Module 2 Part 1 PDF: Presentation of Financial Statements

# MODULE 2 PRESENTATION OF FINANCIAL STATEMENTS ## LEARNING OBJECTIVES After completing this module, you should be able to: - explain and apply the requirements of IAS 1 with respect to a complete set of financial statements and in relation to the considerations for the presentation of financial...

# MODULE 2 PRESENTATION OF FINANCIAL STATEMENTS ## LEARNING OBJECTIVES After completing this module, you should be able to: - explain and apply the requirements of IAS 1 with respect to a complete set of financial statements and in relation to the considerations for the presentation of financial statements - outline and explain the requirements of IAS 8 for the selection of accounting policies - explain and apply the accounting treatment and disclosure requirements of IAS 8 in relation to changes in accounting policies, and changes in accounting estimates and errors - explain and discuss the required treatment for both adjusting and non-adjusting events occurring after the reporting period in accordance with IAS 10 - explain and apply the requirements of IAS 7 with respect to preparing a statement of cash flows - discuss how a statement of cash flows can assist users of the financial statements to assess the ability of an entity to generate cash and cash equivalents. ## ASSUMED KNOWLEDGE It is assumed that before commencing your study in this module, you are able to: - explain the four primary financial statements, including their purpose and interrelationship - identify the content contained within each financial statement, including its structure and format - identify the assumptions and doctrines underpinning the preparation and presentation of financial statements - identify how a listed entity is required to identify and report its operating segments in the financial statements. ## CASE STUDY DATA: WEBPROD LTD Module 2 includes case study data in a separate section at the end of this module. This case study data will be used for a number of questions throughout the module. ## LEARNING RESOURCES International Financial Reporting Standards (IFRSs): - IAS 1 Presentation of Financial Statements - IAS 7 Statement of Cash Flows - IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors - IAS 10 Events after the Reporting Period - IAS 34 Interim Financial Reporting - IFRS 8 Operating Segments. Other resources: - Digital content, such as videos and interactive activities in the e-text, support this module. You can access this content on My Online Learning. # PREVIEW Module 1 discussed the international financial reporting environment, including the stakeholders of financial reports and the institutional arrangements for regulating financial reporting. As outlined in that module, accountants often have to make decisions about how to report on complex arrangements and transactions, such as the classification and measurement of financial instruments, revenue recognition and accounting for business combinations. In making these decisions, accountants use the International Financial Reporting Standards (IFRSs) and the Conceptual Framework for Financial Reporting (Conceptual Framework) for guidance. Module 1 contained a detailed discussion of the Conceptual Framework, as it not only underpins the development of accounting standards but is also used to make accounting policy decisions when no guidance is available from an IFRS. Module 2 commences the discussion of accounting standards used in the preparation and presentation of general purpose financial statements. As discussed in module 1, one of the qualitative characteristics that makes information useful to users is comparability. To assess trends in an entity's financial performance and position, users must be able to compare the financial statements of the entity over time. Likewise, comparability is important when evaluating the financial performance and position of an entity relative to other entities (Conceptual Framework, para. 2.24). For this reason, module 2 commences by considering the requirements specified in International Accounting Standard 1 Presentation of Financial Statements (IAS 1) for the preparation and presentation of general purpose financial statements. - Paragraph 10 of IAS 1 specifies the components of a set of financial statements, which include: - a statement of financial position - a statement of profit or loss (P/L) and other comprehensive income (OCI) - a statement of changes in equity - a statement of cash flows - explanatory notes (including accounting policies) - comparative information with respect to the preceding period - a statement of the financial position at the beginning of the preceding period when an accounting policy is applied retrospectively or items in the financial statements are retrospectively restated or reclassified. - IAS 1 specifies the overall considerations that should be used when preparing financial statements. These considerations include: - fair presentation - going concern - accrual basis of accounting - materiality and aggregation - offsetting - frequency of reporting - comparative information - consistency of presentation. Each of these considerations is discussed later in the module. IAS 1 requires a complete set of general purpose financial statements to disclose the accounting policies used in preparing and presenting the financial statements. According to paragraph 10 of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, preparers of financial statements must choose accounting policies that are both relevant to decision making and reliable. Accounting policy choices have a major influence on the results and financial