IFRS Overview (PDF)

IAS-International Accounting Standards IFRS-International Financial Reporting Standards An overview Chiara Saccon IFRS Conceptual Framework IASB Conceptual Framework: objectives Objectives of financial reporting “to provide financial information about the...

IAS-International Accounting Standards IFRS-International Financial Reporting Standards An overview Chiara Saccon IFRS Conceptual Framework IASB Conceptual Framework: objectives Objectives of financial reporting “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 setting loans and other forms of credit” Focus on information needs of capital providers (investors and creditors) IASB Conceptual Framework: qualitative characteristics Qualitative characteristics of useful financial information Fundamental characteristics – Relevance (Materiality) – Faithful representation (Completeness, Neutrality, Free from errors) Enhancing characteristics – Comparability – Verifiability – Timeliness – Understandability  IASB Framework 2018 - The Elements of Financial Statements: Asset: A present economic resource controlled by the entity as a result of past events An economic resource is a right that has the potential to produce economic benefits Liability: A present obligation of the entity to transfer an economic resource as a result of past events An obligation is a duty or responsibility that the entity has no practical ability to avoid  IASB Framework 2018 - The Elements of Financial Statements: Income: increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity claims Expenses: decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims  IASB Conceptual Framework 2018 - Recognition (inclusion in financial report) of the elements (that meet definitions) is appropriate if it results in both: - relevant information about assets, liabilities, equity, income and expenses and a - faithful representation of those items (being met the definitions of the elements)  IASB Framework 2018 - Measurement of the elements : historical cost measurement bases current cost measurement bases (fair value, value in use, current value…): fair value: the amount at which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length legal transaction  IASB definition, recognition and measurement stages First stage (definition): is there an asset? Second stage (recognition): if yes, should the asset be recognized in the balance sheet? Third stage (measurement): if again yes, how should it be measured? Presentation of financial information Financial statements IAS 1  International Accounting Standard 1 IAS 1- Presentation of Financial Statements Objective To prescribe the basis for presentation of general purpose financial statements to ensure comparability both with the entity’s financial statements of previous periods and with the financial statements of other entities Financial statements: – structure – content  International Accounting Standard 1 Structure and content Purpose of financial statements To provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions Components of financial statements: - Statement of Financial Position (BS) - Statement of Comprehensive Income - Statement of changes in equity - Statement of Cash flow - notes  International Accounting Standard 1 Structure and content Statement of Financial Position (BS): structure and content -Not format or order prescribed -Minimum content provided (list of items sufficiently different in nature or function) -Additional line items, headings and subtotals should also be included on the face of the balance sheet when any other IFRS requires it or when such additional presentation is necessary in order to present fairly the entity’s financial position -Further subclassifications of the line items can be disclosed in the balance sheet or in the notes  International Accounting Standard 1 Structure and content SFP (Balance sheet) minimum content Property, plant and equipment Investment property Intangible assets Financial assets Investment accounted for using the equity method Biological assets Inventories Trade and other receivables Cash and cash equivalents Assets held for sale Trade and other payables Provisions Financial liabilities Liabilities and assets for current tax Deferred tax liabilities and deferred tax assets Liabilities of disposal groups held for sale Non-controlling interests Issued capital and reserves attributable to the owners of the parent  International Accounting Standard 1 Structure and content Statement of Financial Position (BS) Methods of presentation: - 1) current/non current distinction (preferred) - 2) based on liquidity (if reliable and more relevant) For each asset and liability an entity shall disclose the amount expected to be recovered or settled after more than 12 months  International Accounting Standard 1 Structure and content 1) Method of presentation based on current/non current distinction Current asset when: - It is expected to be realised in, or is intended for sale or consumption in, the entity’s normal operating cycle (=time between the acquisition of assets for processing and their realisation in cash or cash equivalents) - It is held primarily for the purpose of being traded - It is expected to be realised within 12 months after the reporting period, or - It is cash or a cash equivalent All other assets shall be classified as non-current  International Accounting Standard 1 Structure and content Current liability when: - It is expected