financial reporting

© 2008 Nelson Lam and Peter Lau Intermediate Financial Reporting: An IFRS Perspective (Chapter 2) - 1

Chapter 2

Framework for International Financial Reporting


Agenda

1. Purpose and Scope of the Framework

2. Objective of Financial Statements and Underlying Assumptions

3. Qualitative Characteristics of Financial Statements

4. The Elements of Financial Statements and their Definitions

5. Recognition of the Elements of Financial Statements

6. Measurement of the Elements of Financial Statements

7. Concept of Capital and Capital Maintenance

8. Development of a Single Converged Framework


1. Purpose & Scope of the Framework

• The Framework addresses the concepts underlying the information presented in general purpose financial statements.

• The objective of the Framework is – To facilitate the consistent and logical formulation of IFRSs.

– To provide a basis for the use of judgement in resolving accounting issues, including to assist the standard setters, including the IASB, in developing new accounting standards and reviewing existing standards,

– To assist the preparers of financial statements in applying accounting standards, and

– To assist the users of financial statements in interpreting the financial statements prepared in accordance with the relevant accounting standards.


1. Purpose & Scope of the Framework

• Distinguished from an IFRS, the Framework specifically clarifies that it is not an IFRS and does not define standards for any particular measurement or disclosure issue.

• Nothing in the Framework overrides any specific accounting standard.

• The Framework deals with the following issues:

1. The objective of financial statements (see section 2);

2. The qualitative characteristics of information in financial statements (see section 3);

3. The elements of financial statements and their definitions (see section 4);

4. The recognition of the elements of financial statements (see section 5);

5. The measurement of the elements of financial statements (see section 6); and

6. Concepts of capital and capital maintenance (see section 7).


Process of communicationProcess of communicationProcess of communicationProcess of communication

Company’s activities

FinancialReporting

User perception

2. Objective & Underlying Assumptions

• The Framework states that: The objective of general purpose financial statements is

to provide information about the financial position, financial performance and change in financial position of an entity that is useful to a wide range of users in making economic decisions.

• Similar to the objective stated in the IAS 1



• To provide the user-oriented information need, a set set of financial statements comprises:

a) a statement of financial position as at the end of the period;

b) a statement of comprehensive income for the period;

c) a statement of changes in equity for the period;

d) a statement of cash flows for the period;

e) notes, comprising a summary of significant accounting policies and other explanatory information; and

f) a statement of financial position as at the beginning of the earliest comparative period

• when an entity applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial statements, or

• when it reclassifies items in its financial statements.

Previously, we call it “Balance Sheet”Previously, we call it “Balance Sheet”

Previously, we call it “Income Statement”Previously, we call it “Income Statement”

3 years’ “balance sheets”3 years’ “balance sheets”



• In order to meet the objectives of financial statements, financial statements are prepared on

– On the accrual basis of accounting (implies that the effects of transactions and other events are recognised when they occur, rather than they have been received or paid, and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate) and

– On the assumption that an entity is a going concern (assumes that an entity will continue in operation for the foreseeable future)


3. Qualitative Characteristics



Qualitative characteristics of financial statements

• Relating to content

- Relevance (Predictive value, Confirmatory value, Interrelated)

- Reliability (Faithful representation, Substance over form, Neutrality,Prudence and Completeness)

• Relating to presentation

- Comparability (Consistency and Disclosure)

- Understandability (Users’ ability, Aggregation and Classification)



Qualitative characteristicsof financial statements

• Relating to content

- Relevance

- Reliability

• Relating to presentation

- Comparability

- Understandability

Management Decision

Management Decision

Financial Financial reportingreportingFinancial Financial reportingreporting



Constraints on Relevant and Reliable Information

• To provide relevant and reliable information to meet the users’ needs, the financial statements should also be subject to certain constraints as follows:

1. Timeliness: Even a reliable set of information is given, there is undue delay in providing such information.

2. Balance between benefit and cost

3. Balance between qualitative characteristics



True and Fair View or Fair Presentation

• The Framework does not directly deal with the concept of a true and fair view of, or as presenting fairly, the financial position, performance and cash flows of an entity; – even the financial statements are usually described as presenting fairly or

showing a true and fair view of the financial position, performance and cash flows of an entity.

• The application of the qualitative characteristics and appropriate accounting standards normally results in financial statements that give a true and fair view of, or as presenting fairly, such information.


4. Elements of Financial Statements


4. Elements of Financial Statements

AssetAsset

LiabilityLiability

EquityEquity

IncomeIncome

ExpensesExpenses

Financial Position (in balance sheet)

Financial Performance (in income statement)

• a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise

• a present obligation of the enterprise arising from past events,the settlement of which is expected to result in an outflow fromthe enterprise of resources embodying economic benefits

• the residual interest in the assets of the enterprise after deducting all its liabilities

• increases in economic benefits during a 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

• decreases in economic benefits during a period in the form of– outflows or depletions of assets or– incurrences of liabilities that result in decreases in equity,– other than those relating to distributions to equity participants


5. Recognition of the Elements

Criteria for recognition – an item that meets the definition of an element should be recognized if:1. it is probable that any future economic benefit associated

with the item will flow to or from the enterprise; and

2. the item has a cost or value that can be measured with reliability.