position reported by an entity, and it is important for comparability reasons that users are able to determine differences in financial performance or position, due to the adoption of alternative accounting policies. This module discusses IAS 8 as part of the overall considerations in preparing and presenting general purpose financial statements. IAS 8 specifies how to determine accounting policies and the disclosures required for accounting policies and changes in accounting policies. In addition, IAS 8 deals with the accounting treatment of accounting estimates revisions and error corrections, which can significantly affect the presentation of financial statements. Part A of this module discusses events after the reporting period and briefly outlines the requirements of IAS 34 Interim Financial Reporting and IFRS 8 Operating Segments. # PART A: PRESENTATION OF FINANCIAL STATEMENTS ## INTRODUCTION IAS 1 prescribes the basis for the presentation of general purpose financial statements. It sets out the overall requirements for the presentation of financial statements together with guidelines for their structure and minimum requirements for their content (IAS 1, para. 1). Part A provides an overview of the requirements contained in IAS 1 for an entity to prepare and present a 'complete set of financial statements'. The application of IAS 1 in the Australian context is explained. The requirements in IFRS 8 for reporting entities to disclose their operations according to segments are briefly discussed. Part A also covers the general features of financial statements described in IAS 1, including fair presentation and compliance with IFRS, the going concern basis, the accrual basis, materiality and aggregation, offsetting, frequency of reporting, and comparative information. The discussion then turns to IAS 8, which governs how an entity selects and discloses its accounting policies used in the preparation and presentation of the financial statements. Part A concludes by examining events arising after the reporting period. IAS 10 deals with how to treat events and transactions that occur from the end of the reporting period to the date that the financial report is signed off by the directors. ## Relevant Paragraphs To help you achieve the objectives outlined in the module preview, you should read the relevant paragraphs in the following accounting standards. Where specified, you will need to be able to apply the following paragraphs. ### IAS 1 Presentation of Financial Statements: | Subject | Paragraphs | |---|---| | Complete set of financial statements | 10-14 | | Fair presentation and compliance with IFRSS | 15-24 | | Going concern | 25-26 | | Accrual basis of accounting | 27-28 | | Materiality and aggregation | 29-31 | | Offsetting | 32-35 | | Frequency of reporting | 36-37 | | Comparative information | 38-38D, 40A-44 | | Consistency of presentation | 45-46 | ### IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors: | Subject | Paragraphs | |---|---| | Selection and application of accounting policies | 7-12 | | Consistency of accounting policies | 13 | | Changes in accounting policies | 14-27 | | Disclosure of changes in accounting policies | 28-31 | | Changes in accounting estimates | 32-40 | | Errors | 41-42 | ### IAS 10 Events after the Reporting Period: | Subject | Paragraphs | |---|---| | Definitions | 3 | | Adjusting events after the reporting period | 8-9 | | Non-adjusting events after the reporting period | 10-11 | | Dividends | 12-13 | | Going concern | 14-16 | | Disclosures | 17-22 | ## 2.1 COMPLETE SET OF FINANCIAL STATEMENTS ### COMPONENTS OF A COMPLETE SET OF FINANCIAL STATEMENTS IAS 1 applies to general purpose financial statements prepared in accordance with IFRSs. It states that: The objective of financial statements is 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. Financial statements also show the results of the management's stewardship of the resources entrusted to it (IAS 1, para. 9). The financial statements provide the following information about an entity in order to satisfy this stated objective: - assets - liabilities - equity - income and expenses, including gains and losses - contributions by and distributions to owners in their capacity as owners - cash flows. The information in the financial statements, together with other information in the notes, assists users to predict the entity's future cash flows - especially the timing and certainty of cash flows. ### EXPLORE FURTHER If you wish to explore this topic further, you should read paragraph 1.2 of the Conceptual Framework to remind yourself of the objective of general purpose financial reporting as discussed in module 1. Think about the differences between this objective and the objective outlined in paragraph 9 of IAS 1. A complete set of financial statements as stated in paragraph 10 of IAS 1 contains: - a statement of financial position as at the end of the period - a statement of P/L and OCI for the period - a statement of changes in equity for the period - a statement of cash flows for the period - notes, which include accounting policies and other explanatory information - comparative information regarding the preceding period - a statement of the financial position as at the beginning of the earliest comparative period when any of the following occurs: - an accounting policy is applied retrospectively - items in the financial statements are retrospectively restated - items in the financial statements are reclassified. Figure 2.1 illustrates the complete set of financial statements required under IAS 1. **FIGURE 2.1 A complete set of financial statements under IAS 1 comprises** Statement