FAR210 Topic 2 Malaysian Conceptual Framework for Financial Reporting PDF

FAR210 TOPIC 2 MALAYSIAN CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING PREPARED BY: HAFIDZAH HASHIM & YUSNALIZA HAMID SEP2019  2 Topic Outcome Ability to: 1. Expl...

FAR210 TOPIC 2 MALAYSIAN CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING PREPARED BY: HAFIDZAH HASHIM & YUSNALIZA HAMID SEP2019  2 Topic Outcome Ability to: 1. Explain the needs and objectives of financial reporting. 2. Explain the Information about a reporting entity’s economic resources, claims and changes in resources & claims. 3. Explain the qualitative characteristics of financial statements. 4. Explain the objectives of financial statements, assumptions and types of reporting entity. 5. Explain the definition of elements of financial statements and the term unit of accounts.  3 Topic Outcome Ability to : 6. Explain the recognition issue of each elements of financial statements (emphasize on relevant & faithful representation). 7. Explain the measurement basis and factors to consider when choosing the basis. 8. Explain the objectives and principles (classification & aggregation) in presenting & disclosure of financial information. 9. Explain the concept of capital and capital maintenance.  4 Introduction » In November 2011 the MASB issued the Conceptual Framework for Financial Reporting (the Conceptual Framework). » The Conceptual Framework is applicable for the preparation and presentation of financial statements in accordance with the Malaysian Financial Reporting Standards (MFRSs). » In April 2018, the MASB issued a revised Conceptual Framework for Financial Reporting. » They are respectively equivalent to the Conceptual Framework for Financial Reporting and revised Conceptual Framework for Financial Reporting as issued by the International Accounting Standards Board (IASB).  5 What is a Conceptual Framework?  6 What is a Conceptual Framework? An accounting conceptual framework can be described as: “a structured system of inter-related objectives, fundamental characteristics and concepts which lead to the development of high-quality and consistent reporting standards to prescribe the nature, function and limits of financial accounting and reporting”  7 Reasons to Develop the Conceptual Framework Reasons or needs for developing an accounting conceptual framework: i. to identify a foundation for financial reporting ii. to identify the objective of financial statements iii. to identify the desirable qualitative characteristics of financial information iv. to provide a basis for setting of high-quality and consistent reporting standards v. to serve as a reference point for resolving accounting issues and disputes  Status and Purpose of the 8 Conceptual Framework Purpose of the Conceptual Framework is to: a) assist the MASB to develop MFRS Standards (Standards) that are based on consistent concepts; b) assist preparers to develop consistent accounting policies when no Standard applies to a particular transaction or other event, or when a Standard allows a choice of accounting policy; and c) assist all parties to understand and interpret the Standards.  9 Status and Purpose of the Conceptual Framework The Conceptual Framework provides the foundation to develop Standards that: a) contribute to transparency by enhancing the international …. b) strengthen accountability by reducing information gap ….. c) contribute to economic efficiency to financial markets. …. [textbook p.32 ]  10 SCOPE- 8 Chapters in the Framework » 1. THE OBJECTIVE OF » 5. RECOGNITION AND GENERAL PURPOSE DERECOGNITION FINANCIAL REPORTING » 6. MEASUREMENT » 2. QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL » 7. PRESENTATION AND INFORMATION DISCLOSURE » 3. FINANCIAL STATEMENTS » 8. CONCEPTS OF CAPITAL AND THE REPORTING AND CAPITAL ENTITY MAINTENANCE » 4. THE ELEMENTS OF FINANCIAL STATEMENTS  11 CHAPTER 1—THE OBJECTIVE OF GENERAL PURPOSE FINANCIAL REPORTING This chapter discuss the: » Objective of financial reporting » Users of financial reports » Information needed to achieve the objective  12 Objective of financial reporting » The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.  13 Users of financial reports » Entity’s existing and potential investors » Lenders; and » Other creditors  14 Decisions made by investors returns and their lenders and amount, other creditors (the USERS) timing and uncertainty of depends on (or prospects for) future expectations net cash inflows to the about: entity  15 (a)buying, selling or holdingequity and debt instruments; The users make (b)providing or settling loansand decisions other forms of credit; or about: exercising rights to vote on, or otherwise influence management’s actions that affect the use of the entity’s economic resources.  