Chapter
Fragments of Corporate Reporting
Revenue recognition
1.1 Measurement of revenue
• The agreement between the buyer and seller usually decides the amount of
revenue. Revenue is measured as the fair value of the consideration received.
1.2 Sale of goods
Revenue from the sale of goods should only be recognized when:
• The entity has transferred the significant risks and rewards of ownership of
the goods to the buyer
• The entity has no continuing managerial involvement to the degree usually
associated with ownership and no longer has effective control over the
goods sold
• The amount of revenue can be measured reliably
• It is probable that the economic benefits associated with the transaction
will flow to the entity
• The costs incurred in respect of the transaction can be measured reliably
• If significant risks and rewards remain with the seller, the transaction is not
a sale, and revenue cannot be recognized.
Rendering of services
When the outcome of a transaction involving the rendering of services can be
estimated reliably, the associated revenue should be recognized by reference to
the transaction's completion stage at the reporting date.
The outcome of a transaction can be estimated reliably when:
• The amount of revenue can be measured reliably
• It is probable that the economic benefits associated with the transaction
will flow to the entity
• The stage of completion of the transaction at the reporting date can be
measured reliably
• The costs incurred for the transaction and the costs to complete the
transaction can be measured reliably
• When services are performed by an indeterminate number of acts over a
period of time, revenue should normally be recognized on a straight-line
basis. If one act is of more significance than the others, then the significant
act should be carried out before revenue is recognized.
• When the outcome of the transaction involving the rendering of services
cannot be estimated reliably, revenue is recognized only to the extent of
the expenses recognized that are recoverable.
1.3 Disclosure
• Accounting Policies
• Amount of each significant category of revenue recognized during the
period
• Amount of revenue from exchanges of goods or services included in each
significant category of revenue
• IFRS 15 is generally agreed to be out of date. It does not address the
relatively complex transactions that now take place, for example, barter
transactions, transactions involving options, and sales of licenses for the
use of computer software. This lack of specific guidance has led to
aggressive earnings management: creative accounting techniques
whereby revenue is recognized before it has been earned.
• The LASB has a current project to develop a new standard, but this is at an
early stage. In the meantime, the general principles of IFRS 15 and the
IASB Framework should be applied.
• At the Advanced level, revenue recognition may relate to issues of offbalance sheet finance, substance over form or creative accounting.
Reporting of Assets
Definition of Asset: A resource controlled by the entity as a result of past events
and from which future economic benefits are expected to flow to the entity.
This definition ties in closely with the definitions produced by other Standard
setters, particularly the FASB (USA) and the ASB (UK).
•A general consensus seems to exist in the standard-setting bodies as to
The definition of an asset, which encompasses three important characteristics.
1. Future economic benefit
2. Control
3. The transaction to acquire control has already taken place
1.1 Property, plant and equipment
Cost is the amount of cash or cash equivalents paid or the fair value of the other
consideration given to acquire an asset at the time of its acquisition or
construction.
Residual value is the estimated amount that an entity would currently obtain
from the disposal of the asset, after deducting the estimated costs of disposal, if
the asset were already of the age and in the condition expected at the end of its
useful life.
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. (Note that this definition changed when IFRS 13 Fair Value Measurement
came into force in January 2013 - see Chapter 2, Section 4.)
Carrying amount is the amount at which an asset is recognized after losses.
deducting any accumulated depreciation and accumulated impairment losses
Accounting Treatment
As with all assets, recognition depends on two criteria
1. It is probable that future economic benefits associated with the item will
flow to the entity
2. The cost of the item can be measured reliably
Once recognized as an asset, items should initially be measured at cost
Cost is the purchase price, less trade discount/rebate plus
✓ Directly attributable costs of bringing the asset to working condition for
intended use
✓ Initial estimate of the unavoidable cost of disassembly and removing the
item and restoring the site on which it is located
IAS 16 also
Provides additional guidance on directly attributable costs, including the cost
of an item of property, plant and equipment.
States that income and related expenses of operations incidental to the
construction or development of an item of property, plant and equipment should
be recognized in profit or loss for the period.
Specifies that exchanges of items of property, plant and equipment, regardless of
whether the assets are similar, are measured at fair value, unless the exchange
transaction lacks commercial substance or the fair value of neither of the assets
exchanged can be measured. reliably If the acquired item is not measured at fair
value, its cost is measured at the carrying amount of the asset given up.
