Financial Reporting - ACCA PDF

FINANCIAL REPORTING-ACCA TOPIC 1: Conceptual Framework  The Meaning of GAAP 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.  Conce...

FINANCIAL REPORTING-ACCA TOPIC 1: Conceptual Framework  The Meaning of GAAP 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.  Conceptual Framework A set of coherent ideas or concepts organized in a manner that makes them easy to communicate to others. An overview of ideas and practices that shape the way we use the standards in preparing the financial statements. A set of assumptions, values, and definitions under which we all work together.  Conceptual Framework In summary a conceptual framework can be defined as “constitution, a coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function and limits of financial reporting and financial reporting statements.” Note: The credibility of the conceptual framework rests upon its general recognition and acceptance by preparers, auditors and other users of financial statements.  Conceptual Framework 1. Contribute to transparency by enhancing the international comparability and quality of financial information, enabling investors and other market participants to make informed economic decisions. 2. Strengthen accountability by reducing the information gap between the providers of capital and the people to whom they have entrusted their money. Standards based on the Conceptual Framework provide information needed to hold management to account. As a source of globally comparable information, those Standards are also of vital importance to regulators around the world.  Conceptual Framework 3. Contribute to economic efficiency by helping investors to identify opportunities and risks across the world, thus improving capital allocation. For businesses, the use of a single, trusted accounting language derived from Standards based on the Conceptual Framework lowers the cost of capital and reduces international reporting costs.  Purpose and Status 1. Assist the board of IASC in the development of future International Accounting Standards and in its review of existing International Accounting Standards. 2. Assist the board of IASC in promoting harmonization 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 International Accounting Standards. 3. Assist national standard-setting bodies in developing national standards.  Purpose and Status 4. Assist preparers of financial statements in applying International Accounting Standards and in dealing with topics that have yet to form the subject of an International Accounting Standard. 5. Assist auditors in forming an opinion as to whether financial statements conform to International Accounting Standards.  Purpose and Status 6. Assist users of financial statements in interpreting the information contained in financial statements prepared in conformity with International Accounting Standards. 7. Provide those who are interested in the work of IASC with information about its approach to the formulation of International Accounting Standards.  Scope The objective of financial statements. The qualitative characteristics that determine the usefulness of information in financial statements. The definition, recognition and measurement of the elements from which financial statements are constructed. Concepts of capital and capital maintenance.  Contents Chapter 1: The objective of the general purpose financial reporting Chapter 2: Qualitative characteristics of useful financial information Chapter 3: Financial statements and Reporting entity Chapter 4: The elements of financial reporting Chapter 5: Recognition and derecognition Chapter 6: Measurement Chapter 7: Presentation and Disclosure Chapter 8: Concept of capital and capital maintenance  Users of Financial Statements Investors (both current and potential) Creditors, lenders and suppliers Financial analysts Customers Employees Government and other agencies General public  Objective The objective of financial reporting is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions.  Notes and Supplementary Schedules The financial statements also contain notes and supplementary schedules and other information. For example, they may contain additional information that is relevant to the needs of users about the items in the balance sheet and income statement. They may include disclosures about the risks and uncertainties affecting the entity and any resources and obligation not recognized in the balance sheet (such as mineral reserves). Information about geographical and industrial segments and the effect on the entity of changing prices may also be provided in the form of supplementary information.  Underlying Assumptions Accrual Basis In order to meet their objectives, financial statements are prepared on the accrual basis of accounting. Under this basis, the effects of transactions and other events are recognized when they occur (and not as cash or its equivalent are received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate.  Underlying Assumptions Going Concern The financial statements are normally prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future. Hence, it is assumed that the entity has neither the intention nor the need to liquidate or curtail materially the scale of its operations  Qualitative Characteristics Fundamental qualitative characteristics The fundamental qualitative characteristics are relevance and faithful representation. Relevance Relevant financial information is capable of making a difference in the decisions made by users. Faithful representation  Qualitative Characteristic Enhancing qualitative characteristics Comparability, verifiability, timeliness and understandability. Comparability Users’ decisions involve choosing between alternatives (comparative figures and consistency). Verifiability Verifiability helps assure users that information faithfully represents the economic phenomena it purports to represent. Verifiability means that different knowledgeable and independent observers could reach consensus.  