16 reporting entity’s economic To make resources those assessment claims against the entity these changes in a reporting entity’s USERS economic resources and claims NEED information how efficiently and effectively the about: entity’s management and governing board have discharged their responsibilities to use the entity’s resources  17 Information about a Reporting Entity about the entity’s the assets 1. Provides information economic resources about the Financial Position the claims against the equity’s & the entity liabilities 2. Provides information about the Changes in a reporting effects of transactions and events -the entity’s economic resources Financial performance and claims 3. Both (1)&(2) provide useful inputs about providing resources to the entity  18 CHAPTER 2—QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION » This chapter discuss what makes financial information useful  Qualitative Characteristics of Useful 19 Financial Information Fundamental Qualitative Characteristics Relevance Faithful representation Predictive Value Materiality Completeness Neutrality Confirmatory Free from error Value Enhancing Qualitative characteristics Comparability Verifiability Timeliness Understandability HAFIDZAH HASHIM &  20 For information to be useful it must both be relevant and provide a faithful representation of what it purports to represent. FUNDAMENTAL QUALITATIVE CHARACTERISTICS of useful financial information RELEVANCE FAITHFUL REPRESENTATION  21 FUNDAMENTAL QUALITATIVE CHARACTERISTICS (FQC) Relevance is relevant if it is is capable of making a capable of making difference in decisions a difference to the if it has predictive decisions made by value, confirmatory users. value or both  FQC-RELEVANCE 22 If it has the following characteristics: Confirmatory Predictive Value Materiality Value Financial Financial Information is information has information can considered material confirmatory be used as an if omitting it or value if it provides input to predict misstating it could feedback about future outcomes influence decisions (confirms or users make on the changes) previous basis of financial evaluations. information about a specific reporting entity  23 FUNDAMENTAL QUALITATIVE CHARACTERISTICS FAITHFUL REPRESENTATION Financial information to be a perfectly faithful faithfully represent the representation, a depiction substance of the would have three economic phenomena characteristics; that are (in words and numbers) completeness, neutrality that it purports to and free from error. represent.  24 FQC-FAITHFUL REPRESENTATION Completeness Neutrality Free from Error A complete depiction A neutral depiction is Free from error means includes all information without bias in the there are no errors or necessary for a user to selection or omissions in the understand the presentation of financial description of the phenomenon being information. phenomenon, and the depicted, including all A neutral depiction is process used to necessary descriptions not slanted, weighted, produce the reported and explanations. emphasised, de- information has been emphasised or selected and applied otherwise manipulated with no errors in the to increase the process. probability that financial information will be received favourably or unfavourably by users.  25 Enhancing Qualitative Characteristics (EQC) » Comparability, verifiability, timeliness and understandability are qualitative characteristics that enhance the usefulness of information that both is relevant and provides a faithful representation of what it purports to represent.  Enhancing Qualitative Characteristics 26 Comparability Verifiability Timeliness Understandability information about Verifiability means Timeliness means Financial a reporting entity is that different having information information can be more useful if it knowledgeable available to read and can be compared and independent decision-makers in understood by with similar observers could time to be capable users information about reach consensus, of influencing their Classifying, other entities and although not decisions. characterising and with similar necessarily presenting information about complete information clearly the same entity for agreement, that a and concisely another period or particular depiction makes it another date. is a faithful understandable. representation.  Applying the Enhancing Qualitative 27 Characteristics (EQC) » Should be maximised to the extent possible. » Process does not follow prescribed order. » Sometimes, one EQC may have to be diminished to maximize another EQC or more importantly FQC. » For example: Temporary reduction in Comparability (EQC) to apply new MFRS such as MFRS 15 Revenue from Contract with Customers may be worthwhile to improve Relevance (FQC)and Faithful Representation (FQC) in the longer term.  Cost constraint on useful financial 28 reporting » Reporting financial information imposes costs. » Cost is a pervasive constraint on information provided by financial reporting » The benefits derived from information should exceed the cost of providing it. » Different individuals’ assessments of the COSTS and BENEFITS of reporting particular items will vary.  