Inventories
Valuation
• Lower of:
• Cost
• Net realizable value
• Each item / group / category is considered separately
Determining cost
• FIFO
• Weighted average cost
• Allowable costs
• Allowable costs
• include:
• Cost of purchase
• exclude:
• Cost of storage
• Cost of selling
Net realizable value
•• Estimated cost of completion
• Estimated costs necessary to make the sale (eg marketing, selling and
distribution)
IAS 38 Intangible Assets
Definition
• An intangible asset is an identifiable non-monetary asset without physical
substance, such as a license, patent or trademark.
• An intangible asset is identifiable if it is separable (i.e. it can be sold,
transferred, exchanged, licensed or rented to another party on its own rather
than as part of a business) or it arises from contractual or other legal rights.
Recognition
• An intangible asset should be recognized if it is probable that future
economic benefits attributable to the asset will flow to the entity and the
cost of the asset can be measured reliably.
• At recognition, the intangible should be recognized at cost (purchase price
plus directly attributable costs). After initial recognition an entity can
choose between the cost model and the revaluation model. The revaluation
model can only be adopted if an active market exists for that type of asset.
• An intangible asset other than goodwill recognized in the acquires financial
statements) acquired as part of a business combination should initially
be recognized at fair value.
• Internally generated goodwill should not be recognized.
• On disposal of an intangible asset the gain or loss is recognized in profit or
loss.
Expenditure incurred
• Expenditure incurred in the research phase of an internally generated
intangible asset should be expensed as incurred.
• Expenditure incurred in the development phase of an internally generated
intangible asset must be capitalized provided certain tightly defined criteria
are met.
• Expenditure incurred prior to the criteria being met may not be capitalized
retrospectively
Amortization
• An intangible asset with a finite useful life should be amortized over its
expected useful life, commencing when the asset is available for use in
the manner intended by management.
• Residual values should be assumed to be nil, except in the rare
circumstances when an active market exists or there is a commitment by a
third party to purchase the asset at the end of its useful life.
• An intangible asset with an indefinite life should not be amortized, but
should be reviewed for impairment on an annual basis.
• There must also be an annual review of whether the indefinite life
assessment is still appropriate
IAS 36 Impairment of Assets (Scope)
IAS 36 applies to impairment of all assets other than:
• Inventories
• Deferred tax assets
• Employee benefit assets
• Financial assets
• Investment property held under the fair value model
• Biological assets held at fair value less estimated point-of-sale costs
• Non-current assets held for sale
IAS 36 most commonly applies to:
• Property, plant and equipment accounted for in accordance with IAS
16 Property, Plant and Equipment.
• Intangible assets accounted for in accordance with IAS 38 Intangible
Assets.
• Some financial assets, namely subsidiaries, associates and joint ventures.
Impairments of all other financial assets are accounted for in accordance
with IAS 39 Financial Instruments: Recognition and Measurement.
Issue
Assets should be carried at no more than their recoverable amount.
Recoverable Amount
= Higher of
Fair value less costs to sell
Value in use
Fair value less costs to sell
Fair value less costs to sell is the price that would be received to sell the asset in
an orderly transaction between market participants at the measurement date
(IFRS 13 definition of fair value, see Chapter 2, Section 4), less the direct
incremental costs attributable to the disposal of the asset.
Examples of costs of disposal are legal costs, stamp duty and similar transaction
taxes, costs of removing the asset, and direct incremental costs to bring an asset
into condition for its sale. They exclude finance costs and income tax expense.
Value in use
Cash flow projections are based on the most recent management-approved
budgets/forecasts. They should cover a maximum period of five years, unless a
longer period can be justified.
The cash flows should include:
• Projections of cash inflows from continuing use of the asset
• Projections of cash outflows necessarily incurred to generate the cash
inflows from continuing use of the asset
• Net cash flows, if any, for the disposal of the asset at the end of its useful
life
• Future overheads that can be directly attributed or allocated on a
reasonable and consistent basis
They should exclude:
• Cash outflows relating to obligations already recognized as liabilities (to
avoid double counting)
• The effects of any future restructuring to which the entity is not yet
committed
• Cash flows from financing activities or income tax receipts and payments
IAS 34 Interim Financial Reporting
Definitions
• Interim period is a financial reporting period shorter than a full financial
year
• Interim financial report means a financial report containing either a
complete set of financial statements (as described in IAS 1) or a set of
condensed financial statements (as described in this Standard) for an
interim period.
