Chapters 1 & 2 The reporting environment & The conceptual framework 1 Chapters 1,2 & 3 Very important chapters – all other chapters will assume the understanding of the first 3 chapters. 3 topics covered 1. Background to IFRS 2. CONCEPTUAL FRAMEWORK 3. IAS 1: Presentation of Financial Statements 2 The modern accountant Pervasive skills ◦ Ethical behaviour and professionalism ◦ Personal attributes ◦ Professional skills Specific competencies ◦ ◦ ◦ ◦ ◦ ◦ ◦ Accounting and external reporting Auditing and assurance Management decision-making and control Financial management Strategy, risk management and governance Taxation IT 3 Language of Accounting We all need to be able to understand each other! Generally accepted accounting practice (GAAP) GAAP differs from country to country Court cases, financial loss, liquidation INTERNATIONAL HARMONISATION PROJECT 4 International Harmonization Project Avoids miscommunication Best statements of GAAP merged Form Global set of GAAP IFRS International Financial Reporting Standards 5 Other projects Convergence project ◦ “iron out project” to iron out differences between IFRS and US GAAP Improvements project ◦ During the process of harmonization = changes were made to existing standards & interpretations 6 Who has to Comply with IFRS? In South Africa State owned - IFRS Listed Public companies – IFRS Small to medium – Choice of IFRS or IFRS for SMEs or SA GAAP Disclosure of compliance – IAS 1 ◦ Credibility ◦ Understandable to foreigners ◦ Encourages foreign investment 7 Overview of Process Refer to diagram - page 13 (GG: 2023) What is an Exposure Draft? Standards – 42 standards - page 13 (GG: 2023) ◦ IASB – international accounting standards board ◦ IAS / IFRS depending which committee / board developed them 20 Interpretations ◦ SIC / IFRIC depending which committee set developed them 8 9 10 Company Legislation & Related Governance 11 Big changes: Effective 1 May 2011 Companies Act 2008 Shares no longer issued with par value CC will cease to be created Companies divided into non-profit companies and profit companies AFS need to be published within 6 months The 4th schedule disclosure falls away Companies have the contractual powers of a natural person 12 New categories of companies Profit Companies – page 22(GG) ◦ State-owned companies – “SOC Ltd” ◦ Private companies – “PTY Ltd” ◦ Personal liability companies “Inc” ◦ Public Companies – “Ltd” Non-Profit Companies – “NPC” Audit table – page 24/25(GG) Standards table – page 23/42 (GG: 2023) 13 Differential Reporting Refers to the level of compliance Allows smaller entities to produce AFS using simpler standards as opposed to IFRS. IFRS for SMEs What is a SME? ◦ No public accountability ◦ Still produces general purpose AFS for external users. ◦ When does a Co have public accountability? Their debt/equity instruments are publicly traded Legal authority to make financial decisions for group of outsiders 14 Companies Act (2008) Company records ◦ Writing ◦ 7 years Financial year ◦ 365 days ◦ Max 15 months Accounting records ◦ Definition ◦ Requirements Financial statements ◦ ◦ ◦ ◦ ◦ Comply with standards S30 Annual financial statements Prepared within 6 months of year end Audit or Independent review? Other docs i.e. directors report/auditors report 15 JSE Listing Requirements Very onerous requirements to be listed on the JSE Align JSE list requirements with Co’s Act Section 3: Continuing obligations AFS issued 4 months after year end and at least 15 business days before AGM Section 8: Financial information ◦ Info to be included in prospectus/pre-listing statement/circular ◦ Minimum contents of AFS: AFS/Annual report/analysis of directors remuneration 16 The King IV Report Published 1 November 2016, effective 1 April 2017 Replaces King III, developed and refined Not legal requirement – except if JSE listed Key aspects: Ethical culture, good performance, effective control, legitimacy Importance of sustainability reporting – integrated reports Recommended to all entities ◦ Disclosure of remuneration to directors & senior executives ◦ Sustainability reporting 17 King Report on Remuneration Disclose remuneration – page 27 (GG: ) Principle: fair, responsible and transparent Remuneration report: ◦ Context of organization’s remuneration ◦ Main provisions of remuneration policy ◦ Implementation report – benefits to governing body members and prescribed officers Address remuneration gap between executive management and all other employees. 18 Sustainability and Integrated Reporting Sustainable development – page 31 (GG) ◦ To meet the needs of the present ◦ Without compromising the ability of future generations to meet their own needs Triple bottom reporting ◦ Economic, social & environmental issues facing the entity 19 Chapter 2 The conceptual framework for financial reporting This chapter should be applied by students to every chapter covered in accounting. This is the foundation and basis for all accounting standards. 