IAMC – Kurs I
Session 1
IFRS stands for à International Financial Reporting Standards
“Accounting is a service activity. Its function is to provide quantitative information, primarily
financial in nature, about economic entities that is intended to be useful in making economic
decisions, in making resolved choices among alternative courses of action.”
Accounting is useful to compare company decisions à Companies have to be comparable
Users of financial statements:
• Customers à e.g. want to know, that the company still exists the next 10 years
• Government à interested, because taxes, sustainable information for pubic
• Creditors à interest in information about the risks – wants to know how likely it is to
get money back
• Employees à jo security
• Information intermediaries à e.g. grading agencies (Moody´s)
• Suppliers à want to rely on payment of bills
Types of Accounting:
• Financial
o Provides information for external users
§ Investors
§ Creditors
§ Government
§ The public
• Managerial
o Provides information for internal users – managers
o Includes:
§ Budgets
§ Forecasts
Financial statements:
•
Individual Statement à for each one
•
Group statement à group report presents the group if it were 1 single entity
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IAMC – Kurs I
Accounting objectives
• Individual Statement
o Payment
§ Profit distribution
• Minimum pay-out (Shareholder protection)
• Maximum pay-out (Creditor protection)
§ Determination of taxable income
o Legal Consequences
§ Assessment of Liability (insolvency). (Haftungsfeststellung)
§ Documentation i.e. for court (Gericht)
o Information
§ For investors
• Accountability
• Assistance in investment decisions
§ For management
§ For others
• Group statement
o primary for Information (same infos)
•
Components of annual reports
o Accounting information
§ Income statement (tells you about the financial performance)
§ Statement of changes in equity
§ balance sheet (àstructure of assets & liability – how they are bonded – shows you if
there is a lack of liquidity on one page)
Statement of cash flows (only when cash is flowing, the cash flow is changing)
§ Notes
o Narrative information
§ Management report / MD&A
• Auditor’s report
• Chairman’s / director’s report
• Other reports
§
What are IFRS Standards?
•
are globally recognised set of standards for the preparation of financial statements
by business entities
•
they prescribe
o
o
o
o
The items that should be recognised as assets, liabilities, income and expenses
How to measure those items
How to present them in financial statements
Related disclosures about those items
à you can make sure, that the company speaks the same language (IFRS) to attract / go to
other markets
(e.g. Daimler-Benz using German GAAP & US GAAP à US GAAP show the actual
performance & German GAAP smoothens profits (Vorsichtsprinzip, hidden reserves, …)
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IAMC – Kurs I
GAAP = Generally Accepted Accounting Principles
• Different countries are characterised by different cultural, political, legal and
economic conditions
o Code law vs. common law, shareholder versus credit-oriented countries
• Such differences traditionally gave rise to different GAAP regimes, with the aim of
best reflecting underlying economic reality in a given country
o Ownership concentration
§ Different ownership patterns create differing degrees of reliance on
published financial statements
§ GAAP tend to be more highly developed in jurisdictions where
ownership is more disperse (due to demands for greater investor
protection)
o Financing mix
§ Cross-country variation in the optimal debt-to-equity ratio results in
differing preferences regarding the information provided
§ Debt-oriented systems such as Germany and Austria traditionally
favoured conservative valuation practices as a means protecting
creditors’ investments
Austrian GAAP
à UGB is the most authoritative legal source of Austrian Accounting & is supplemented
through legal form-specific laws
à tax regulations also have significant impact on the accounting regulations (Maßgeb.prinz.)
à Laws are rather abstract & general in nature
Impact of GAAP diversity à GAAP differences – few problems when markets are isolated,
but increasing globalization rises the costs of GAAP diversity (Lack of transparency &
comparability & differences are predicted to affect the cost of capital à countries with low
quality GAAP – investors require a risk premium)
à cross-listed firms need to produce multiple sets of financial statements
Proposed benefits of IFRS
• Increased accounting quality and cross-country comparability
o Easier access to foreign capital markets
o Greater transparency
o Lower cost of capital
• Need for firms to keep only 1 set of books (lower costs)
• Reduced national standard setting costs
Costs of IFRS
• High cost of transition (e.g., education, information system) (very costly to train everyone,
everytime on the new IFRS standards)
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•
•
o Direct transition costs can be significant especially for small firms
o Audit fees significantly increase in the year of IFRS adoption
High preparation and certification costs
Increased volatility of earnings and balance sheet items (e.g., fair value accounting)
Changes to existing firm strategies are necessary (e.g., tax strategies, dividend policy,
management incentive plan)
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IAMC – Kurs I
The importance of legal enforcement and reporting incentives
• Properties of accounting numbers are also determined by
o The underlying economic environment and business model
o Managerial incentives (e.g. bonus contract)
o Restrictions on managers’ financial reporting choices
• The effect of IFRS adoption on accounting quality depends on
o Whether IFRS are of higher quality than domestic GAAP
o How they are actually enforced
o Managerial incentives
• Information quality is determined by underlying economic and political factors
influencing preparers’ incentives, not by acc. Standards per se
The institutional framework shapes financial reporting outcomes
IFRS Foundation
• Is an independent, not-for-profit private organization working on public interest
• The IASB (International Accounting Standards Board) is the standard-setting body of
the IFRS Foundation
• The objective of the Foundation is
o “to develop, in the public interest, a single set of high quality,
understandable, enforceable and globally accepted financial reporting
standards based upon clearly articulated principles”
o These standards should require high quality, transparent and comparable
information in financial statements and other financial reporting to help
investors, other participants in the world´s capital markets and other users
of financial statement information make economic decisions”
Bodies of the IFRS Foundation
(Trustees are not involved in standard setting)
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•
•
•
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Monitoring Board
o Aim of 'providing a formal link between the Trustees and public authorities' in
order to enhance the public accountability of the IFRS Foundation
o Consists of eight capital markets authorities responsible for setting the form
and content of financial reporting (e.g., IOSCO, SEC, EU, Japan, Brazil, China)
o Review and provide advice to the Trustees on their fulfilment of the
responsibilities
o Participate in the process for appointing IFRS Foundation Trustees and
approve the appointment of Trustees
Trustees
o 22 trustees of different professional and geographic backgrounds
o Must “be financially knowledgeable” and “sensitive to the challenges
associated with the adoption and application of high quality global accounting
standards”
o Appoint members of the IASB, the IFRS Interpretations Committee, the IFRS
Advisory Council and the Accounting Standards Advisory Forum
o Ensure the financing of the IFRS Foundation and approve annually its budget
IASB
o Group of 14 experts from different geographical regions
o Experts must have an appropriate mix of recent relevant practical experience
and professional competence (e.g., auditors, preparers, users, academics,
market regulators)
o Responsible for the development and publication of IFRS
IFRS Interpretations Committee (IFRS IC)
o Comprises 14 voting members drawn from a variety of countries and
professional backgrounds
o The core task is to interpret the application of IFRS, provide timely guidance
on financial reporting issues that are not addressed in IFRS and providing
authoritative guidance on those issues (IFRIC Interpretations)
Due Process
• Lawfulness of the IASB and od IFRS is enhanced by strict compliance with a
transparent process for setting and adopting standards
• Formal due process à engagement with investors, regulators, … at every stage
• Due Process Handbook
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IFRS à 144 of 166 (87%) of authorities require IFRS standards
International Accounting (IAS/IFRS) à European Accounting (EU Regulations) à National
Accounting (UK GAAP, UGB, ..)