of profit or loss and other comprehensive income + Statement of changes in equity + Statement of financial position + Statement of cash flows Notes to the accounts **Source:**CPA Australia 2022. Entities are permitted to use other appropriate titles for the financial statements (IAS 1, para. 10). One example is using the title of balance sheet instead of statement of financial position. Another example is using the title of statement of comprehensive income instead of statement of P/L and OCI. General purpose financial statements (GPFSs) must present all the financial statements shown in figure 2.1. In Australia, reporting entities are required to prepare and present general purpose financial statements. However, some entities that are considered non-reporting entities because they do not have users dependent on general purpose financial statements to satisfy their information needs are allowed to prepare and present only special purpose financial statements (SPFSs) in accordance with the specific information needs of the entity's financial statement users. If these non-reporting entities lodge their SPFSS with the Australian Securities and Investments Commission (ASIC) or with Australian Charities and Not-for-profits Commission (ACNC), they must still apply, as a minimum, the disclosure requirements of the following set of Australian Accounting standards: - AASB 101 Presentation of Financial Statements - AASB 107 Statement of Cash Flows - AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors - AASB 1048 Interpretation of Standards, and - AASB 1054 Australian Additional Disclosures. Entities that lodge special purpose financial reports with ASIC are also required to ensure that the financial statements give 'a true and fair' view (Corporations Act, s. 297). According to ASIC, SPFSs can only present a true and fair view if they apply all recognition and measurement requirements in Australian Accounting Standards (e.g. depreciation, tax-effect accounting, leases, inventories, employee benefits). According to paragraph 9 of AASB 1054 Australian Additional Disclosures, an entity is required to disclose in its accounting policy note whether the financial statements are general purpose or special purpose financial statements. As such, users should be mindful of whether they are reading general purpose financial statements or special purpose financial statements. An entity must give 'equal prominence to all of the financial statements in a complete set of financial statements' (IAS 1, para. 11). For example, the statement of cash flows cannot be relegated to a note disclosure or be presented as an appendix at the end of the notes. As will be discussed in further detail in part B, IAS 1 allows alternative presentations for the statement of profit or loss and other comprehensive income (IAS 1, para. 10A). The first alternative is a single statement with two sections, that is, one each for the profit or loss and other comprehensive income. The second alternative is two statements, that is, one statement for profit or loss and one statement for other comprehensive income. ### EXPLORE FURTHER If you wish to explore this topic further, you should read paragraphs 10-11 of IAS 1. The requirements of IAS 1 for a complete set of financial statements are also relevant for interim financial reports (IAS 34, para. 5). IAS 34 does not specify which entities have to prepare interim financial reports as this is usually specified by governments, stock exchange requirements and other regulators (IAS 34, para. 1). In Australia, for example, according to section 302 of Corporations Act, disclosing entities must prepare and present half-year financial reports. A disclosing entity is defined in the Corporations Act as an entity that issues 'enhanced disclosure' (ED) securities (s. 111AC). For example, a company whose shares are listed on the ASX is a disclosing entity. As a matter of fact, the ASX Listing Rules also require all listed entities to prepare and present half-year financial reports. A half-year report contains condensed financial statements and substantially reduced disclosure requirements in accordance with IAS 34. The objective of IAS 34 is to prescribe the minimum requirements of an interim financial report to provide timely and reliable information that 'improves the ability of investors, creditors and others to understand an entity's capacity to generate earnings and cash flows and its financial condition and liquidity' (IAS 34, 'Objectives'). Timely and reliable financial information are concepts that were discussed in module 1. Paragraph 19 of IAS 34 requires entities that prepare an interim financial report to disclose their compliance with the requirements of the standard, which includes the requirement of IAS 1 to comply with IFRSs. ### EXPLORE FURTHER If you wish to explore this topic further, you should read the 'Objective' paragraph and paragraphs 1, 5 and 19 of IAS 34. In addition to the complete set of financial statements and the notes to the financial statements, entities may provide additional information required by law or disclosed voluntarily. Paragraph 13 of IAS 1 notes that many entities present a financial review by management, outside of the financial statements, to describe the key features of an entity's financial performance, financial position and the principal uncertainties it faces. The review by management may include a review of: - the main factors and influences determining an entity's financial performance, including changes in the environment in which the entity operates and how the entity is responding to those changes - details about the entity's sources of