Scope of IAS 34
IAS 34 does not make the preparation of interim financial reports mandatory,
taking the view that this is a matter for governments, securities regulators, stock
exchanges or professional accountancy bodies to decide within each country. The
IASB does, however, strongly recommend to governments, and regulators, that
interim financial reporting should be a requirement for companies whose equity
or debt securities are publicly traded.
• IAS 34 encourages publicly traded entities:
• To provide an interim financial report for at least the first six, months of
their financial year (i.e. a half-year financial report),
• To make the report available no later than 60 days after the end of the
interim period.
Thus, a company with a year ending 31 December would be required as a
minimum to prepare an interim report for the half year to 30 June and this report
should be available before the end of August.
Minimum Components of Interim Report
• IAS 34 specifies the minimum component elements of an interim financial
report as follows:
• Condensed statement of financial position
• Condensed statement of profit or loss and other comprehensive income,
presented either as a single condensed statement or a statement of profit or
loss and a statement showing other comprehensive income
• Condensed statement of changes in equity
• Condensed statement of cash flows
• Selected note disclosures
• IAS 34 applies where an entity is required to or chooses to publish an
interim financial report in accordance with International Financial
Reporting Standards (IFRSs).
• An interim report complying with IFSs may be:
✓ A complete set of financial statements at the interim reporting date
complying in full with IFRSs, or
✓ A condensed interim financial report prepared in compliance with
IAS 34.
• The rationale for allowing only condensed statements and selected note
disclosures is that entities need not duplicate information in their interim
report that is contained in their report for the previous financial year.
Interim statements should focus more on new events, activities and
circumstances.
Periods covered in interim financial reports
• The Standard requires that interim financial reports should provide financial
information for the following periods or as of the following dates.
Statement of financial position data as at the end of the current interim period
and comparative data as at the end of the most recent financial year.
Statement of profit or loss and other comprehensive income data for the
current interim period and cumulative data for the current year to date, together
with comparative data for the corresponding interim period and cumulative
figures for the previous financial year.
Statement of cash flow data should be cumulative for the current year to date,
with comparative cumulative data for the corresponding interim period in the
previous financial year.
Data for the statement of changes in equity should be for both the current
interim period and for the year to date, together with comparative data for the
corresponding interim period, and cumulative figures for the previous financial
year.
Chapter
Accounting for Price Level Changes
Price Level Change
• Price level changes refer to the changes in the value of monetary unit.
• On the other hand, price level changes refer to the increase or decrease in
the purchasing power of money.
• Purchasing power refers to the ability of a given sum of money to buy a
certain amount of goods or services now, in comparison to what the same
sum of money could have bought at a previous date.
History and Impact of Inflation
• The global economy is experiencing one of its most serious economic
downturns since the 1930s. During times such as these, national
governments are often tempted to adopt expansive fiscal stimulus and
monetary measures designed to lift their economies out of recession.
• Disproportionate stimulus measures, however, are sure to encourage the
flames of inflation as too much stimulus money chases the same goods and
labor. It is too early to tell what path governments affected by the current
recession will follow or how soon, economic recovery will manifest itself.
• Recent reports, however, suggest that inflation worries are heating up.
Developing economies, some of which fought serious clashes to domestic
inflation in the 1980s and 1990s, are especially worrisome.
• In several large emerging markets, such as India, Indonesia, the
Philippines, Russia, Turkey, and South Africa, double digit inflation has
already arrived.
• Given the distortive effects of changing prices on financial statements and
their interpretation, it is important that financial statement readers
understand what these effects are and how to cope with this reporting
challenge.
• While changing prices occur worldwide, their business and Europe ne
North America, for instance, have enjoyed relatively modest general pricelevel increases, averaging less than 3 percent per year during the last
decade.
• By contrast, Eastern Europe, Latin America, and Africa have experienced
much higher inflation rates. Annual rates of inflation have been as high as
106 percent in Turkey, 2,076 percent in Brazil, and, most recently,
231,000,000 percent in Zimbabwe.
• Local inflation affects the exchange rates used to translate foreign currency
balances to their domestic currency equivalents. As we shall see, it is hard
to separate foreign currency translation from inflation when accounting for
foreign operations.
Types of Price Level Change
1. General Price Level Changes
• This refers to the increase or decrease in the value of monetary units
measured in terms of a price index. A general price level change occurs
when, on average, the prices of all goods and services in an economy
change.
• The monetary unit gains or loses purchasing power. An overall increase in
prices is called inflation; a decrease, deflation.
• What causes inflation? Evidence suggests that aggressive monetary and
fiscal policies designed to achieve high economic growth targets, excessive
spending associated with national elections, and the international
transmission of inflation are causal explanation. The issues however, is
complex.