Accounting Regulation in EU à 2002 IAS Regulation à for each financial year starting on or
after 1 January 2005 all publicly listed companies in the EU whose securities are traded on
the regulated market in the EU are obliged to prepare their consolidated financial
statements in accordance with IFRS (Article 4)!!!!!!!!
Objectives of the IAS Regulation
• Article 1
o harmonising the financial information presented by listed EU companies
to ensure a high degree of transparency and comparability of financial
statements and hence an efficient functioning of the Community capital
market and of the Internal Market
• §4
o “contributing to the efficient and cost-effective functioning of the capital
market”
o “the protection of investors and the maintenance of confidence in the
financial markets is also an important aspect of the completion of the
internal market in this area”
o „equal footing for financial resources available in the Community capital
markets, as well as in world capital markets.”
• §5
o “It is important for the competitiveness of Community capital markets to
achieve convergence of the standards used in Europe for preparing
financial statements, with international accounting standards that can be
used globally, for cross-border transactions or listing anywhere in the
world“
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IAMC – Kurs I
Overview of the IAS Regulation (EC) No 1606/2002
Implementation of IAS Regulation in Austria for consolidated financial statements
Implementation of IAS Regulation in Austria for individual financial statements
à IFRS not permitted for individual financial statements! à based on UGB reporting
requirements! à GmbH & Co KG + revenue >700.000 € à Accounting acc. To § 189 UBG /
<700.000€ (freie Berufe) à No accounting acc. To UGB (Einn.-Ausg.-Rg.)
Endorsement process
à Problem: IFRS are not legally binding in the EU
• IASB is an independent organisation under private law. Therefore, it does not have
the legislative power
• Before IFRS are implemented, the EU needs to endorse them before they come into
force
• The IAS Regulation sets up a specific endorsement process under the responsibility of
the European Commission
• The endorsement process :
o The EC decides on the applicability of individual IFRS in the EU. It may adopt
an IFRS only if (Article 3 par. 2 IAS Regulation):
§ it is not contrary to the “true and fair view principle” set out in the
Fourth and Seventh Directives (now integrated in the Accounting
Directive 2013/34/EU)
§ it is conducive to the European public good
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IAMC – Kurs I
it meets the criteria of understandability, relevance, reliability and
comparability
o The EC is assisted in the endorsement decision by consultative and advisory
organizations (see:
§
)
1.) EFRAG advises EC on whether an IFRS standard should be adopted
2.) If the EC decides to endorse the new standard, interpretation or amendment, it prepares
a draft regulation and submits it to the ARC
3.) If ARC approves, the Commission submits the draft regulation to the European
Parliament and the Council for a 3-month scrutiny period
4.) Approved jointly by Council and Parliament and published in the EU Official Journal
What is EFRAG?
à European Financial Reporting and Accounting Group
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Technical private law entity (with international non-profit organization status under
the Belgian law) created in 2001 by organisations representing European preparers,
users and accounting professionals
Comprises an EFRAG Technical Expert Group (TEG) of up to 16 independent volunteer
experts, discussing and preparing endorsement advice to the EFRAG Board
EFRAG Board decides on final endorsement advice. Board includes in equal numbers
representatives of European stakeholder organisations and national accounting
standard setters
EFRAG is one of the four European members of accounting standards advisory forum
(ASAF)
What is ARC?
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•
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The Accounting Regulatory Committee (ARC) was set up in accordance with Article 6
of the IAS Regulation
Composed of representatives of the EU Member States
Vote at the qualified majority (more votes for larger member states) on the IASB's
standards and interpretations proposed by the Commission
ARC's approval is a decisive step, but further discussions in the European Parliament
and Council
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IAMC – Kurs I
Enforcement of IFRS in the EU
• Definition
o To monitor compliance of the financial information with the applicable
reporting framework
o To take appropriate measures in case of violations discovered
• Purpose
o To protect investors (e.g. from accounting scandals)
o To promote market confidence
o To contribute to the transparency of financial information relevant to the
investors´ decision making process
o To ensure consistent application of IFRS in the EU
Enforcement of IFRS – Legal Basis
•
IAS Regulation, recital (16):
o “A proper and rigorous enforcement regime is key to underpinning investors'
confidence in financial markets. Member States, by virtue of Article 10 of the
Treaty, are required to take appropriate measures to ensure compliance
with international accounting standards. The Commission intends to liaise
with Member States, notably through the Committee of European Securities
Regulators (CESR), to develop a common approach to enforcement.”
à CESR was replaced in 2011 by the European Securities and Market
Authority (ESMA)
•
Transparency Directive (2004)
o “Each competent authority shall have all the powers necessary for the
performance of its functions. It shall at least be empowered to: ... examine
that information referred to in this Directive is drawn up in accordance with
the relevant reporting framework and take appropriate measures in case of
discovered infringements.”
Enforcement in the EU
• ESMA
o Coordinates supervisory actions in the EU to ensure supervisory convergence
in accounting enforcement
o Oversees and stimulates European Enforcement Coordination Sessions (EECS)
o EECS is a forum of EU national enforcers that
§ analyzes and discusses enforcement decisions by national enforcers to
achieve harmonization and coordination of future decisions
§ identify issues which are not covered by financial reporting standards
that may be referred to standard setting or interpretive bodies such as
IASB or IFRS IC
o ESMA collects enforcement decision in the EECS database and publishes
extracts from it each year
o To foster supervisory convergence, ESMA establishes common enforcement
priorities published as European Common Enforcement Priorities (ECEP) every
year since 2012
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IAMC – Kurs I
•
Enforcement activities in 2017 (ESMA Report 2017)
o Enforcers examined the financial statements of 1,141 issuers (19 % of all IFRS
issuers listed on regulated markets)
o Enforcement actions against 328 issuers
Enforcement in Austria
Aim à to ensure the reliability and correctness of financial reporting and thereby increase
confidence in the Austrian capital market
Legal basis à The Austrian Accounting Control Act (Rechn.leg.-Kontrollgesetz) was passed by
the Austrian Parliament in December 2012 and came into force on July 1, 2013.