20 Conceptual Framework Objective of general purpose financial reporting: To provide useful information Conceptual framework: includes concepts that achieve usefulness and provide the basis on which IFRS’s are built IFRS: are the foundation on which financial reports are prepared General purpose financial reports: aim to achieve the objective by applying the IFRS’s and where the development of the IFRS’s were based on the concepts in the CF 21 Conceptual Framework It is not an IFRS, however, it forms the basis of IFRS’s and may not override an IFRS. Purpose of CF: ◦ Assist IASB to develop IFRS’s ◦ Assist preparers to create accounting policies ◦ Assist all parties to understand and interpret the IFRS’s 22 Conceptual Framework Chapters 1: The Objective of General Purpose Financial Reporting 2: Qualitative Characteristics of Useful Financial Information 3: Financial Statements and the Reporting Entity 4: The Elements of Financial Statements 5: Recognition and De-recognition 6: Measurement 7: Presentation and Disclosure 8: Concepts of Capital and Capital Maintenance 23 1: Objectives of General Purpose Financial Reporting Provide financial information about the reporting entity that is useful in making decisions about providing resources to the entity. Who are the users? ◦ Investors, lenders and other creditors What information? ➢Economic resources & claims against resources - SOFP ➢Changes in economic resources & claims SOCI 24 Limitations of General Purpose Financial Reporting Only provides financial information Not designed for all users (3 only) Not designed for all decisions Not exact information Only provides historic information Not designed to show the entity’s value 25 General Purpose Financial Reporting ➢ Users made decisions based on their potential returns. ➢ A user’s potential returns is based on the user’s assessment of the entity’s: ➢Prospects of making future net cash inflows ➢Management efficiency and effectiveness ➢ For users to make this assessment, they need financial reports to contain information about the entity’s: ➢Economic resources (A) ➢Claims (L and Eq) and ➢Changes in these resources and claims (I and E) ➢Managements efficiency and effectiveness in using the entity’s resources 26 General Purpose Financial Reporting ➢ Economic resources & claims (SOFP): A – L = OE therefore SOFP ➢ Changes in Economic resources & claims SOCI - Financial perform on Accrual system SOCF - Financial perform on Cash system SOCIE – Any other changes i.e. Shares issued Reviewing WHY resources / claims changed is vital in decision making – user must drill down to the root cause of the change 27 2: Qualitative Characteristics Why do we have qualitative characteristics? Financial statements must be useful Two types ◦ Fundamental characteristics ◦ Enhancing characteristics 28 Qualitative Characteristics Fundamental characteristics ◦ Relevance – What does this mean? Predictive Confirmatory Materiality – page 45 ‘If the decisions of users about a specific reporting entity could be influenced if it were misstated or omitted from the financial statements.’ ◦ Faithful representation Complete Neutral Free from error ◦ Steps to apply fundamental characteristics Page 47 29 Qualitative Characteristics Enhancing Characteristics ◦ Comparability Year to year Entity to entity ◦ Verifiability Direct & indirect ◦ Timeliness ◦ Understandability User has reasonable knowledge of business and economic activities, and Will review, analyze the financial information 30 3: Financial Statements and the Reporting Entity Financial reports have more information that financial statements and are descriptive Financial report = ◦ Economic phenomena (elements) AND ◦ Management efficiency and effectiveness Financial statement – ◦ Economic phenomena (elements) ONLY See summary of comparison 31 Set of Financial Statements Statement of Financial Position (SOFP) Statement of Financial Performance (SOCI) Other statements and notes ◦ SOCF ◦ SOCIE ◦ Notes (detailed information) 32 Reporting Entity An entity that Is required / chooses to Prepare financial statements 33 Reporting Period Normally on an annual basis for one year Events after the reporting period ◦ If a transaction or event that occurs after the reporting period that we believe provides information that relates to the elements included in the AFS and which may be considered useful to users, then we would include this information in the AFS. Prior reporting periods ◦ Important for comparison. 