Criteria for recognition – an item that meets the definition of an element should be recognized if:1. it is probable that any future economic benefit associated

with the item will flow to or from the enterprise; and

2. the item has a cost or value that can be measured with reliability.

Recognition is the process of incorporating in the balance sheet or income statement an item that1. meets the Definition of an element and

2. satisfies the Criteria for Recognition

Recognition is the process of incorporating in the balance sheet or income statement an item that1. meets the Definition of an element and

2. satisfies the Criteria for Recognition


6. Measurement of the Elements

Historical cost

Current cost

Realisable (settlement) value

Present value

Historical cost

Current cost

Realisable (settlement) value

Present valueFair value less cost to sell

Value in use


6. Measurement of the Elements

• Fair value can be applied to

– initial measurement,

– subsequent measurement, or

– both

Applied to initial measurement but not subsequent measurement:• Held-to-maturity (IAS 39)

• Loans and receivables (IAS 39)

• Business combination (IFRS 3)

Applied to initial measurement but not subsequent measurement:• Held-to-maturity (IAS 39)

• Loans and receivables (IAS 39)

• Business combination (IFRS 3)

Not applied to initial measurement but applied to subsequent measurement (incl. selective):• Property, plant and equipment

(IAS 16)

• Intangible assets (IAS 38)

• Investment property (IAS 40)

Not applied to initial measurement but applied to subsequent measurement (incl. selective):• Property, plant and equipment

(IAS 16)

• Intangible assets (IAS 38)

• Investment property (IAS 40)

ExampleExampleExampleExample

Applied to both initial and subsequent measurement:• Inventories (IAS 2)

• Financial assets and liabilities at fair value through P/L (IAS 39)

• Available for sale financial assets (IAS 39)

• Agriculture (IAS 41)

Applied to both initial and subsequent measurement:• Inventories (IAS 2)

• Financial assets and liabilities at fair value through P/L (IAS 39)

• Available for sale financial assets (IAS 39)

• Agriculture (IAS 41)


7. Capital and Capital Maintenance

Concept of Capital

Financial concept of capital

• is adopted by most enterprises in preparing their financial statements

• Under it, such as invested money or invested purchasing power, capital is synonymous with the net assets or equity of the enterprise.

Physical concept of capital

• Under it, such as operating capability, capital is regarded as the productive capacity of the enterprise based on

• For example, units of output per day

Concept of Capital Maintenance Financial concept maintenance

• Under this concept, a profit is earned only if

• the financial (or money) amount of the net assets at the end of the period

• exceeds the financial (or money) amount of net assets at the beginning of the period

• after excluding any distributions to, and contributions from, owners during the period.

• Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power


7. Capital and Capital Maintenance

Concept of Capital

Financial concept of capital

• is adopted by most enterprises in preparing their financial statements

• Under it, such as invested money or invested purchasing power, capital is synonymous with the net assets or equity of the enterprise.

Physical concept of capital

• Under it, such as operating capability, capital is regarded as the productive capacity of the enterprise based on

• For example, units of output per day

Concept of Capital Maintenance Physical concept maintenance

• Under this concept, a profit is earned only if

• the physical productive capacity (or operating capability) of the enterprise (or the resources or funds needed to achieve that capacity) at the end of the period

• exceeds the physical productive capacity at the beginning of the period

• after excluding any distributions to, and contributions from, owners during the period.


8. A Single Converged Framework

• Since 2004, the IASB and FASB have begun a joint project to develop an improved common conceptual framework (i.e. a single converged framework) that builds on their existing frameworks, i.e. the Framework of the IASB and the conceptual framework of the FASB’s SFAC.

• They intend to provide a sound foundation for developing future financial reporting standards and is essential to fulfilling the their goal of developing standards that lead to financial reporting that provides the information required for the users.


8. A Single Converged Framework

• In accordance with the IASB and FASB, the project will do the following:

1. Focus on changes in the environment since the original frameworks were issued, as well as omissions in the original frameworks, in order to efficiently and effectively improve, complete, and converge the existing frameworks.

2. Give priority to addressing and deliberating those issues within each phase that are likely to yield benefits to the IASB and FASB in the short term; that is, cross-cutting issues that affect a number of their projects for new or revised standards.

3. Initially consider concepts applicable to private sector business entities. Later, the IASB and FASB will jointly consider the applicability of those concepts to private sector not-for-profit organizations.


Chapter 2

Framework for International Financial Reporting

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