to be settled in the entity’s normal operating cycle - It is held primarily for the purpose of being traded - It is due to be settled within 12 months after the balance sheet date All other liabilities shall be classified as non- current  International Accounting Standard 1 Structure and content 2) Method of presentation based on liquidity An entity should disclose the amount included in each item that are expected to be recovered or settled before and after 12 months  International Accounting Standard 1 Structure and content Income Statement: structure and content Additional line items, headings and subtotals should be presented on the face of the IS when required by more specific IFRSs or when such additions are necessary to present fairly the entity’s financial performance The materiality and the nature of the entity’s operations may require additions to, deletions from, or amendments of descriptions within the list of items Presentation of an expenses analysis using a classification by nature or by function (in the IS or in the Notes, better in the IS) (always information on the nature of expenses because it is useful in predicting future cash flows)  International Accounting Standard 1 Structure and content Expenses analysis using a classification by nature or by function classification by nature (easier): aggregate expenses by considering nature (wages, depreciation, materials, transport, etc) classification by function (more understandable): aggregate expenses by considering function (cost of sales, distribution expenses, administrative expenses, financial expenses) of the item  International Accounting Standard 1 Structure and content Income statement minimum content Revenues Finance costs Share of the profit or loss of associates & JV accounted for using the equity method Tax expense Post-tax gain or loss on discontinued operations, and disposal of their assets/liabilities Profit or loss (As allocation of profit and loss of the period: Profit or loss attributable to non-controlling interests Profit or loss attributable to the the parent)  International Accounting Standard 1 Income statement evolution Tendency in the past to focus attention on the income statement and on the final net profit figure View that only gains received in cash are reliable (creditor perspective) However other recognized changes in assets and liabilities carry significant information content (e.g. revaluation) This thinking led to the idea of an additional reporting statement ‘a statement of recognised gains and losses/income and expense’ International Accounting Standard 1 Statement of Comprehensive (total) Income An entity shall present all items of income and expenses recognised in a period: In a single ‘statement of profit or loss and other comprehensive income’, or In two statements: – a separate income statement displaying components of profit or loss – a statement of comprehensive income beginning with profit or loss and displaying components of ‘other comprehensive income’ (Profit or loss=total of income less expenses, excluding the component of ‘other comprehensive income’) International Accounting Standard 1 A statement of Other Comprehensive Income (OCI) begins with the balance from the income statement, after that the most common items to be found are: Changes in revaluation surplus (IAS 16 Property, Plant and Equipment and IAS 38 Intangible Asset) Actuarial gains and losses on defined benefit plans recognized in accordance with IAS 19 Employee Benefits Gains and losses arising from translating the financial statements of foreign operations (IAS 21 The Effects of Changes in Foreign Exchange Rates)  INCOME STATEMENT classification of expenses by function Revenues - Cost of sales = Gross profit - Distribution costs - Administrative expenses - Finance costs + Share of profit of associates = Profit before tax - Income tax expense = Profit for the period  INCOME STATEMENT classification of expenses by nature Revenues Changes in inventories of finished goods and work in progress - Raw material & consumables used - Employee benefits expenses - Depreciation and amortisation expense - Impairment - Other expenses - Finance costs + Share of profit of associates = Profit before tax - Income tax expense = Profit for the period  IAS 1 Balance sheet ASSETS EQUITY & LIABILITIES – Non current assets – Equity – Property, plant & – Share capital equipment – Retained earnings – Goodwill – Reserves – Intangible assets – Non current liabilities – Other non current assets – Long term liabilities – Long-term provisions – Current assets – Borrowings – Inventories – Current liabilities – Cash & cash equivalents – Trade payables – Current portion of non – Short term provisions current assets – Current portion of long – Trade receivables term borrowings  Income statement by nature Revenues -Services expenses -Labour costs -Raw material purchases -Insurance expenses -Depreciation =OPERATING RESULT (E.B.I.T) Financial income -Financial costs PRE TAX PROFIT -Income taxes =NET PROFIT FOR THE PERIOD (EBIT=Earnings Before Interests and Taxes)  IAS 1 – Notes to the financial statements Functions of the Notes: – To present information about the basis of preparation of financial statements and the specific accounting policies – To disclose any information required that is not included elsewhere – To provide additional information Systematic presentation (cross-references) Statement of compliance with a set of A/C principles Measurement of tangible and intangible assets IAS 16, 38  Measurement Measurement of assets and liabilities Alternatives: cost…or...market value Initial measurement (at recognition): “cost” (Which cost? Which cost components?) Subsequent measurement (after recognition): “cost or market value” (Which market value? Eg. fair value/net realizable value ) International Accounting Standard 16 International Accounting Standard 38 Property, Plant and Equipment (IAS 16) Intangible assets (IAS 38)  IAS 16 Tangible assets Property, plant and equipment are tangible items that: -are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and -are expected to be used during more than one period Examples: land, buildings, plant, machinery, fittings, warehouses, offices, factories equipment, tools, vehicles,...  