34 Going concern: Underlying Assumption The entity will continue operating into foreseeable future Does not intend to or need to: ◦ Liquidate ◦ Materially downsize operations If yes, disclosure required? ◦ Facts detailed for users ◦ Basis (Liquidation values vs. Cost / FV to measure assets) 35 4: The Elements of Financial Statements 5 elements used in the language of accounting: ◦ Position (3) – Assets, liabilities and equity ◦ Performance (2) – Income and expenses 36 Asset Definition A present economic resource ◦ A right that has ◦ The potential to produce economic benefits controlled by the entity ◦ Direct the use of the economic resource ◦ Obtain it’s benefits / enforce legal rights Resulting from past events Example 1 and 2 37 Example 1 Alpha rents office space from a landlord, at R10 000 per month. It uses this space to run a business selling financial advice. At 31 December 20X4, it pays for the rent for January 20X5. Required: From Alpha’s perspective, prove that this payment is an asset at 31 Dec 20X4. 38 Example 1 Present economic resource ◦ Right to occupy office space for Jan 20X5 ◦ Right to occupy office can be used to produce cash Resource controlled by the entity ◦ Ability to direct use and obtain economic benefits by enforcing legal rights As a result of a past event ◦ Signing of the rental agreement AND ◦ Prepayment of cash 39 Example 2 The accountant is concerned that the new asset definition in the CF will result in certain items, which are currently considered to be assets, no longer meeting the asset definition, and vice versa. Required: ◦ A) Are the accountants concerns valid? ◦ B) Prove that the following are assets: inventory, trade receivables, bank, land, equipment, investment in shares, investment property 40 Example 2 A) No, the concerns are not valid as the new definition is expected to result in the same outcome as the old definition in most instances. B) ◦ Inventory Present economic resource Right to sell inventory Inflow of cash or other economic resource when sold Controlled through legal ownership (invoice) Past event is purchasing and obtaining control of goods 41 Example 2 Trade receivables ◦ Present economic resource Right to collect amount owed Inflow of cash upon collection ◦ Controlled through legal contract of sale ◦ Past event is completing performance obligations Bank ◦ Present economic resource Right to receive cash from bank Usage of the cash has potential to generate economic resources ◦ Controlled through legal contract with bank ◦ Past event is contract with bank and depositing cash 42 Example 2 Land ◦ Present economic resource Right to direct use of land Usage of land has potential to generate economic resources ◦ Controlled through legal ownership (title deed) ◦ Past event is purchasing and obtaining control of land Equipment ◦ Present economic resource Right to direct use of equipment Potential to generate inflow of economic resource or enhance another ◦ Controlled through legal ownership (invoice) ◦ Past event is purchasing and obtaining control of equipment 43 Example 2 Investment in shares ◦ Present economic resource Right to hold / sell shares Inflow of dividends / capital appreciation ◦ Controlled through legal ownership (share certificates) ◦ Past event is purchasing and obtaining control of shares Investment property ◦ Present economic resource Right to direct the use of the property Inflow of cash when lease rentals are received ◦ Controlled through legal ownership (title deed) ◦ Past event is purchasing and obtaining control of property 44 Liability Definition a present obligation (not a future commitment!) ◦ A duty that the entity has ◦ No practical ability to avoid to transfer an economic resource resulting from past events Example 3 and 4 45 Example 3 Beta rents office space from a landlord, at R10 000 per month. It uses this space to run a business selling financial advice. At 31 Dec 20X4, it still owes the rent for Dec 20X4. Required: From Beta’s perspective, prove that this payable is an liability at 31 Dec 20X4. 46 Example 3 Present obligation ◦ Duty to pay landlord monthly rental ◦ No practical ability of avoiding – legally enforceable rental agreement Transfer of economic resource ◦ Outflow - payment of cash to the landlord As a result of a past event ◦ Used the benefits in Dec 20X4 47 Example 4 The accountant is concerned that the new liability definition in the CF will result in certain items which are currently considered to be liabilities, no longer meeting the definition of a liability, and vice versa. Required: ◦ Prove that the following are liabilities: Trade payables, provision for legal costs (Taking competitor to course over patent infringement), bank overdraft 48 Example 4 Trade payables ◦ Present obligation Duty to pay the supplier No practical ability to avoid payment due to legal contract of purchase ◦ Transfer of economic resource Outflow of cash ◦ As a result of a past event Purchase and obtaining possession of the goods 49 Example 4 Provision for legal costs ◦ Present obligation Duty to pay the lawyer No practical ability to avoid payment due to legal contract (service agreement) ◦ Transfer of economic resource Outflow of cash ◦ As a result of a past event Engagement of the services of the lawyer 50 Example 4 Bank overdraft ◦ Present obligation Duty to pay the bank No practical ability to avoid payment due to