Cost constraint on useful financial 29 reporting Providers of financial Users of financial information information bear the bear the following costs: following costs: » costs of analysing and » collecting, processing, interpreting the information verifying and provided disseminating financial » additional costs to obtain the information information elsewhere or to estimate it (if needed information is not provided)  30 CHAPTER 3—FINANCIAL STATEMENTS AND THE REPORTING ENTITY This chapter describes: » The objective and scope of financial statements » Reporting period » Going concern assumption » The reporting entity » Consolidated and unconsolidated financial statements  31 The objective of financial statements » The objective of financial statements is to provide financial information about the reporting entity’s assets, liabilities, equity, income and expenses that is useful to users of financial statements in assessing the prospects for future net cash inflows to the reporting entity and in assessing management’s stewardship of the entity’s economic resources  32 Reporting period » Financial statements are prepared for a specified period of time (reporting period) » To help users of financial statements to identify and assess changes and trends, financial statements also provide comparative information for at least one preceding reporting period.  33 Going concern assumption » Financial statements are normally prepared on the assumption that the reporting entity is a going concern and will continue in operation for the foreseeable future. » It is assumed that the entity has neither the intention nor the need to enter liquidation or to cease trading. » If such an intention or need exists, the financial statements may have to be prepared on a different basis. If so, the financial statements describe the basis used.  34 The Reporting Entity » A reporting entity is an entity that is required, or chooses, to prepare financial statements. » A reporting entity can be a single entity (such as a stand-alone reporting entity) or a portion of an entity or can comprise more than one entity.  The Reporting Entity 35 » Sometimes one entity (parent) has control over another entity (subsidiary). Reporting entity may comprise: ⋄ both parent and subsidiary (as a single entity) ⋄ parent only » There is a reporting entity comprises two or more entities that are not all linked by a parent-subsidiary relationship.  36 Financial statements Both parent & Not linked as Parent only subsidiary parent-subsidiary Consolidated Unconsolidated Combined financial financial financial statements statements statements  Consolidated and unconsolidated financial 37 statements Consolidated financial Unconsolidated financial statements statements provide information provide information about the assets, about the parent’s liabilities, equity, assets, liabilities, equity, income and expenses income and expenses, of both the parent and and not about those of its subsidiaries as a its subsidiaries. single reporting entity. a parent may be required, or choose, to prepare unconsolidated financial statements in addition to consolidated financial statements  38 CHAPTER 4—THE ELEMENTS OF FINANCIAL STATEMENTS » This chapter describes the five elements of financial statements  39 THE ELEMENTS OF FINANCIAL STATEMENTS Elements of Financial Statements Elements of Elements of Financial Financial Positions Performance  Elements of Financial Position - 40 Definition Assets Liabilities Equity - A present economic - A present - The residual resource controlled obligation of the interest by the entity as entity - in the assets of - a result of past - to transfer an the entity events. economic - after deducting all - an economic resource its liabilities. resource is a right - as a result of that has the past events. potential to produce economic benefit.  41 ASSETS The criteria to determine the existence of assets are (refer p. 45) : 1. RIGHT TO, including: a) Rights that correspond to an obligation of another party b) Rights that do not correspond to an obligation of another party; 2. POTENTIAL to produce ECONOMIC BENEFITS FROM ; 3. CONTROL OF AN ECONOMIC RESOURCE as a result of PAST EVENT  ASSETS 42 Control criterion (of economic resources) Has the present ability To direct the use To prevent other parties from of economic directing the use of economic resource and resources and to obtain the from obtaining the economic economic benefits benefits that may flow from it that may flow from it  ASSETS 43 Potential to produce economic benefits The right : does not need to be is only necessary that the right certain, or even likely already exists and that, in at that the right will least one circumstance, it would produce economic produce for the entity economic benefits. benefits beyond those available to all other parties.  ASSETS 44 Potential (a) receive contractual cash flows or another to produce economic resource; economic (b) exchange economic resources with another party benefits on favourable terms; (entitling (i) using the economic resource either or enabling (c) produce individually or in combination with other cash inflows for an or avoid cash economic resources to produce goods entity) or provide services; outflows by, for example: (ii) using the economic resource to enhance the value of other economic resources; or (iii) leasing the economic resource to another party;  ASSETS 45 Potential to (d) receive cash or other economic resources by produce selling the economic resource; or economic benefits (entitling or (e) extinguish liabilities by transferring the economic resource. enabling for an entity)  46 LIABILITIES For a liability to exist, three criteria must all be satisfied: a) the entity has an OBLIGATION b) the obligation is to TRANSFER AN ECONOMIC RESOURCE; and c) the obligation is a present obligation that exists AS A RESULT OF PAST EVENTS.  