IAS 38 Intangible assets Intangible assets are: identifiable non-monetary assets without physical substance Examples: R&D, patents, licences, trade marks, concessions, goodwill, know how, software, brands,…  Recognition of fixed assets For tangible assets the problems of recognition are generally smaller than for the intangible assets. This is because it is usually possible to physically identify tangible assets and to establish a cost or value. Intangible assets created by the company cannot be recognized as assets (capitalized) unless they have been bought from somebody else because otherwise a cost or value is difficult to determine (ex. brand names, customer lists..)  IAS 16 Tangible assets Tangible assets - Measurement at recognition (IAS 16) An item of property, plant and equipment that qualifies for recognition as an asset shall be measured at its cost The cost comprises: -purchase price -any costs directly attributable (delivery charges, legal fees, installation charges..) -the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located  Tangible assets - IAS 16 Company B is installing a new plant at its production facility. It has incurred these costs: -cost of the plant 3.300 -consultants fees (for advice on the plant acquisition) 500 -transportation and installation costs 200 -estimated dismantling costs of 400 to be incurred after 10 years Initial total cost of the plant according to IAS 16: 3.300+500+200+400=4.400  IAS 38 Intangible assets Intangible assets - Measurement at recognition (IAS 38) Recognition if: - Probable expected future economic benefits - Reliable measurement of cost (this cuts out goodwill, research, brands or customer lists if they were internally generated) An intangible asset shall be measured initially at cost  Depreciation / amortization Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life Depreciation of tangible assets Amortization of intangible assets In the case of an asset that has a potentially unlimited/indefinite useful life, it seems reasonable that no expense should ever be charged for using it up. This generally applies to land, purchased brand…  International Accounting Standard 16 Depreciation of tangible assets (IAS 16) Depreciation amount and depreciation period The depreciable amount (cost – residual value) of an asset shall be allocated on a systematic basis over its useful life (period/number of production) Depreciation method The depreciation method used shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity International Accounting Standard 38 Amortization of Intangible assets Intangible assets useful life: - Finite - Indefinite (when based on an analysis of all of the relevant factors, there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity) International Accounting Standard 38 Amortisation period The depreciable amount (cost – residual value/generally assumed to be zero) of an intangible asset with a finite useful life shall be allocated on a systematic basis over its useful life (period/number of production) Amortisation method The amortisation method used shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity. If it cannot be determined reliably, the straight-line method shall be used International Accounting Standard 38 An intangible asset with indefinite useful life shall not be amortise The useful life of an intangible asset that is not being amortised shall be reviewed each period to determine whether events and circumstances continue to support an indefinite useful life assessment. If they do not, the change in the useful life assessment from indefinite to finite shall be accounted for as a change in estimate by adjusting depreciation in the current and future periods  Impairment – loss of value The carrying value of the asset may overstate what the asset is worth to the business➔impairment in the value of the asset (due to: rapid economic obsolescence, physical damage…) IAS 36 provides a method of measuring the size of impairment: if there is any impairment of an asset, the company must take it into account and record the relative loss (loss when recoverable amount is lower than the carrying amount; recoverable amount is the higher of value in use- DCF and Net selling price/Net realizable value)  Tangible and intangible assets Tangible/Intangible assets - Measurement after recognition An entity shall choose either the cost model or the revaluation model as its accounting policy and shall apply that policy to an entire class of property, plant and equipment Cost model The asset shall be carried at its cost less any accumulated depreciation and any accumulated impairment losses Revaluation model The asset whose fair value can be measured reliably shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Revaluation shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date.  