funding and its targeted ratio of liabilities to equity - details of the entity's resources not recognised in the financial statements. Furthermore, many entities also present environmental reports and value-added statements that are outside the financial statements. Reports and statements presented outside financial statements are outside the scope of IFRSs (IAS 1, para. 14). ### EXPLORE FURTHER If you wish to explore this topic further, you should read paragraphs 13 and 14 of IAS 1 to expand on this discussion. ## SEGMENT REPORTING IFRSs also include disclosure requirements that assist users to unpack additional detail about the numbers presented in the financial statements. Segment reporting in IFRS 8 involves presenting disaggregated financial information in the notes to support an understanding of the aggregated financial information in the financial statements. IFRS 8 applies to an entity that has publicly traded debt or equity instruments on issue or that files, or is in the process of filing, its financial statements with a regulatory body for the purpose of issuing instruments in a public market (IFRS 8, para. 2). IFRS 8 requires an entity to disclose information that enables users of its financial statements to evaluate the nature and financial effects of the business activities that the entity engages in and the economic environments in which it operates (IFRS 8, para. 20). IFRS 8 requires disclosure of the: - factors used to identify the entity's reportable segments including the basis of organisation (e.g. differences in products and services, geographical areas, regulatory environments, or some combination thereof) - judgements made by management if operating segments have been aggregated - types of products and services that each reportable segment derives its revenues from (IFRS 8, para. 22). An operating segment is defined as a component of the entity that: - undertakes business activities from which it may generate revenues and incur expenses - has its operating result regularly reviewed by the chief operating decision maker within the entity, such as the general manager, managing director or chief executive officer (CEO) - has discrete financial information available (IFRS 8, para. 5). The focus in IFRS 8, therefore, is to identify and report on operating segments effectively using the same basis as the internal decision maker. IFRS 8 typically requires an entity to disclose the following financial information for each reportable segment: - a measure of profit or loss - a measure of total assets and liabilities - revenues from external customers - revenues from transactions with transactions from other operating segments - interest revenue - interest expense - depreciation and amortisation - material items of income and expense - the interest in the profit or loss of associates and joint ventures accounted for by the equity method - income tax expense or income - material non-cash items other than depreciation and amortisation (IFRS 8, para. 23). ## FAIR PRESENTATION AND COMPLIANCE WITH INTERNATIONAL FINANCIAL REPORTING STANDARDS IAS 1 requires financial statements to present fairly the entity's financial performance, financial position and cash flows (IAS 1, para. 15). Fair presentation requires faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Conceptual Framework. The application of IFRSs, with additional disclosures where necessary, is presumed to result in financial statements that are fairly presented (IAS 1, para. 15). IAS 1 requires entities with financial statements prepared in accordance with the IFRSs to make an explicit and unreserved statement of such compliance in the notes to the accounts. In order to make this statement, an entity must comply with all the requirements of IFRSs (IAS 1, para. 16). IAS 1 states that an entity is not permitted to depart from a requirement in an IFRS except in the extremely rare circumstance in which compliance would be so misleading that it would conflict with the objective of financial statements set out in the Conceptual Framework, that is, to provide financial information that is relevant and faithfully represents what it purports to represent. In this rare case, an entity departs from the requirement in an IFRS only if permitted by its regulatory framework and with full disclosure (IAS 1, para. 19). An entity that departs from a requirement of an IFRS must make the following disclosures: - a statement that management believes the departure provides financial statements that present fairly the entity's financial position, financial performance and cash flows - that except for departing from a particular requirement to achieve a fair presentation, it has complied with applicable IFRSs - the title of the IFRS from which the entity has departed, the nature of the departure, including the treatment that the IFRS requires and the treatment adopted, and the reasons why the IFRS treatment would be misleading in the circumstances that it would conflict with the objective of the financial statements stated in the Conceptual Framework - the financial impact of the departure on each item in the financial statements that would have been reported in complying with the requirement (IAS 1, para. 20). IAS 1 makes it clear that adopting an accounting policy that is not permitted by an IFRS and disclosing the details in the notes to the financial statements does not overcome non-compliance with an IFRS (IAS 1, para. 18). In the Australian context, the Corporations Act requires that the financial statements comply with accounting standards (s. 296). Also, if compliance accounting standards does not provide a true and fair view, the