Two-tier enforcement in Austria
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IAMC – Kurs I
Session 2
General purpose of financial accounting
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•
•
Aim à to provide useful information about the reporting entity to primary users who
cannot require the reporting entity to provide information directly to them
General Purpose Reporting Frameworks include
o IFRS and IFRS for Small and Medium-Sized Entities (SMEs)
o Local financial frameworks such as US GAAP
o International Public Sector Accounting Standards (IPSAS)
Special Purpose Reporting Frameworks
o Reply to the requirements of (specific) users that have the authority to
require the reporting entity to provide the information that they need for
their purposes directly to them. E.g.:
o Prudential reporting frameworks
o Tax reporting requirements
IFRS as a general purpose financial reporting framework
à IFRS are designed for general purpose financial reporting primarily for profit-oriented
entities (might be found appropriate for not-for-profit entities
à IFRS focus on information needs of primary users (existing and potential investors,
lenders and other creditors)
§
§
to make their own assessments of the reporting entity´s prospects for future net
cash inflows
as a basis for their decision to buy, hold, sell equity and debt instruments or to
provide a loan or to require settlement of a loan
Principles-based standards
•
•
No universal definition of the term or clear categorization of different standards
Term often used in discussion of advantages & disadvantages of US GAAP and
IFRS
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IAMC – Kurs I
Arguments for Conceptual Framework
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•
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When standard setters determine the form & content of external reports they
address fundamental issues as:
§ What are the objectives of financial reports?
§ Who are the users of these reports?
§ What are the information needs of these users?
§ What types of report will best satisfy these needs?
Without any guiding framework (theory), standards are likely to be developed on a
chaotic and inconsistent basis
o Absent an agreed framework, the same theoretical issues are revisited on
different occasions by different standard-setting working parties
A conceptual framework for financial reporting provides a theory of accounting
against which practical problems can be tested objectively
IASBS´s Conceptual Framework
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•
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Conceptual Framework sets out the concepts that underlie the preparation and
presentation of financial statements
Objectives of IASB´s Conceptual Framework (CF)
o Assist the IASB in the development of standards and review of existing
standards
o Provide a basis for reducing the number of permitted alternative accounting
treatments
o Assist preparers in dealing with topics that have yet to form the subject of
standards
Development of the Conceptual Framework
o IASC issues conceptual framework in 1989
o IASB and FASB were working on ja joint project to develop a common
conceptual framework (based on existing IASB and FASB frameworks)
o In Sep 2010 the IASB issued the revised framework: The Conceptual
Framework for Financial Reporting
o IASB resumes the work on its Conceptual Framework
o In March 2018 new revised Conceptual Framework was issued, effective
immediately for the IASB, for preparers from 2020
Status of Conceptual Framework
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•
•
•
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CF is not an accounting standard. The Framework does not override any specific IASB
standard if there appears to be a conflict
However, entities need to use the CF to develop or select accounting policies when
no Standard specifically applies to a transaction
o IAS 8 states that the absence of a specific standard addressing an issue, an
entity is required to look at the CF
The CF guides the IASB when it develops Standards, so it affects financial statements
indirectly when entities implement new or revised Standards based on the CF.
Sequence of interpretation
o Interpretations à Standards à Framework
Framework
o Conceptual basis for financial reporting
o Basis for the development standards
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IAMC – Kurs I
•
•
o Basis for preparers for issues for which no standard
o Not a standard; standards override the Framework
Standards
o International Accounting Standards IAS 1 to 41
o International Financial Reporting Standards IFRS 1 to 17
Interpretations
o SIC 7,10,15,25,27,29,32
o IFRIC 1 to 23
Structure of Conceptual Framework
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Chapter 1. The objective of 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 statements
Chapter 5. Recognition and derecognition
Chapter 6. Measurement
Chapter 7. Presentation and disclosure
Chapter 8. Concepts of capital and capital maintenance
Overview
1. Objective of general purpose financial reporting
à to provide financial information that is useful to users in making decisions relating
to providing resources to the entity
•
•
Users´ decisions involve decisions of
o Buying, selling or holding equity or debt instruments
o Providing or selling loans and other firms of credit
o Voting, or otherwise influencing management´s actions
To make decisions, users assess
o Prospects for future net cash inflows to the entity
o Management´s stewardship of the entity´s economic resources
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IAMC – Kurs I
•
To make both these assessments, users need information about both
o The entity´s economic resources, claims against the entity and changes in
those resources and claims
o How efficiently and effectively management has discharged its
responsibilities to use the entity´s economic resources
2. Qualitative Characteristics
• Fundamental (CF 2.5)
o Relevance (making decisions)
o Faithful representation or Reliability (complete, neutral, free from error)
• Enhancing (CF 2,23)
o Comparability (time and cross-sectional)
o Verifiability
o Timeliness
o Understandability
• Pervasive constraint (CF 2.39 ff.)
o Cost
2.1. Relevance
• Relevant financial information is capable of making a difference in the
decisions made by users (CF 2.6)
• Financial information is relevant if it has predictive value, confirmatory value
or both à it must be capable of making a difference in a decision
• E.g. significant stock price/trading volume reactions around earnings
announcement vs. no reaction
• Ingredients:
o Predictive value
à fin.inform. has PV. if it can be used as an input to predictive processes
employed by users to inform their own expectations about the
future (CF 2.8)
o Confirmatory Value
à relevant information also helps users confirm or change prior
expectations (CF 2.9)
o Materiality
à Information is material if omitting it / misstating it could influence decisions
that users make on the basis of the reported financial information.
à is an entity-specific aspect of relevance. (CF 2.11)
2.2. Faithful representation
• To be useful, financial information must faithfully represent the economic
phenomena that it wants to represent (CF 2.12)
• To be perfectly faithful representation, a depiction would have three
characteristics. It would be complete, neutral and free from error (CF 2.13)
• A faithful representation provides information about the substance of an
economic phenomenon instead of merely providing information about its
legal form (-> substance over form)
• The term “reliability” in the 1989 Framework was replaced with “faithful
representation” to convey the intended meaning more clearly
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•
Ingredients:
o Completeness
à means that all the information that is necessary for faithful
representation is provided. (CF 2.14)
(E.g., for a group of assets, at a minimum, description of the nature of assets, numerical
depiction of the assets, description what numerical depiction represents.)
o Neutrality
à means that a company cannot select information to favour one
set of interested parties over another, i.e., no bias.
A neutral depiction is not slanted, weighted, emphasized, deemphasised or otherwise manipulated to favour certain users. (CF
2.15)
o Free from error
à An information item that is free from error will be a more
accurate (faithful) representation of a financial item.
à means that the numbers and descriptions match what really existed or happened
Measurement uncertainty: When monetary amounts must be estimated, measurement uncertainty
arises. Measurement uncertainty does not prevent information from being useful. However, when
measurement uncertainty is too high, most useful information may be the information that is slightly
less relevant but is subject to lower measurement uncertainty.
Prudence (term reinstated in CF 2018) Neutrality is supported by the exercise of prudence = exercise
of caution when making judgments under conditions of uncertainty. Prudence does not allow over/understatement of liabilities / assets.
à Financial information must be both relevant & representationally faithful if it is to be
useful (CF 2.20), but in practice there is sometimes a trade-off
2.3. Enhancing Qualitative Characteristics
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Comparability (CF 2.24 ff.)
àFinancial reports are comparable if information can be compared with similar
information about other entities and with similar information about the
same entity for another period or another date
àComparability enables users to identify similarities in, and differences,
among items
à “Consistency” refers to the use of the same methods for the same
items, either from period to period within a reporting entity or in
a single period across entities. Comparability is the goal;
consistency helps to achieve that goal
à Comparability is not “uniformity”
•
Verifiability (CF 2.30 ff.)