Arguments in favor of cost or revaluation model Historical cost is an easier and cheaper method of valuation than most Historical cost is more reliably determined than other current valuation could be Historical cost it is not the most relevant information for making economic decisions Fair value is more relevant than past value but it involves much more subjectivity For certain assets fair values are reliable (particularly those where there are active markets, such as some markets for shares) Measurement of Inventories IAS 2 International Accounting Standard 2 Inventories (or stock) are assets: a) Held for sale in the ordinary course of business; b) In the process of production for such sale; or c) In the form of materials or supplies to be consumed in the production process or in the rendering of services Inventory categories: ➔ Finished goods ➔ Work in progress ➔ Raw material  Inventory measurement/valuation The valuation of inventory directly affects the Income statement and the Balance sheet Balance sheet considerations for inventory are important The valuation of inventory at the end of an accounting period directly affects the profit There must be an attempt to match the charge for inventory used against the sales that relate to it There are many ways of valuing the remaining inventory Although the total profit of all accounting periods is not affected by the valuation of inventory (because one year’s closing inventory is the next year opening inventory), the profit of any individual year is affected IAS 2-Inventory valuation criterion Measurament of inventories “Inventories shall be measured at the lower of cost and net realisable value” Cost (input value)? Net realisable value (output value)?  IAS 2 Cost – input value (How to determine the cost of items in inventory) Cost shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition On the basis of the allocation criterion: - Direct costs: figures that can be related to particular inventory directly by definition (ex. labour, materials, direct production overhead like specific machines depreciation) - Indirect costs: production overhead (ex. rent, factory managers) (Administrative and selling overhead should not be included in the cost measure)  Cost – input value A difficulty will arise when the company has to determine the cost of particular remaining units when several identical items have been purchased or made at different times and therefore at different unit costs Two situations: – It is possible to identify the actual physical units that have moved in or out – It is impossible or inconvenient to identify the units➔assumpion needed (FIFO, LIFO, WA)  IAS 2 - Cost formula (FIFO, WAM) Cost formulas The cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects shall be assigned by using specific identification of their individual costs. The cost of inventories, ordinarily interchangeable, shall be assigned by using the first-in, first-out (FIFO) or weighted average cost formula. An entity shall use the same cost formula for all inventories having a similar nature and use to the entity. For inventories with a different nature or use, different cost formulas may be justified. IAS 2 Net realisable value – output value Net realisable value Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs (marketing, distribution) necessary to make the sale ‘Selling price’ for finished goods or materials ‘Selling price less costs of completation’ for work in progress  IFRS Inventory valuation “Inventories shall be measured at the lower of cost and net realisable value” COST NRV Case 1 100 120 Case 2 100 70 (prudent alternative chosen) Financial assets, liabilities and equity  Financial Assets Assets can be of 3 kinds: – Tangible (inventory; PPE) – Intangible (Software, patents, purchased goodwill…) – Financial (cash, receivables, investments ) Financial assets can be current or non-current – Current financial assets: cash, receivables, investments* – Non-current assets: long-term investments* * Investment are divided into current and non-current on the basis of whether they are intended for continuing use or if they are held for trading purposes.  Cash Cash is generally easy to recognize and measure – Cash at hand and in the bank  It is important to distinguish between cash and investment – Money deposited for a fixed two-year term in order to gain a higher level of interest ?? → it is an investment! – Common practice: investments of up to three months’ maturity that are convertible to known amounts of cash are considered as “cash equivalent”  Receivables Recognition → a contractual right to receive cash by a particular date by a debtor Measurement: →Receivables are valued at the amount expected to be received. I.e. they are measured at their nominal value less allowances for bad debts →Long-term receivables are valued at the present value of the amount that will be received after a considerable period  Financial instruments The most common financial instruments are: Debt instruments (e.g. government or corporate bonds) – A bond represents a loan agreement between the issuer and the investor, and the terms of the bond obligate the issuer to repay the borrowed amount by a specific date (the maturity). In addition, the issuer pays periodically (usually every six months) to the investor an interest computed by applying an annual interest rate to the face value of the bond  Equity instruments (e.g. shares of another company) – An share is a document that certifies the right of ownership in a firm. Equity instruments are issued by a company to raise funds. The entities that buy the share are called shareholders.  