legal nature of credit granted ◦ Transfer of economic resource Outflow of cash ◦ As a result of a past event Usage of the overdraft facility 51 Equity Definition the residual interest in the entity’s assets after deducting all it’s liabilities 52 Income Definition an increase in assets or decrease in liabilities resulting in increases in equity other than contributions from holders of equity claims Worked example 4 53 Worked example 4 If an entity receives R100 in cash (A), but there is no increase in L, therefore an increase in Equity. Increase in Equity results from: ◦ Contribution from holder of equity claim ◦ Increase in income ◦ Decrease in expense 54 Expense Definition a decrease in assets or increase in liabilities resulting in decreases in equity other than distributions to holders of equity claims Example 5 55 Example 5 Beta rents office space from a landlord, at R10 000 per month. It uses this space to run a business selling financial advice. At 31 Dec 20X4, it still owes the rent for Dec 20X4. Required: Prove that Beta’s payable results in an expense at 31 Dec 20X4. 56 Example 5 Increase in liabilities ◦ Refer to Example 3. Increase in L results in decrease in Eq ◦ Increased L, no change in A, therefore Eq decreased Decrease in Eq is not a distribution to a holder of an equity claim ◦ Payment to landlord and not to equity participant DR Rent expense (E) CR Rent payable (L) 57 5: Recognition and De-recognition Recognise = Journalise Not recognised but still relevant – disclose information in notes Assess the cost / benefit An element can only be recognised if it meets BOTH the relevant: ◦ Element definitions AND ◦ Recognition criteria 58 Recognition Criteria Assets and liabilities, and any resulting income, expenses or changes in equity, must only be recognised if the user would find this information useful. ◦ Relevant AND Effected by: Existence uncertainty Outcome uncertainty ◦ A faithful representation Effected by: Measurement uncertainty 59 Uncertainties Existence: eg. There may be a legal dispute and thus we do not know where an obligation exists Outcome: eg. The probability of the flow of economic benefits may be remote / low. The amount or timing in relation to the flow of economic benefits may be uncertain Measurement: Arises when the amounts presented in the financial statements can’t be observed directly and must be estimated. Level of uncertainty must be considered to be acceptable 60 Accounting Mismatch If information is not recognised – may cause a recognition inconsistency = provide explanatory information in the notes to explain the uncertainties. 61 Derecognition Removal of all / part of a recognised asset / liability from the SOFP Usually occurs when asset / liability fails to meet the relevant definition = derecognise! 62 6: Measurement If the definition AND recognition criteria are met, the element needs to be recorded via a journal entry Recognise, measure and record ◦ Measurement = calculate amount to use in the journal entry – requires significant judgement ◦ Method depends on the applicable standard 63 Methods of Measurement Historical cost (Entry price) ◦ (A) Min economic benefits expects to recover / (L) Max economic benefits expects to settle Current value ◦ Fair value (Exit price) ◦ Price that would be received to sell an asset, or paid to settle a liability, in an orderly transaction between market participants at the measurement date ◦ Value in use (Exit price) ◦ PV of the cash flows, or other economic benefits that an entity expects to derive from the use of an asset and from it’s disposal ◦ Current cost (Entry price) ◦ Cost of an equivalent asset at the measurement date, comprising the consideration that would be paid at the measurement date, plus the transaction costs that would be incurred at that date 64 Considerations for measurement basis selection The measurement basis selected must provide information that is: ◦ Relevant and ◦ A faithful representation of the SUBSTANCE of the transaction Other considerations: ◦ Comparable ◦ Verifiable ◦ Timely 65 7: Presentation and Disclosure If definition AND recognition criteria are met: ◦ recognise in financial statements and ◦ disclose in financial statements if required or material If definition AND recognition criteria are NOT met: ◦ do not recognise in financial statements; but ◦ disclose in notes if still relevant See decision-tree 66 Principles of Presentation and Disclosure Main principle: Providing information that is relevant and a faithful representation of the transaction and events – entity must: ◦ Focus on presentation and disclosure objectives rather than focusing on rules ◦ Classify information in a manner that groups similar items and separates dissimilar items ◦ Aggregate information in such a way that it is not obscured either by unnecessary detail or by excessive aggregation 67 8: Concepts of Capital and Capital Maintenance Excluded from scope of ACCT211. 68