à means that different knowledgeable and independent observers could
reach consensus, although not necessarily complete agreement, that a
particular depiction is a faithful representation
à Verification can be either by direct way (e.g., counting cash) or indirect
way (e.g., checking the inputs and recalculating the ending inventory)
•
Timeliness (CF 2.33)
à means having information available to decision-makers in time to be
capable of influencing their decisions
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•
(e.g., disclosing financial statements within a month vs. within six months)
Understandability (CF 2.34 ff.)
àClassifying, characterising and presenting information clearly and
concisely makes it understandable
à For users who have a reasonable knowledge of business and economic
activities and who review and analyse the information diligently
à while the enhancing qualitative characteristics should be maximized to the extent
possible, they cannot, either individually or as a group, make information useful if that
information is irrelevant or does not give a faithful representation (CF 2.37)
Reporting entity and financial statements
• Reporting entity
o An entity that is required, or chooses, to prepare financial statements (not
necessarily a legal entity)
• Financial statements
o A particular form of financial reports that provide information about the
reporting entity´s assets, liabilities, equity, income and expenses
• Boundary of a reporting entity
o Should be determined based on the needs of users for relevant information
and faithful representation
o Types of financial statements with different boundaries:
§ Consolidated financial statements
à provide information about assets, liabilities, equity, income and expenses
of both the parent and its subsidiaries as a single reporting entity
§ Unconsolidated financial statements
à provide information about assets, liabilities, equity, income and expenses
of the parent only
§ Combined financial statements
à provide information about assets, liabilities, equity, income and expenses
of two or more entities that are not all linked by a parent-subsidiary
relationship
3. Elements
3.1. Assets
• An asset is a present economic resource controlled by the entity as a
result of past events (CF 4.3)
• An economic resource is a right that has the potential to produce
economic benefits (CF 4.4)
• Three criteria:
o Right (CF 4.6 – 4.13): e.g., contractual rights (to receive cash or
goods or services), physical rights (over physical objects such as
PPE, intellectual property rights)
§ An entity might obtain a right by, e.g., acquiring or creating
know-how that is not in the public domain
§ Must produce economic benefits beyond the economic
benefits available to all other parties
o Potential to produce economic benefits (CF 4.14 – 4.18): e.g.,
receive contractual cash flows, produce cash inflows using the
economic resource to produce goods or services
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3.2.
o Control (CF 4.1 – 4.25): links an economic resource to an entity
§ the present ability to direct the use of the economic
resource and obtain the economic benefits that may flow
from it; prevent other parties from directing the economic
resource
Liabilities
• A liability is a present obligation of the entity to transfer an economic
resource as a result of past events (CF 4.26)
• Three criteria:
o Obligation (CF 4.28-4.35): is a duty or responsibility that the entity
has no practical ability to avoid
§ Always owed to another party (e.g., person, entity, society
at large); not necessary to know the identity of the party
§ Many obligations are established by contract, legislation or
similar means and are legally enforceable
§ However, obligations can also arise from an entity‘s
customary practices, published policies or specific
statements, if the entity has no practical ability to act in a
manner inconsistent with those practices, policies or
statements (“constructive obligations”)
o Transfer of an economic resource (CF 4.36-4.41): e.g., obligation to
pay cash, obligation to deliver goods or provide services
§ Obligations must have the potential to require an entity to
transfer economic resources. It does not need to be certain
or even likely that transfer required
o Present obligation as a result of past events (CF 4.42-4.47):
§ the entity has received economic benefits (e.g., goods or
services) or taken an action (e.g., operating a business), and
§ as a consequence, the entity will or may have to transfer an
economic resource that it would not otherwise have had to
transfer
BEISPIELE!!!!
3.3.
3.4.
3.5.
Equity
• The residual interest in the assets of the entity after deducting all its
liabilities (CF 4.36)
• No guidance on how to distinguish liabilities from equity instruments
• IASB explores in a research project (Financial Instruments with
Characteristics of Equity) how to distinguish liabilities from equity,
including whether to amend the definitions of liabilities and equity
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 (CF 4.68)
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 (CF 4.69)
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à Changes in assets and liabilities that result in change in equity, for
example:
o transformation of an asset (e.g., converting raw materials into
finished goods; biological transformation; depleting an asset’s
service potential through use)
o change in the value of an asset or liability (e.g., changes in the
price of commodities; interest rate change effects on value of
fixed-rate instruments)
4. Principles
4.1. 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
• recognition involves depicting the item in words and by a monetary
amount (“carrying amount”)
• Criteria:
o meets the definition of assets/liabilities/ equity/income/expenses
(CF 5.6)
o results in relevant information about those items; affected by
§ low probability of a flow of economic benefits
§ existence uncertainty (CF 5.7a)
o results in faithful representation of those items; affected by
§ measurement uncertainty
§ recognition inconsistency (accounting mismatch) (CF 5.7b)
•
Derecognition à is the removal of all or part of a recognised asset or
liability from an entity’s statement of financial position (CF 5.26)
o Normally occurs:
§ For an asset: when the entity loses control of all or part of the
recognised asset (e.g., consumption of the asset; collection of the loan)
§ For a liability: when the entity no longer has a present obligation for all
or part of the recognised liability (e.g., fulfilled the liability)
o aims to faithfully represent both
§ any assets and liabilities retained after the transaction that led to the
derecognition
§ the change in the entity‘s assets and liabilities as a result of that
transaction
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4.2.
4.3.
Measurement
• Measurement involves assigning monetary amounts at which elements of
financial statements are to be recognised and reported
• Conceptual Framework describes what information measurement bases
provide:
o Historical cost (CF 6.4-6.9)
§ provides information derived, at least in part, from the
price of the transaction or other event that gave rise to
the item being measured
§ historical cost is reduced to reflect consumption of an
asset or its impairment
o Current value measurement bases: provide information that is
updated to reflect conditions at the measurement date
§ Fair value (CF 6.12-6.16):
• 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
• reflects market participants’ current
expectations about the amount, timing and
uncertainty of future cash flows
§ Value in use (for assets) or Fulfilment Value (for
liabilities) (CF 6.17-6.20):
• reflects entity-specific current expectations
about the amount, timing and uncertainty of
future cash flows
§ Current cost (CF 6.21-6.22):
• reflects the current amount that would be: paid
to acquire an equivalent asset or received 56 to
take on an equivalent liability
• The factors to be considered when selecting a measurement basis are
relevance and faithful representation, because the aim is to provide
useful information to financial statement users:
o Relevance (is affected by:
§ Characteristics of the asset or liability
• The variability of cash flows
• Sensitivity of the value to market factors
or other risks
§ Contribution to future cash flows
• Whether cash flows are produced
directly/indirectly
• The nature of entity´s business activities
o Faithful representation (is affected by:
§ Measurement inconsistency
§ Measurement uncertainty
Presentation & Disclosure
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IAMC – Kurs I
• Chapter 7 of the revised Framework includes concepts on presentation
and disclosure and guidance on including income and expenses in the
statement of profit or loss and other comprehensive income
• The reason why this chapter was added:
o 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
• Main principles:
o The statement of profit or loss is the primary source of
information about an entity’s financial performance for the
reporting period
§ Nevertheless, understanding an entity’s financial
performance for the period requires an analysis of all
recognised income and expenses—including income and
expenses included in other comprehensive income—as well
as an analysis of other information included in the financial
statements
o In principle, all income and expenses are classified and included
in the statement of profit or loss
o In exceptional circumstances, the Board may decide to exclude
from the statement of profit or loss income or expenses arising
from a change in current value of an asset or liability and include
those income and expenses in other comprehensive income
o The Board may make such a decision when doing so would result
in the statement of profit or loss providing more relevant
information or a more faithful representation
5. Constraints and assumptions
5.1.