Qualitative Characteristic Enhancing qualitative characteristics Timeliness Timeliness means having information available to decision-makers in time to be capable of influencing their decisions. Generally, the older the information is the less useful it is. Understandability Classifying, characterizing and presenting information clearly and concisely makes it understandable.  Cost Constraint Cost is a pervasive constraint on the information that can be provided by financial reporting. Reporting financial information imposes costs, and it is important that those costs are justified by the benefits of reporting that information.  Definition of an Asset An asset is a present economic resource controlled by the entity as a result of past events.  Definition of a Liability A liability is a present obligation of the entity to transfer an economic resource as a result of past events. For a liability to exist, three criteria must all be satisfied: 1. The entity has an obligation 2. The obligation is to transfer an economic resource 3. The obligation is a present obligation that exists as a result of past events  Definition of Equity Equity is the residual interest in the assets of the entity after deducting all its liabilities. Equity can be classified as share capital and reserves. Reserves include share premium, revaluation reserves and retained earnings (revenue reserves).  Definitions of Income and Expenses Income is 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 are decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims.  The Recognition Process 1. Meets the definition of an element of financial statements. 2. It is probable that any future economic benefits associated with the item will flow to or from the entity. 3. The item has a cost or value that can be measured with reliability.  Derecognition Derecognition is the removal of all or part of a recognized asset or liability from an entity’s statement of financial position. Derecognition normally occurs when that item no longer meets the definition of an asset or of a liability: 1. For an asset, derecognition normally occurs when the entity loses control of all or part of the recognized asset; and 2. For a liability, derecognition normally occurs when the entity no longer has a present obligation for all or part of the recognized liability.  Measurement 1. Historical cost: Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.  Measurement 2. Current cost Assets are carried at the amount of cash or cash equivalents that would have paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently.  Measurement 3. Realizable (settlement) value Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement values; that is the, the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.  Measurement 4. Present value Assets are carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of the future net cash outflows that expected to be required to settle the liabilities in the normal course of business.  Measurement 5. Fair Value Fair value is the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. Fair value reflects the perspective of market participants; participants in a market to which the entity has access. The asset or liability is measured using the same assumptions that market participants would use when pricing the asset or liability if those market participants act in their economic best interest.  Measurement 5. Fair Value In some cases, fair value can be determined directly by observing prices in an active market. In other cases, it is determined indirectly using measurement techniques, e.g. cash-flow-based measurement techniques, reflecting all the following factors: 1. Estimates of future cash flows. 2. Possible variations 3. The time value of money. 4. The price for bearing the uncertainty inherent in the cash flows (a risk premium or risk discount). 5. Other factors e.g. liquidity, if market.  Measurement 6. Value in Use Value in use is the present value of the cash flows, or other economic benefits, that an entity expects to derive from the use of an asset and from its ultimate disposal.  Measurement 7. Fulfilment Value Fulfilment value is the present value of the cash, or other economic resources, that an entity expects to be obliged to transfer as it fulfils a liability. Presentation and Disclosure A reporting entity communicates information about its assets, liabilities, equity, income and expenses by presenting and disclosing information in its financial statements. Effective communication of information in financial statements makes that information more relevant and contributes to a faithful representation of an entity’s assets, liabilities, equity, income and expenses. It also enhances the understandability and comparability of information in financial statements. Presentation and Disclosure Effective communication of information in financial statements requires: 1. Focusing on presentation and disclosure objectives and principles rather than focusing on rules; 2. Classifying information in a manner that groups similar items and separates dissimilar items; and 3. Aggregating information in such a way that it is not obscured either by unnecessary detail or by excessive aggregation.  Concept of Capital 1. Financial capital 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. 2. Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.  Concept of Capital Physical capital maintenance: under this concept profit is earned only if the physical productive capacity (or operating capability) of the entity (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. Ole Sangale Road, Madaraka Estate. PO Box 59857-00200, Nairobi, Kenya Tel: (+254) (0)703 034000/200/300 Fax : +254 (0)20 607498 Email: [email protected] Website: www.strathmore.edu