2. Specific Price Level Change:
• Such changes amount to the prices of a specific good or service.
• A specific price change, on the other hand, refers to a change in the price
of a specific good or service caused by changes in demand and supply.
Thus, the annual rate of inflation in a country may average 5 percent, while
the specific price of one-bedroom apartments may rise by 50 percent during
the same period.
3. Relative Price Level Change: This result from the change in the prices of one
commodity in relation to the changes in the prices of all commodities and services
taken together.
Need for Price Level Changes Adjustment
• Financial statements prepared under the traditional methods are based on
the basic assumption that the purchasing power of money is always stable.
• However, as the monetary unit does not remain stable due to inflation, the
inflation contained in the financial statements without adjustments for
inflation becomes highly distorted owing to misrepresentation of certain
elements like cost of goods sold, depreciation, deferred expenses and
purchasing power gain and losses.
• Generally, profit as revealed by the profit and loss account prepared under
the historical cost method has a tendency to be overstated in times of rising
prices.
• Taxation on overstated profits in real term amounts to tax on capital.
• Financial statements too lose their credibility and interpretative benefits for
overstatement of value of assets in the balance sheet, inflated rate of return
on capital, substantial distribution of dividend, high wage payments and
poor liquidity, all due to inflated profits.
Chapter
Financial Statement Analysis
Meaning of Financial Statement Analysis
• Financial statement analysis refers to an information system that is meant
to provide financial data which are appropriate and helpful to decisionmakers who are concerned with evaluating the economic situation of the
firm and predicting its future course.
• The relevant parties who use financial information are- shareholders,
investors, managers, employees, lenders, customers, government
regulatory authorities etc.
• The information in the context is derived basically from the published
financial statements such as the firm's income statement and balance sheet.
Non-accounting Information like stock price and economic indicators are
also used in financial statement analyses,
• In Brief...
• Financial statement analysis is how users extract information to answer
their questions about the firm
What are the different parties demanding financial statement information?
There are so many parties demanding financial statement information. They are• (A) Shareholders and Investors: Shareholders and other investors are
significant recipients of the financial statements of corporations. The decisions
made by these parties include not only which shares to buy, retain, or sell but also
the timing of the purchases or sales of those shares.
• Typically, these decisions will have either an investment or stewardship focus;
in some cases, both will occur simultaneously.
• In an investment focus, the emphasis is on choosing a portfolio of securities that
ensure low risk, high return, dividend yield, better liquidity, etc.
• In decisions with a stewardship focus, the concern of shareholders is with
monitoring the behavior of management and attempting to affect its behavior in a
way deemed appropriate.
Purpose of Financial Statement Analysis
• Financial statement analyses are used by investors, creditors, employees,
regulatory agencies, environmentalists, social activists, researchers, and
management.
• Investors, for example, are concerned with portfolio decisions, creditors
are responsible for determining the firm's creditworthiness, and employees
are responsible for establishing economic bases for collective bargaining.
• The regulatory and policy formulating bodies or the state are interested in
'controlling' decisions; environmentalists and social activists on 'social
accounting' issues; researchers are studying firm and industry behavior;
and the management for evaluating the operational and financial efficiency
of the firm and its subunits.
• As the financial statement analyses serve as a decision-making tool for
different stakeholders. So, it is an important decision-making tool in
business and industry.
Techniques of Financial Statement Analysis
Traditional techniques
Modern techniques
(a) Horizontal Analysis
(a) Economic Value Added
(b) Vertical Analysis
(b) Market Value Added
(c) Ratio Analysis
(c) Multiple Discriminate Analysis
Horizontal Analysis
• Horizontal analysis, also known as trend analysis or dynamic analysis, is
the kind of analysis under which financial statements of a number of years
of the firm are analyzed against a 'common base.'
• Figures of the initial year of the periods for which the analysis is made are
usually taken as the base and converted into percentages, facilitating easy
comparison.
• It is considered suitable for intra-firm comparison. The trend that would
emerge out of the analysis will indicate the improvement or deterioration
in the performance of the firm.
Vertical Analysis
• Vertical analysis, also referred to as common size analysis, is one under
which financial statements of firms of different size are compared and
analyzed against a common base rather than based on absolute figures
themselves.
• The general practice is to express each component of the total assets or
liabilities and also of the components of income statements as a percentage
of a total sales.
• The common size analysis is found useful to inter-firm comparisons.