Constraints
• Benefits vs. costs
• Cost: cost of data collection, processing, verifying and disseminating
information
• Will benefits > cost?
5.2. Assumptions
• Accrual Accounting
o Transactions and other events are recognised when they occur (and
not as cash or its equivalent is received or paid)
o They are recorded in the accounting periods and reported in the
financial statements of the periods to which they relate
• Going-concern assumption
o The entity will continue in operation for the foreseeable future (long
enough to fulfil objectives and commitments)
o The entity has no intention or need to liquidate or curtail materially
the scale of its operations
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IAMC – Kurs I
Session 3 – Recording Business Transactions
What are business transactions? à events, that have an impact on your economic business
The “father” of bookkeeping à Luca Pacioli à published 1st printed paper on bookkeeping
Double-entry accounting
•
•
•
Business transactions include 2 parts à Giving & Receiving
à the idea is, you always have a giving side & a receiving side
Accounting is based on a double-entry system à Each transaction affects at least 2
accounts
T-account
The rules of debit & credit:
à when you increase
the asset – you debit it
(Assets equal liability + shareholders equity)
Recording transactions in the journal
•
•
Chronological record of transactions
Three steps
o Specify each account affected by the transaction and classify by time (asset,
liability, shareholders´euqity, income or expense)
o Determine if each account is increased or decreased (credit vs. debit)
o Record in journal, including a brief explanation
BEISPIELE!!
Why do we focus on accrual accounting?
•
•
•
Accrual = an expense or revenue that occurs before the business pays or receives
cash
Conceptual Framework (2018) par. 1.17.:
“Accrual accounting depicts the effects of transactions and other events and
circumstances on a reporting entity’s economic resources and claims in the periods
in which those effects occur, even if the resulting cash receipts and payments occur
in a different period. This is important because information about a reporting entity’s
economic resources and claims and changes in its economic resources and claims
during a period provides a better basis for assessing the entity’s past and future
performance than information solely about cash receipts and payments during that
period.”
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IAMC – Kurs I
à Example: t=0 à buy Inventory 500
t=1 à sell prom.acc. 800
t=2 à receive cash
§
t=1
t=0
800
t=2
Cash accounting à
500
§
Accrual accounting à
300
t=1
à Timing and matching are different, but result is the same
Cash basis vs. accrual accounting
Deferrals & accruals
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IAMC – Kurs I
Accruals
•
•
Accrued expenses
o Record expense before paying cash
o Salaries, interest, and income taxes
Accrued revenues
o Record revenue before collecting cash
o Earned and will collect next period
Deferrals (Business has paid/received cash in advance)
•
•
Prepaid expense
o Recorded as an asset when purchased
o Expensed when used or expired
Unearned revenue
o Recorded as a liability when payment is received
o Recorded as a revenue when earned
BEISPIELE!
Depreciation
•
•
•
Systematically allocates cost of property, plant and equipment (PPE) to expense over
its useful life
Most common long-term deferral
Examples of PPE:
o Buildings
o Equipment
o Furniture
Accumulated depreciation
•
•
•
Sum of all depreciation expense
o Increases over plant asset´s life
Contra-asset account
o An account with normal credit balance
o Always has a companion account
Carrying amount reported on the balance sheet
o =cost of plant asset less accumulated depreciation
BEISPIELE!
Session 3 – IFRS Financial Statements
Typical Structure of IAS/IFRS standards
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IAMC – Kurs I
Objective of IAS1
•
IAS 1 prescribes the basis for presentation of general purpose financial statements
o To ensure financial statement comparability both across time and between
firms (CF 2018, par 2.24-2.29)
•
IAS 1 sets out overall requirements for presentation of financial statements dealing
with fair presentation, fundamental accounting concepts (e.g. going concern, accrual
accounting), and the disclosure of accounting policies
•
IAS1 sets out minimum levels of required items to be shown in each statement
o Management allowed considerable discretion over and above his minimum
o IAS1 adopts a generally permissive stance regarding the structure of financial
statements
Scope of IAS 1
•
IAS 1 applies to ‘general purpose financial statements’ that are prepared in
accordance with International Financial Reporting Standards (IFRSs) (IAS 1.2)
•
Other IFRSs set out the recognition, measurement and disclosure requirements for
specific transactions and other events (IAS 1.3)
•
IAS 1 does not apply to the structure and content of condensed interim financial
statements prepared in accordance with IAS 34 Interim Financial Reporting.
However, paragraphs 15–35 apply to such financial statements (i.e., the provisions
relating to fair presentation, compliance with IFRS and fundamental accounting
principles) (IAS 1.4)
•
This Standard applies to consolidated financial statements in accordance with IFRS 10
Consolidated Financial Statements and to separate financial statements in
accordance with IAS 27 Separate Financial Statements (IAS 1.4)
Purpose of financial statements
•
The primary objective of general purpose financial statement is (IAS 1.9):
o To provide information about the financial position, performance and cash
flows useful to a wide range of users in making economic decisions
o Focus on assisting decision making by the users of financial statements is
seeking (at least a part) a forward-looking or predictive quality)
•
Standard also acknowledges a second important role of financial statements:
o Reveal the results of management´s stewardship od resources entrusted to it
•
To meet this objective, IFRS financial statements provide information about an
entity´s:
o Assets, Liability, Equity
o
Income and expenses, including gains and losses
o Contributions by and distributions to owners in their capacity as owners
o Cash flows
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IAMC – Kurs I
IFRS financial statements
•
Complete set of financial statements (IAS 1.10)
o Statement of financial position (balance sheet) as at the end of the period
o Statement of profit or loss and other comprehensive income for the period
o Statement of changes in equity for the period
o Statement of cash flows for the period
o Notes (comprising a summary of significant accounting policies and other
explanatory information)
o Comparative information in respect of the preceding period
• An entity shall present with equal prominence all of the financial statements in a
complete set of financial statements
• Financial reviews by management (e.g., environmental reports, review of main
factors influencing financial performance etc., outside the financial statements are
outside of the scope of IFRSs (IAS 1.13 and 1.14)
General features
• Fair representation and statement of compliance with IFRSs (IAS 1.15-1.17)
§ Fair presentation override in extremely rare circumstances (IAS 1.19)
• Going concern (IAS 1.25)
• Accrual basis of accounting (IAS 1.27)
• Aggregation
§ 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 1.29)
•
•
•
•
Offsetting
o Not allowed to offset assets and liabilities, income and expenses (IAS 1.32)
o Offsetting is different from netting (IAS 1.33)
Frequency of reporting
o Complete set of financial statements at least annually (IAS 1.36)
Comparative information
o Entities shall present comparative information, i.e., financial amounts from
the previous period
o As a minimum, two complete sets of financial statements, i.e., for the current
and the previous period (IAS 1.38 & 1.38A)
o Comparatives must also be made in the narrative and descriptive information
in the notes
Consistency of presentation
o Firms are expected to maintain presentation and classification of items from
one period t another (IAS 1.45)
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IAMC – Kurs I
Content of financial statements under IAS 1 à IAS 1.10
•
A complete set of financial statements under IAS 1 comprises:
o a statement of financial position as at the end of the period;
o a statement of profit or loss and other comprehensive income for the period;
o a statement of changes in equity for the period;
o a statement of cash flows for the period;
o notes, comprising a summary of significant accounting policies and other
explanatory information;
o comparative information in respect of the preceding period
o a statement of financial position as at the beginning of the preceding period
when an entity applies an accounting policy retrospectively or makes a
retrospective restatement of items in its financial statements, or when it
reclassifies items in its financial statements
•
An entity may use titles for the statements other than those used in this standard
(e.g., ‘statement of comprehensive income’)
Content of financial statements under IAS 1 – cont.