Corporations Act requires an entity to provide additional disclosures necessary to give a 'true and fair' view (s. 297). ### EXPLORE FURTHER If you wish to explore this topic further, you should read paragraphs 15-24 of IAS 1, which confirm and expand on this discussion. ## OTHER GENERAL FEATURES In addition to requiring financial statements to be presented fairly, IAS 1 specifies a number of other general features that must be complied with when preparing and presenting general purpose financial statements. These include: - going concern - accrual basis - materiality and aggregation - offsetting - frequency of reporting - comparative information - consistency. ### Going Concern While preparing the finanical statements, management must make an assessment of an entity's ability to continue as a going concern. IAS 1 states as follows: An entity shall prepare financial statements on a going concern basis unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so (IAS 1, para. 25). There is no specific requirement in IAS 1 for the entity to disclose that it is considered a going concern. This is an implicit assumption when preparing financial statements. However, where the entity is not considered a going concern, this must be disclosed together with the reasons why the entity is not considered a going concern and the basis on which the financial statements are prepared. If there is significant uncertainty as to the continuity of an entity's operations, but the financial statements are still prepared on a going concern basis, then details of the uncertainty must be disclosed (IAS 1, para. 25). In assessing whether an entity is a going concern, management should consider all available information about the future - at least up until 12 months after the end of the reporting period (IAS 1, para. 26). In particular, management should consider whether the entity will be able to discharge its debts as and when they fall due. Where an entity is no longer considered a going concern, the financial statements would normally be prepared on a reaslisable (or liquidation) basis. ### EXPLORE FURTHER If you wish to explore this topic further, you should read paragraphs 25 and 26 of IAS 1. ### Accrual Basis IAS 1 requires that, except for cash flow information, financial statements be prepared under accrual accounting principles (IAS 1, para. 27). The accrual basis of accounting provides users with richer information about the financial performance and financial position of an entity that would not otherwise be available if the cash basis were used. Under the accrual basis, items are recognised as assets, liabilities, equity, income and expenses when they satisfy the definitions and recognition criteria in the Conceptual Framework (IAS 1, para. 28). ### EXPLORE FURTHER If you wish to explore this topic further, you should read paragraphs 27 and 28 of IAS 1. ### Materiality and Aggregation The finanical statements are derived after processing large numbers of transactions or other events that are aggregated into classes according to their nature or function. This process of aggregation and classification is necessary to determine the line items presented in the financial statements or notes to the financial statements (IAS 1, para. 30). IAS 1 uses the concept of materiality to assist preparers to decide which items can be added together and which must be separately reported. IAS 1 requires that: An entity shall present separately each material class of similar items. An entity shall present separately items of a dissimilar nature or function unless they are immaterial (IAS 1, para. 29). In applying this requirement, an entity takes into consideration all the relevant facts and circumstances (IAS 1, para. 30A). A specific disclosure requirement of an IFRS need not be applied if the information resulting from that disclosure is immaterial (IAS 1, para. 31). IAS 1 explains materiality in three parts as follows. 1. Information is material if it could reasonably be expected to influence the primary users of financial statements decision making. 2. The nature or magnitude of information, or both, can have an effect on materiality. Whether information, either individually or in combination with other information, is material in the context of its financial statements taken as a whole must be assessed by the entity. 3. Information is obscured if it is communicated in a way that has a similar effect to omitting or misstating that information. Examples include: - the language used is vague or unclear - information is scattered throughout the financial statements - dissimilar items, transactions or other events are inappropriately aggregated - similar items, transactions or events are inappropriately disaggregated - the understandability of the financial statements is reduced by material information being hidden by immaterial information (IAS 1, para. 7). ### EXPLORE FURTHER If you wish to explore this topic further, you should read paragraphs 29 - 31 of IAS 1. ### Offsetting Offsetting, or combining the balances, of assets and liabilities or income and expenses may result in the loss of relevant information for financial statement users. Unless it reflects economic substance, offsetting detracts from the ability of users to understand the transactions and other events and conditions that have occurred (IAS 1, para. 33). IAS 1 prohibits offsetting, except where it is required or permitted by an IFRS (IAS 1, para. 32). Examples of permissible offsetting are as follows. - IAS 12 Income Taxes (IAS 12) permits the offsetting of current tax assets and current tax liabilities in the statement of financial position, provided