the financial position of the entity which is information about economicresources and the claims against them; and

changes in its financial position which could be due to:

financial performance; and/or

other events or transactions (e.g. share issues).

Economic resources and claims

Information about the nature and amounts of economic resources and claims can

help users to:

identify the financial strengths and weaknesses of a reporting entity; to assess a reporting entitys liquidity and solvencyand its needs for

additional financing;

Information about priorities and payment requirements of existing claims helps

users to predict how future cash flows will be distributed among those with a

claim against the reporting entity.

Changes in economic resources and claims Financial performance

Accrual accounting depicts the effects of transactions and other events and

circumstances on a reporting entitys economic resources and claims in the

periods in which those effects occur, even if the resulting cash receipts andpayments occur in a different period.

This is important because such information provides a better basis for assessing

the entitys past and future performance than information solely about cash

receipts and payments during that period.

Importance of information about a reporting entitys financial performance:

It helps users to understand the return generated from its economic

resources. This in turn provides an indication of how well management has

discharged its responsibilities to make efficient and effective use of these

resources.


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It shows the capacity of a reporting entity to generate net cash inflows

through its operations rather than by obtaining additional resources directly

from investors and creditors.

It gives an indication of the extent to which events such as changes in

market prices or interest rates affect its ability to generate net cash inflows.

Information about the variability and components of return is also important,

especially in assessing the uncertainty of future cash flows.

Information about past financial performance is helpful in predicting the

entitys future returns on its economic resources.

Another aspect of performance is management of cash flow. Information about a

reporting entitys cash flows during a period helps users to assess the entitys

ability to generate future net cash inflows. It indicates how the reporting entity

obtains and spends cash, including information about its borrowing and

repayment of debt, cash dividends or other cash distributions to investors, and

other factors that may affect the entitys liquidity or solvency. Information about

cash flows helps users understand a reporting entitys operations, evaluate its

financing and investing activities, assess its liquidity or solvency and interpret

other information about financial performance.

Changes in economic resources and claims Other events and transactions

Information about this type of change is necessary to give users a complete

understanding of why the reporting entitys economic resources and claims

changed and the implications of those changes for its future financial

performance.

Objectives of financial statements: summary

The objectives of financial statements are met by:

the main financial statements (statement of financial position, statement of

profit or loss and other comprehensive income (or statement of profit or

loss and statement of other comprehensive income), statement of cash

flows, and statement of changes in equity), and

supporting notes to the accounts, which provide additional details.


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3 QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL

INFORMATION

Section overview

Introduction

Relevance

Faithful representation

Enhancing qualitative characteristics

Cost constraint on useful information

3.1 Introduction

This is covered by chapter 3 of The IASB Conceptual Framework.

Information must have certain characteristics in order for it to be useful for

decision making. The IASB Conceptual Frameworkdescribes:

fundamental qualitative characteristics; and

enhancing qualitative characteristics

Fundamental qualitative characteristics:

relevance; and

faithful representation

The qualitative characteristics that enhance the usefulness of information that isrelevant and a faithful representation are:

comparability;

verifiability

timeliness; and

understandability

If financial information is to be useful, it must be relevant and faithfully represent

what it purports to represent. The usefulness of financial information is

enhanced if it is comparable, verifiable, timely and understandable.

Emphasis

Information must be both relevant and faithfully represented if it is to be useful.

The enhancing qualitative characteristics cannot make information useful if that

information is irrelevant or not faithfully represented.


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3.2 Relevance

Information must be relevant to the decision-making needs of users. Information

is relevant if it can be used for predictive and/or confirmatory purposes.

It has predictive valueif it helps users to predict what might happen in the

future. It has confirmatory valueif it helps users to confirm the assessments and

predictions they have made in the past.

The relevance of information is affected by its materiality.

Information is material if omitting it or misstating it could influence decisions that

users make on the basis of financial information about a specific reporting entity.