•
An entity shall present with equal prominence all of the financial statements in a
complete set of financial statements
•
IAS1 emphasizes that financial reviews by management (e.g. environmental reports,
…) presented outside the financial statements are outside of scope of IFRSs
Typical structure of annual reports
1) Corporate Information
à e.g. short history of the company, members of the board of directors, organizational structure, …
2) Analysis and commentaries
à e.g. letter from Chairman of the Board of Executive Directors
3) Other statements or disclosures
à e.g. corporate governance report, environmental reports
4) Financial statements
à Includes acknowledgement of responsibility for preparing financial statements by management,
audior´s report
Identification financial statements
•
An entity shall clearly identify the financial statements and distinguish them from
other information in the same published document (IAS 1.49)
•
Entities shall clearly display the following information (IAS 1.51)
o The name of the reporting entity
o Whether the financial statements are consolidated or of an individual entity
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IAMC – Kurs I
o The date of the end of the reporting period or the period covered by the
financial statements
o The presentation currency used
o The level of rounding used
•
Let’s see the F/S of BASF (as part of its annual report)
Complete set of financial statements (IAS 1.10)
1. Statement of financial position – Required line items (IAS 1.54)
Current vs. non-current dichotomy – IAS 1.60-76
•
IAS 1 requires balance sheets to distinguish current assets and liabilities from noncurrent ones
o Uses the term non-current to include tangible, intangible, and financial assets
of a long-term nature
•
Separate classification aims to provide useful information by:
o Distinguishing the net assets that are continuously circulating as working
capital from those used in long-term operations
o Highlight assets that are expected to be realised within the current operating
cycle, and liabilities that are due for settlement within the same period
•
Assets classified as current if they satisfy any of the following criteria (IAS1.66):
o Realised in, or intended for sale/consumption in, the normal operating cycle
o Time between the acquisition of assets for processing and their realisation in
cash or cash equivalents
o It is held primarily for the purpose of being traded
o It is expected to be realised within 12 months of the B/S date
o It is cash or cash equivalent
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IAMC – Kurs I
•
Liabilities classified as current if they satisfy any of the following criteria (IAS 1.69):
o Expected to be settled in the entity’s normal operating cycle
o It is held primarily for the purpose of being traded
o It is due to be settled within 12 months of the B/S date
o No unconditional right exists to defer settlement for ³ 12 months after B/S
date
•
All other assets and liabilities classified as non-current by default
•
IAS 1 contains an exception to the current/non-current split (IAS 1.60)
o When a presentation based on liquidity provides information that is equally
reliable and more relevant
•
For cases where such an exception applies, all assets and liabilities are required to be
presented broadly in order of liquidity (see B/S of Barclays)
•
Approach particularly applicable to entities such as financial institutions that do not
supply goods or services in a clearly identifiable operating cycle
o Categorisation by current vs. non-current has little meaning in such contexts
because the notion of an operating cycle is not applicable to financial claims
o Provides quick insights about degree of liquidity matching between assets and
liabilities
o Start with most liquid assets (cash on deposit) and liabilities (cash from other
banks) and work down to most illiquid
Shareholders equity on the balance sheet à represents shareholders ownership of
business assets
• IAS 1.78 (e) requires disclouse of
o Paid-in capital
o Additional paid-in capital
o Retained earnings
2. Statement of comprehensive income (IAS 1.81-105)
•
Provides information about an entity’s financial performance
•
While the statement of comprehensive income includes all income and gains,
expenses and losses, a distinction is made between:
o Profit or loss for the period
o Other comprehensive income (i.e., gains and losses recognised directly in
equity in the period)
•
Net income + other comprehensive income = Total comprehensive income
•
General principle (IAS 1.88): An entity shall recognize all items of income and
expense in a period in profit or loss unless an IFRS requires or permits otherwise
•
Recall Conceptual Framework (par. 7.16): The statement of profit or loss is the
primary source of information about an entity´s financial performance for the
reporting period
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IAMC – Kurs I
Other comprehensive income (OCI)
•
IAS 1.7: “Other comprehensive income comprises items of income and expense
(including reclassification adjustment) that are not recognised in profit or loss as
required or permitted by other IFRSs.”
•
Recall Conceptual Framework (par. 7.17): “In exceptional circumstances, the
Board may decide to exclude from the statement of profit or loss income or
expenses arising from a change in current value of an asset or liability and include
those income and expenses in other comprehensive income”
•
The other comprehensive income includes:
o Changes in revaluation surplus for PPE and intangible assets (IAS 16, 38)
o Gains/losses from:
§ Foreign operation translations (IAS 21)
§ Financial investments measured at fair value through OCI (IFRS 9)
§ And others….
Statement of comprehensive income: Format
•
IAS 1.10A allows two options for the presentation of the statement of profit or loss
and other comprehensive income
•
IAS 1 distinguishes revenues / expenses and gains / losses (see IAS 1.34, CF 7.14(b))
o Gains and losses transactions that do not generate revenue but are incidental
to the main revenue-generating activities
•
General rule is that revenue and expense items are not offset (i.e., netted) unless
certain criteria are met
o But, e.g., gains and losses from the sale of property, plant and equipment can
be offset / netted when such presentation reflects the substance of the
transaction (see IAS 1.34)
•
IAS 1 defines the format of the income statement by setting out:
o Certain items that must appear on the face of the income statement
o Other required disclosures that may be made either on the face of the income
statement or in the accompanying notes to the financial statements
•
IAS 1.82 requires the presentation of the following items (in addition to the items
required by other IFRSs
o Revenue,
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IAMC – Kurs I
o Gains and losses arising from the derecognition of financial assets measured
at amortised cost
o Finance costs
o Impairment losses (including reversals of impairment losses or impairment
gains) in acc. with IFRS 9);
o Share of the profit or loss of associates and joint ventures accounted for using
the equity method;
o Reclassification gains and losses (as defined in IFRS 9);
o Tax expense;
o A single amount for the total of discontinued operations (see IFRS 5).