Financial instruments A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. A company issues equity or debt instruments to raise capital (to be invested in its business) – A debt instrument increases its debt capital (liability) – An equity instrument increases its own capital (equity) When a company buys equity or debt instruments issued by another company is making an investment (it invests cash now, with the aim of receiving an higher amount in the future) – Both debt and equity instruments increase its assets  Financial instruments Many financial instruments can be traded (e.g. in the stock exchange market) – The entity that originally bought them, can sell them in the market to another entity, generating a gain or a loss – The acquiring company now is the new investors and has the rights associated with the instruments (right to be paid back, or ownership rights) – The position of the company that issued the instrument remain unchanged  Financial instruments For the investor company (assets): → Many companies do not hold the debt instruments they bought until the maturity date (the date in which the company that issued them has to pay back the debt), but they rather prefer to sell them → Equity instruments do not have a maturity date, but they can be traded The type of instruments and the intention of the directors to trade them or not, define whether a financial instrument is – Held to maturity (only for debt securities) – Available for sale (default category, both shares and bonds) – Held for trading purposes (both shares and bonds)  Investments on financial assets under IFRSs Financial assets held to maturity: – Valued at cost – Gains/losses are recorded only in case of sales (in the income statement)  Financial assets available for sale: – Valued at fair value – Unrealized gains/losses caused by changes in fair value are not recorded in the profit and loss statement (they are showed in the OCI)  Financial assets held for trading purposes: – Valued at fair value – Unrealized gains/losses caused by changes in fair value are recorded directly in the profit and loss statement  Liabilities A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow of resources from the entity Payables/creditors – Creditor’s identity, amount and due date are clear – Creditors can be different: banks, suppliers (trade creditors), the state, social security institutions, employees, shareholders, etc – They are divided into current and non-current on the basis of whether or not they are to be repaid within one year – They are valued at their “face value” (for long term debts, interests must be added) – Debenture loan/bonds: is a debt instrument issued by the company. The loan is repayable on a fixed date (maturity date) and pays a fixed rate of interest – Accruals: recognition that the business has used up services in the period but has not paid from them yet.  Liabilities Provisions – Liability of uncertain timing or amount – they must be measured at the best estimate – E.g. provisions for pensions (staff expenses with postponed payment date) – Other provisions such as; estimates of amounts to pay for cleaning the land or dismantling a plant; for repairing products covered by warranties  Equity Equity is the owners’ interest in the residual difference between assets and liabilities. Components: Subscribed capital Share premium Legal reserve Profit or loss reserves  Subscribed capital The share capital of a company is divided into shares of equal amount - Therefore, the nominal value (or par value) of a share is the capital divided by the number of shares. - E.g. subscribed capital is 100.000€: 100 shares, nominal value 1.000€ The amount of subscribed capital that has not yet been paid by shareholders is shown as an asset in the BS (similar to receivables): “subscribed capital unpaid” Companies can buy their own shares from shareholders. These are called “treasury shares” and are shown within the Equity with negative sign.  Share premium To raise more capital, a company can issue additional shares, that investors can buy. Ordinary shares → give right to share profit (but no guarantee of any profit or capital repayment) and voting rights Preference shares → give right to receive a fixed amount of dividend and to be paid before ordinary shareholders (but no- voting rights) The price at which the shareholders buy the new shares can be higher than the nominal value of the share. The difference is called “share premium”  E.g. the company issue 100 new shares, nominal value 1.000€, price 1.500€  100.000€ capital → credits  150.000€ bank (if paid immediately) → debits  50.000€ “share premium” → credits  Reserves Legal reserve – Undistributable reserve required to be set up by law. – In Italy the law requires companies to set aside 5% of profits each year until the legal reserve equals 20% of share capital – It’s a kind of “buffer” to protect creditors, an amount of capital that the company is required to hold – Profit or loss reserve (or retained profits) – Includes the profit that are not distributed (excluded those already reported into the legal reserve)