47 Elements of Financial Performance - Definition Income Expenses - Income is increases in - Expenses are assets, or decreases in decreases in assets, or liabilities, that result in increases in liabilities, increases in equity, that result in decreases other than those in equity, other than relating to contributions those relating to from holders of equity distributions to holders claims. of equity claims.  48 CHAPTER 5—RECOGNITION AND DERECOGNITION This chapter discuss: » Criteria for including assets and liabilities in financial statements (recognition); and » Guidance on when to remove the assets and liabilities (derecognition)  49 RECOGNITION » Recognition is the process of capturing for inclusion in the statement of financial position or the statement(s) of financial performance an item that meets the definition of an asset, a liability, equity, income or expenses.  50 RECOGNITION CRITERIA 1 Only items that meet the definition of Asset Liability Equity Income Expenses are recognised in the are recognised in the statement of statement(s) of financial position financial performance (also known as SOPL&OCI)  51 RECOGNITION CRITERIA 2 When the items provide USERS of financial statements with USEFUL INFORMATION in line with Relevance and Faithful representation:  52 DERECOGNITION » Derecognition is the removal of all or part of a recognised asset or liability from an entity’s statement of financial position.  53 DERECOGNITION Derecognition normally occurs when that item no longer meets the definition of an asset or of a liability: (a) for an asset, derecognition normally occurs when the entity loses control of all or part of the recognised asset; and (b) for a liability, derecognition normally occurs when the entity no longer has a present obligation for all or part of the recognised liability.  54 CHAPTER 6—MEASUREMENT This chapter: » Describe measurement bases; » Discuss factors to be considered when selecting a measurement basis  55 MEASUREMENT » Elements recognised in financial statements are quantified in monetary terms. » “how much” an entity allocates to amount recognized as element in financial statements » - it is a process of determining the monetary amounts at which the elements of the financial statement are to be recognized  56 Measurement Bases CURRENT HISTORICAL VALUE COST Value in use (for asset) and Fair value Current cost fulfilment value (for liabilities)  57 Historical Cost » Historical cost measures provide monetary information about assets, liabilities and related income and expenses, using information derived, at least in part, from the price of the transaction or other event that gave rise to them. » Historical cost does not reflect changes in values  58 Historical Cost – for assets The historical cost of an asset when it is acquired or created is the value of the costs incurred in acquiring or creating the asset, comprising the consideration paid to acquire or create the asset plus transaction costs.  59 Historical Cost – for liabilities » The historical cost of a liability when it is incurred or taken on is the value of the consideration received to incur or take on the liability minus transaction costs  60 Current value » Provides information updated to reflect conditions at the measurement date » Measurement bases include: ⋄ Fair value ⋄ Value in use (for assets), fulfilment value (for liabilities) ⋄ Current cost  61 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. » In some cases, fair value can be determined directly by observing prices in an active market.  62 Value in use (for assets) » 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.  63 Fulfilment value (for liabilities) » 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. Those amounts of cash or other economic resources include not only the amounts to be transferred to the liability counterparty, but also the amounts that the entity expects to be obliged to transfer to other parties to enable it to fulfil the liability.  64 Current cost Reflects the current amount that would be: » Paid to acquire an equivalent asset » Received to take on an equivalent liability  65 Factors to consider when selecting a measurement basis The relevance of information provided by a measurement basis for an asset or liability and for the related income and expenses is affected by: (a) the characteristics of the asset or liability; and (b) how that asset or liability contributes to future cash flows  66 (a) the characteristics of the asset or liability The relevance of information depends on: » the variability of cash flows; » whether the value of the asset or liability is sensitive to market factors or other risks.  67 (b) how that asset or liability contributes to future cash flows » some economic resources produce cash flows directly; in other cases, economic resources are used in combination to produce cash flows indirectly. » How economic resources are used, and hence how assets and liabilities produce cash flows, depends in part on the nature of the business activities conducted by the entity.  