Two alterative formats for categorizing expenses (IAS 1.99-1.105)
Classification of expenses
•
Classification by function can provide more relevant information to users than
classification by nature
o However, allocating costs to functions may require arbitrary allocations and
involve considerable judgement (IAS 1.103)
•
Entities classifying by function therefore required to disclose additional information
on the nature of expenses (IAS 1.104)
o E.g., depreciation and amortisation expense, and employee benefits expense
•
Both methods provide indication of costs that might vary, directly or indirectly, with
the level of sales or production of the entity
o Ultimate choice governed by whichever approach provides information that is
reliable and more relevant
o Firms also allowed to use a mixed basis on face of the income statement, as
long as required classification presented in the notes
3. Statement of changes in equity (IAS 1.106-110)
• Changes in equity during the period comprise:
o Comprehensive income
o Transactions with owners (e.g., contributions of new capital and
payment of dividends)
o Adjustment to beginning of period retained earnings due to
retroperspective application of a change in accounting standards or
the correction of past errors
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IAMC – Kurs I
• The statement of changes in equity shows a company´s transactions with its
owners
• Net income (or net loss) flows from the income statement to the statement of
changes in equity
• (Compare with the requirements of IAS 1.106)
•
Changes in an entity’s equity between the beginning and the end of the
reporting period reflect the increase or decrease in its net assets during the
period
•
Except for changes resulting from transactions with owners in their capacity as
owners (such as equity contributions or dividends), the overall change in equity
during a period represents the total amount of income and expense, including
gains and losses, generated by the entity’s activities during that period (IAS
1.109)
4. Statement of cash flows à IAS 7 à Covered in Course II
5. Notes (IAS 1.112-138)
• Function of the Notes (IAS 1.112):
•
o Present information about the basis of preparation of the financial
statements and the specific accounting policies selected and applied
for significant transactions and events
o Disclose the information required by IFRSs that is not presented
elsewhere in the financial statements
o Provide additional information which is not presented on the face of
financial statements but that is relevant to an understanding them
Include the following information:
o Explicit and unreserved statement of full compliance with IFRS (IAS
1.16)
o Significant accounting policies, judgements, sources of estimation
uncertainty and assumptions (IAS 1.117-1.133)
o Supporting information for items on the financial statements (e.g.,
additional breakdown of the numbers)
o Other disclosure requirements (e.g., disclosures on capital
management)
•
Notes are an integral part of financial statements, presented in a systematic
manner, with appropriate cross-references from each item on the financial
statements
Relationship among financial statements
Do&CO Questions!
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IAMC – Kurs I
Session 4 – Inventories and PPE
Definition of asset and asset types
•
•
Conceptual Framework à “A present economic resource controlled by the entity as
a result of past events” (CF 4.3)
“An economic resource is a right that has the potential to produce economic
benefits.” (CF 4.4)
à if an item satisfies this conditions you have an asset according to CF
Asset types (à how to recognize those items à here you have, that you have different
asset types)
•
“Different types of economic resources affect a user’s assessment of the reporting
entity’s prospects for future cash flows differently. Some future cash flows result
directly from existing economic resources, such as accounts receivable. Other cash
flows result from using several resources in combination to produce and market
goods or services to customers.” (CF 1.14)
à E.g. PPE & Inventories
IFRS asset types
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IAMC – Kurs I
Beispiele:
Different accounting for some asset?
Inventories – IAS 2
•
•
•
The international standard governing inventories is IAS2 Inventories
Inventories are defined as assets (IAS 2.6)
o Held for sale in the ordinary course of business
o In the process of production for such sale
o In the form of material or supplies to be consumed in the production process
or in the rendering of services
Inventories include (IAS 2.8):
o Goods or assets purchased for resale (e.g. merchandise purchased by a
retailer for resale; land or property held for resale)
o Raw materials and components purchased for incorporation into products for
sale
o Work in progress and finished goods
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IAMC – Kurs I
•
Inventories measured at the lower of cost and net realisable value (NRV) (IAS 2.9) –
on an item-by-item basis
Scope of IAS 2
•
•
An entity has to apply IAS 2 to all inventories, except the following:
o Financial instruments (IAS 32, IFRS 9)
o Biological assets related to agricultural activities and agricultural produce at the
point of harvest (IAS 41) ↳ e. g. grapes
↳ ( processed to Wine → inventories
An entity does not apply IAS 2 to the measurement of inventories held by:
o Producers of agricultural and forest products, agricultural produce of harvest, and
minerals and mineral products, to the extent that they are measured at net
realisable value in accordance with well-established practices in those industries
o Commodity broker-traders who measure their inventories at fair value less costs
to sell
Inventories on the face of BS
Inventories on the face of IS
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IAMC – Kurs I
Key issues
• The principal challenge in accounting for inventories for inventories is the
determination of cost and its subsequent recognition as an expense (à Why
important how to expense inventories? à Impacts Cross Profit; Impact on financial
position)
• Key practical issues regarding accounting for inventories include the following:
o Initial recognition for inventory (i.e. determining the cost of inventory acquired
or made)
o Determining the physical quantities in inventory (using either perpetual or
periodic inventory methods)
o Assignment of costs to inventory using an inventory valuation method (e.g. FIFO
or weighted average cost)
o Measurement subsequent to initial recognition (lower of cost or market value
and associated inventory write.downs)
Inventory equation
Initial recognition (IAS 2.10-18)
• Inventory will initially be recognised at cost (Why? Because fair value would
represent, the potential revenue when it is sold à just see the sale value, not the
profitability)
• Three cost components of inventories (IAS 2.10):
o Costs of purchase
o Costs of conversion
o Other costs incurred in bringing inventories to present location and condition
Initial recognition: Costs of purchase (IAS 2.11)
• Cost of purchase comprises
o Purchase price
o Import duties and other taxes
o Transportation
o Handling and other costs directly attribute to the acquisition of finished
goods, materials and services
o Trade discounts, cash discounts, rebates and other similar items are deducted
in determining the costs of purchase
Initial recognition: Costs of conversion (IAS 2.12-14)
•
•
Apply only to manufacturing entities where raw materials and other supplies are
purchased and then converted into other products
o Conversion costs included in inventory known as product costs
Costs of conversion include:
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IAMC – Kurs I
•
•
•
o Costs related directly to production (e.g. raw materials, direct labour, etc.)
o Systematic allocation of fixed and variable production overheads incurred in
converting materials into finished goods
§ Fixed overheads remain constant regardless of the volume of
production (e.g., depreciation of production equipment, maintenance
charges)
§ Variable production overheads vary directly or nearly directly with the
volume of production (e.g., indirect materials and indirect labour)
o Variable overheads are allocated based on the actual use of facilities
o Allocation of fixed overheads is based on the normal capacity of production
§ See IAS 2.13 also regarding abnormally low or high production
Other costs not closely associated with production (e.g. general administration and
selling costs) are not inventoried
Instead they are treated as expenses of the period in which they are incurred
à known as period costs
Examples of period costs include (IAS 2.16):
o General administration associated with purchases
o Abnormal amounts of wasted materials, labour or other production costs
o Storage costs (unless these costs are necessary in the production process
before a further production stage) ↳ e.g. wine, whiskey (10-20 years of
storage – part of production)
o Administrative overheads that do not contribute to bringing inventories to
their present location and condition
o Selling costs
Summary: Costs of inventories
Exercises IAS 2 Inventories!!