that the entity: '(a) has a legally enforceable right to set off the recognised amounts; and (b) intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously' (IAS 12, para. 71). - IFRS 15 Revenue from Contracts with Customers requires the amount of revenue recognised to be after any trade discounts and volume rebates the entity allows (IAS 1, para. 34). - Foreign exchange gains and losses or gains and loss on financial instruments held for trading should be presented on a net basis, except if such gains and losses are separately material (IAS 1, para. 35). It should be noted that reporting assets net of valuation allowances is not offsetting and is permissible (IAS 1, para. 33). Examples include reporting receivables net of a provision for credit loss or impairment or inventories net of an allowance for obsolescence. ### EXPLORE FURTHER If you wish to explore this topic further, you should read paragraphs 32- 35 of IAS 1. ### Frequency of Reporting An entity must present a complete set of financial statements at least annually (IAS 1, para. 36). If an entity changes the end of its reporting period, then it may present financial statements for a shorter or longer period than 12 months but the change, and the reason for the change, needs to be disclosed. Entities may report using a 52-week period rather an annual period (IAS 1, para. 37). Entities such as retailers usually prefer the 52-week period because it ensures comparability year-on-year for the number of retail days during which they conducted their business. ### EXPLORE FURTHER If you wish to explore this topic further, you should read paragraphs 36 - 37 of IAS 1. ### Comparative Information Enhancing the inter-period comparability allows users of the financial statements to assess trends in financial information for predicitive purposes (IAS 1, para. 43). An entity must present comparative information regarding the preceding period for all amounts reported in the current period's financial statements, except when the IFRSs permit or require otherwise (IAS 1, para. 38). Comparative information for narrative and descriptive information is also required if it is relevant to understanding the current period financial statements. The requirement for comparative information means that an entity will, as a minimum, present two statements for each of the financial statements (IAS 1, para. 38A). For example, at least two statements of financial position should be prepared: one for the current period and one for the prior period. IAS 1 requires the presentation of a third statement of financial position as at the beginning of the preceding period if: - it applies an accounting policy retrospectively, makes a retrospective restatement of items in its financial statements or reclassifies items in its financial statements - the retrospective application, retrospective restatement or the reclassification has a material effect on the information in the statement of financial position at the beginning (IAS 1, para. 40A). Where items in the financial statements are reclassified, the comparative amounts should also be reclassified, unless it is impracticable to do so (IAS 1, para. 41). Where it is impracticable, the entity should disclose the reasons why and the 'nature of the adjustments that would have been made if the amounts had been reclassified' (IAS 1, para. 42). ### EXPLORE FURTHER If you wish to explore this topic further, you should read paragraphs 38, 38A, 38B, 40A and 41- 44 of IAS 1. ### Consistency Financial statements should be prepared on a consistent basis from one period to the next, as described in paragraph 2.26 of the Conceptual Framework. IAS 1 requires that an entity should retain the presentation and classification items in the financial statements from one period to the next. The presentation and classification of items contained in the financial statements should only be changed when: - 'a significant change' has occurred in an entity's operations, or after reviewing the entity's financial statements, management is of the opinion that a change in accounting policy is necessary to show a more appropriate presentation or classification, or - a change is required by an IFRS (IAS 1, para. 45). A significant change on an entity's operations might arise following the disposal of a major line of its businesses (IAS 1, para. 46). ### EXPLORE FURTHER If you wish to explore this topic further, you should read paragraphs 45 and 46 of IAS 1. ## 2.2 ACCOUNTING POLICIES A complete set of financial statements identified in IAS 1 includes notes that comprise 'a summary of significant accounting policies and other explanatory information' (IAS 1, para. 10). For users to be able to compare the financial statements of different entities across different reporting periods, it is important that there is adequate disclosure of accounting policies. This will provide the necessary information for users to make allowances for differences in the financial results that are due to different accounting policies between different entities or differences for the same entity across time. ### EXPLORE FURTHER Refer to Note 1 'Summary of significant accounting policies' in the notes to financial statements of Techworks Ltd. Note how the accounting policies enable the financial statement user to determine the basis of preparation of the financial report and the accounting policies adopted in relation to various items, such as the 'Basis of preparation' (Note 1(c)), 'Significant management judgements in applying accounting policies' (Note 1(d)), 'Property, plant and equipment' (Note 1(e)(ix)) and 'Revenue' (Note 1(e)(i)), to give a few examples. If you