68 » When a business activity of an entity involves the use of several economic resources that produce cash flows indirectly, by being used in combination to produce and market goods or services to customers, historical cost or current cost is likely to provide relevant information about that activity. » For example, property, plant and equipment is typically used in combination with an entity’s other economic resources. Similarly, inventory typically cannot be sold to a customer, except by making extensive use of the entity’s other economic resources (for example, in production and marketing activities).  69 » For assets and liabilities that produce cash flows directly, such as assets that can be sold independently and without a significant economic penalty (for example, without significant business disruption), the measurement basis that provides the most relevant information is likely to be a current value that incorporates current estimates of the amount, timing and uncertainty of the future cash flows.  70 CHAPTER 7—PRESENTATION AND DISCLOSURE  71 Presentation and disclosure as communication tools » A reporting entity communicates information about its assets, liabilities, equity, income and expenses by presenting and disclosing information in its financial statements.  Presentation and disclosure 72 objectives and principles To facilitate effective communication of information in financial statements, a balance is needed between: » (a) giving entities the flexibility to provide relevant information that faithfully represents the entity’s assets, liabilities, equity, income and expenses; and » (b) requiring information that is comparable, both from period to period for a reporting entity and in a single reporting period across entities.  73 Classification » Classification is the sorting of assets, liabilities, equity, income or expenses on the basis of shared characteristics for presentation and disclosure purposes. » Such characteristics include—but are not limited to—the nature of the item, its role (or function) within the business activities conducted by the entity, and how it is measured.  74 Classification » Classifying dissimilar assets, liabilities, equity, income or expenses together can obscure relevant information, reduce understandability and comparability and may not provide a faithful representation of what it purports to represent.  75 Classification of assets and liabilities » to separate an asset or liability into components that have different characteristics and to classify those components separately » classifying those components separately would enhance the usefulness of the resulting financial information. » For example, it could be appropriate to separate an asset or liability into current and non-current components and to classify those components separately.  76 Offsetting » Offsetting occurs when an entity recognises and measures both an asset and liability as separate units of account, but groups them into a single net amount in the statement of financial position. » Offsetting classifies dissimilar items together and therefore is generally not appropriate.  77 Classification of equity » To provide useful information, it may be necessary to classify equity claims separately if those equity claims have different characteristics » it may be necessary to classify components of equity separately if some of those components are subject to particular legal, regulatory or other requirements  78 Classification of income and expenses Profit or loss and other comprehensive income: » Income and expenses are classified and included either: » (a) in the statement of profit or loss; or » (b) outside the statement of profit or loss, in other comprehensive income.  79 Aggregation » Aggregation is the adding together of assets, liabilities, equity, income or expenses that have shared characteristics and are included in the same classification. » Aggregation makes information more useful by summarising a large volume of detail.  80 CHAPTER 8—CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE This chapter discuss: » Concept of capital » Concept of capital maintenance » Capital maintenance adjustments  81 Concepts of Capital Financial concept Physical concept of capital of capital capital is the net capital is assets or equity regarded as the of the entity productive invested money capacity of the or invested entity purchasing power operating capability  Concepts of Capital maintenance 82 Financial capital Physical capital maintenance maintenance profit is only profit is only earned if the earned if the financial or money physical amount of net productive assets at the end capacity at the exceeds at the end exceeds the beginning of the physical period productive capacity at the beginning  83 Capital maintenance adjustments » The revaluation or restatement of assets and liabilities gives rise to increases or decreases in equity. » While these increases or decreases meet the definition of income and expenses, they are not included in the income statement under certain concepts of capital maintenance. » Instead these items are included in equity as capital maintenance adjustments or revaluation reserves.  84 » The end References: Tan Liong Tong (2019). “Financial Accounting and Reporting in Malaysia”, CCH (Malaysia) Sdn Bhd, Vol. 1, 7th Edition. IFRS Foundation (2018). The Conceptual Framework for Financial Reporting.