Assigning costs
•
Basic problem involves allocating goods available for sale between closing inventory
and cost of goods sold
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IAMC – Kurs I
Assigning costs: Identifiable items
à
Assigning costs: Homogeneous items
Cost flow methods
•
•
•
Two different rules for the assigning of cost to inventory items sold
o Rules differ depending on the nature of the goods held
IAS 2.23: Where inventory consists of items that can be individually identified due to
unique nature or by other means (or acquired for a specific project)
o à Exact cost of item must be recorded as the cost of goods sold expense
IAS 2.25: Where a specific cost cannot be identified due to the nature of the item
sold (most inventory items fall into this category)
o à Estimate the cost to be recorded as the cost of goods sold expense
o
IAS 2 allows FIFO and weighted average (LIFO not allowed under IFRS; only these two!)
Cost flow methods: FIFO
•
•
FIFO à first-in-first out
o Proponents argue that method best reflects the physical movement of
inventory
Assumes items of inventory purchased first are sold first
o And items remaining in inventory at end of the period are those most recently
purchased or produced (à impact on the inventory value, you have on the balance
sheet à you have more recent prices à balance sheet values show more recent prices
à doesn’t match costs with balances)
•
•
More recently purchased costs are assigned to the inventory asset account
o B/S value is a good approximation of current cost/replacement value
Older costs are assigned to the COGS expense account
o Failure to match in income à old costs matched with current sales prices
´Holding gains´ treated as part of periodic income – Q. Why is this
problematic?
o Leads to overstated profit when prices are rising
o (Inventory holding gains/losses: price changes of inventory that occur
following the purchase of inventory)
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IAMC – Kurs I
Cost flow methods: Weighted average
•
•
Cost of each item sold determined from the weighted average of the cost of similar
items at the beginning of a period and the cost of similar items purchased or
produced during the period
o Method is easy to apply and is particularly well suited to inventory where
homogenous products are mixed together
Average may be calculated either:
o On a periodic basis à pure weighted average
o As each additional shipment is received (on a perpetual basis) à moving
average
Which cost flow method?
•
Choice of which method to use is a matter for management judgement
o Depends on the nature of the inventory, information needs of management
and financial statement users, and cost of applying the formulas
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IAMC – Kurs I
•
Once a cost formula has been selected, management cannot switch randomly from
one formula to another
o IAS 8 requires that accounting policies be consistently applied to ensure
comparability of financial information
o Changes in accounting policies only allowed when required by a standard or
where change results in reporting reliable and more relevant information
à Cost formula unlikely to change unless nature of inventory changes
Subsequent valuation
•
•
•
Measurement rule required by IAS 2 for inventories is lower of cost or net realisable
value (NRV) (IAS 2.9)
o Rationale: assets should not be carried in excess of amounts expected to be
realised from their sales/uses
NRV is the net amount that an entity expects to realise from the sale of inventory in
the ordinary course of business (IAS 2.6)
o Estimated selling price in the ordinary course of business less the estimated
costs of completion and the estimated costs necessary to make the sale
↳ selling price – selling costs
NRV may fall below cost for a number of reasons:
o Fall in selling price (e.g. fashion garments) (à e.g. H&M – new season – old season
priced less)
•
•
o Physical deterioration (e.g. fruit and vegetables)
o Product obsolescence (e.g. computers) (à technological changes)
o Decision to manufacture and sell at a loss (as part of marketing strategy)
Where estimated NRV < historical cost, enzity is required to take an inventory writedown:
o Journal entries (IAS 2.34)
IAS 2.33: The amount of a previous write-down can be reversed (subject to an upper
limit of the original write-down) if:
o Circumstances that previously caused inventories to be written down below
cost change
o New assessment confirms that NRV has increased
o Journal entries (IAS 2.34):
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Expense recognition (IAS 2.34)
•
•
•
When inventories are sold, the carrying amount of those inventories must be
recognised as an expense in the periods in which the related revenue is recognised
à Matching of expenses with related revenues!
Example:
Disclosure in the Notes (IAS 2.36-39)
Property, Plant & Equipment – Initial Recognition – IAS 16
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IAMC – Kurs I
Overview: PPE
IAS 16 deals with the following issues in relation to property, plant and equipment:
• Initial measurement - determination of cost
• Measurement after initial recognition
• Depreciation
• Derecognition of the asset
• Property, plant and equipment are tangible items:
o Held for use in the production or supply of goods or services, for rental to
others, or for administrative purposes
o Expected to be used during more than one period
• “Used in operations” (not for resale); long-term in nature and
• usually depreciated; possess physical substance
Criteria for Recognition
• An item of property, plant and equipment should be recognised as an asset only if
(IAS 16.7):
o Probable that future economic benefits will flow to the entity
o The cost can be measured reliably → related to faithful representation
• Definition of cost:
o Amount of cash paid or the fair value of other consideration given to acquire
an asset at the time of its acquisition or construction (IAS 16.6)
• Aggregation of items that may individually be insignificant is allowed (e.g., tools) (IAS
16.9)
• When significant components of an asset have significantly different useful lives then
each part accounted for as a separate item
Initial measurement
• An item of PPE should initially be measured at its cost
o Basic working rule: The cost of any asset is the sum of all costs incurred to
bring the asset to its intended use
• The cost comprises (IAS 16.16)
o Its purchase price, including import duties and non-refundable purchase
taxes, after deducting trade discounts or rebates
o Any directly attributable costs of bringing the asset to working condition for
its intended use
o The estimated cost of dismantling and removing the asset and restoring the
site, to the extent that it is recognised as a provision (IAS 37)
• Examples of directly attributable costs (IAS 16.17): Cost of site preparation
o Initial delivery and handling costs
o Installation and assembly costs
o Professional fees (for architects and
engineers), building permits
o Costs of testing whether the asset is
functioning properly
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IAMC – Kurs I
•
•
•
Recognition of costs in the carrying amount of PPE ceases, when the item is in the
location and condition necessary for its intended use (IAS 16.20)
The following costs are not included in the carrying amount of PPE (IAS 16.19-20):
o Initial operating losses, such as those incurred while demand for the item´s
output builds up
o Costs of relocating or reorganising operations
o Costs of introducing a new product/service (costs of advertising and
promotional activities)
o Costs of conducting business in a new location or with a new class of
customer (costs of staff training)
o Administration and other general overhead costs
The cost of an item of PPE is the cash price equivalent at the recognition date (IAS
16.23)
Measurement: Subsequent costs
Examples
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