wish to explore this topic further, you should read paragraphs 2.24- 2.29 of the Conceptual Framework, which discuss the importance of the comparability characteristic. ## SELECTION OF ACCOUNTING POLICIES Accounting policies are defined as 'the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements' (IAS 8, para. 5). Examples of accounting polices include whether to capitalise or expense borrowing costs and whether to value non-current assets at cost or at fair value. IAS 8 requires management to select and apply accounting policies using a hierarchy. According to IAS 8, if an IFRS specifically applies to a transaction, other event or condition, the accounting policy or policies applied to that item must be determined by applying the IFRS (IAS 8, para. 7). In addition, the accounting policy must be determined by reference to any implementation guidance associated with a relevant IFRS where it is mandatory (IAS 8, para. 9). It is important to note that IAS 8 defines IFRSs to encompass standards and interpretations adopted by the IASB. They include: - International Financial Reporting Standards (IFRSs) - International Accounting Standards (IASS) - Interpretations of accounting standards developed by the IFRSs Interpretations Committee (referred to as IFRIC Interpretations) - Standards Interpretations Committee Interpretations previously issued by the IASB (SIC Interpretations) (IAS 8, para. 5). Accordingly, an accounting policy for a particular transaction, event or condition must comply with any relevant accounting standards (and consider any relevant implementation guidance issued by the IASB) and IASB Interpretations. ### EXPLORE FURTHER If you wish to explore this topic further, you should read the definition of 'International Financial Reporting Standards' in paragraphs 5 and 7- 9 of IAS 8. Where specific IFRSs requirements do not apply to a transaction, other event or condition, IAS 8 requires management to use professional judgement and develop and apply accounting policies that result in information that is: - (a) relevant to the economic decision-making needs of users; and - (b) reliable, in that the financial statements: - (i) represent faithfully the financial position, financial performance and cash flows of the entity; - (ii) reflect the economic substance of transactions, other events and conditions, and not merely the legal form; - (iii) are neutral, ie free from bias; - (iv) are prudent; and - (v) are complete in all material respects (IAS 8, para. 10). IAS 8 provides additional guidance on the selection of appropriate accounting policies if management has to use professional judgement. Management is required to consider the applicability of other sources in the following priority order: 1. the requirements in the IFRSs that deal with similar and related issues 2. the Conceptual Framework's definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses (IAS 8, para. 11). In making the judgement, management may also refer to the pronouncements of other standard-setting bodies that use a similar Conceptual Framework, other accounting literature and industry practice, but only to the extent that these are consistent with the preceding two sources of guidance (IAS 8, para. 12). ### EXPLORE FURTHER If you wish to explore this topic further, you should read paragraphs 10 - 12 of IAS 8. ## CONSISTENCY OF ACCOUNTING POLICIES Consistency of accounting policies allows users to compare the financial statements of an entity over time to identify trends in financial position, financial performance and cash flows (IAS 8, para. 15). IAS 8 requires that an entity must apply its accounting policies consistently for similar transactions, other events and conditions unless an IFRS specifically requires or allows a categoriation of items for different accounting policies (IAS 8, para. 13). For an example, IAS 16 Property, Plant and Equipment allows different classes, or categories, of plant and equipment to be presented using a different measurement basis. It is possible to recognise land and buildings using the fair value basis and office furniture using the cost basis. ## DISCLOSURE OF ACCOUNTING POLICIES Accounting policies adopted by an entity can significantly affect the way profits and financial position are reported. This influences economic decisions and other evaluations, including evaluations about the discharge of managerial accountability by users of those statements. As such, it is important that users are provided with information about those policies and changes therein. IAS 1 requires an entity to disclose accounting policy information that is material - 'accounting policy information is material if, when considered together with other information included in an entity's financial statements, it can be reasonably expected to influence' the decisions of the primary users (i.e. existing and potential investors, lenders and other creditors) of general purpose financial statements (IAS 1, para. 117). More specifically, accounting policy information is expected to be material if users of an entity's finanical statements need the accounting policy information to understand other material information in the finanical statements (IAS 1, para. 117B). When disclosing accounting policy information, it should be entity-specific information that focuses on how the entity has applied the requirements of the standards to its own circumstances (IAS 1, para. 117C). ### EXPLORE FURTHER If you wish to explore this topic further, you should read the following paragraphs of IAS 1: - paragraphs 112- 117, which outline the requirements for the structure of the notes to the financial statements and