Materiality is an entity-specific aspect of relevance based on the nature or

magnitude (or both) of the items to which the information relates in the

context of an individual entitys financial report.

Therefore, it is not possible for the IASB to specify a uniform quantitative

threshold for materiality or predetermine what could be material in a

particular situation.

3.3 Faithful representation

Financial reports represent economic phenomena (economic resources, claims

against the reporting entity and the effects of transactions and other events and

conditions that change those resources and claims) by depicting them in words

and numbers.

To be useful, financial information must not only represent relevant phenomena,but it must also faithfully represent the phenomena that it purports to represent.

A perfectly faithful representation would have three characteristics. It would be:

completethe depiction includes all information necessary for a user to

understand the phenomenon being depicted, including all necessary

descriptions and explanations.

neutralthe depiction is without bias in the selection or presentation of

financial information; and

free from errorwhere there are no errors or omissions in the description

of the phenomenon, and the process used to produce the reported

information has been selected and applied with no errors in the process.

3.4 Enhancing qualitative characteristics

Comparability

Comparability is the qualitative characteristic that enables users to identify and

understand similarities in, and differences among, items

Information about a reporting entity is more useful if it can be compared with

similar information about other entities and with similar information about the

same entity for another period or another date.


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Consistency is related to comparability but is not the same. Consistency refers tothe use of the same methods for the same items, either from period to periodwithin a reporting entity or in a single period across entities. Consistency helps toachieve the goal of comparability.

Verifiability

This quality helps assure users that information faithfully represents theeconomic phenomena it purports to represent.

Verifiability means that different knowledgeable and independent observerscould reach consensus that a particular depiction is a faithfulrepresentation.

Quantified information need not be a single point estimate to be verifiable.A range of possible amounts and the related probabilities can also beverified.

Verification can be direct or indirect.

Direct verification means verification through direct observation, e.g. bycounting cash.

Indirect verification means checking the inputs to a model, formula or othertechnique and recalculating the outputs using the same methodology. Forexample, the carrying amount of inventory might be verified by checking theinputs (quantities and costs) and recalculating the closing inventory usingthe same assumption (e.g. FIFO).

Timeliness

This means having information available to decision-makers in time to be capableof influencing their decisions.

Understandability

Information is made understandable by classifying, characterising and presentingit in a clear and concise manner.

Financial reports are prepared for users who have a reasonable knowledge ofbusiness and economic activities and who review and analyse the informationdiligently.

3.5 Cost constraint on useful information

Reporting financial information that is relevant and faithfully represents what itpurports to represent helps users to make decisions with more confidence. This

results in more efficient functioning of capital markets and a lower cost of capitalfor the economy as a whole. An individual investor, lender or other creditor alsoreceives benefits by making more informed decisions. However, it is not possiblefor general purpose financial reports to provide all the information that every userfinds relevant.

The benefits obtained from financial information should exceed the cost ofobtaining and providing it. Information should not be provided if the cost is notworth the benefit.

Since it is difficult to measure the benefits of financial information, the setters ofaccounting standards must use their judgement in deciding whether certain itemsof information should be provided in the financial statements (and if so, in how

much detail).


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4 THE ELEMENTS OF FINANCIAL STATEMENTS

Section overview

Assets

Liabilities

Equity

Income

Expenses

The IASB Framework discusses the five elements of financial statements:

for reporting financial position: assets, liabilities and equity

for reporting financial performance: income and expenses.

4.1 Assets

An asset is defined as:

a resource controlled by the entity;

as a result of past events; and

from which future economic benefits are expected to flow to the entity.

Resource controlled by the entity

Control is the ability to obtain economic benefits from the asset, and to restrict

the ability of others to obtain the same benefits from the same item.

An entity usually uses assets to produce goods or services to meet the needs of

its customers, and because customers are willing to pay for the goods and

services, this contributes to the cash flow of the entity. Cash itself is an asset

because of its command over other resources.

Many ass

Documents

CFAP FAFR Study Text