PUB3714_STUDY GUIDE.pdf

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PUB3714/1/2020–2022
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CONTENTS
Page
Theme 1: INTRODUCTION TO GENERALLY RECOGNISED ACCOUNTING
PRACTICES (GRAP)1
Learning unit 1: GRAP framework for the preparation and
presentation of financial statements3
1.1 INTRODUCTION TO GENERALLY RECOGNISED ACCOUNTING
PRACTICES (GRAP) FRAMEWORK 3
1.1.1 Public entities 4
1.1.2 Municipalities4
1.2 SCOPE OF THE FRAMEWORK STATEMENT 5
1.2.1 The GRAP reporting framework 6
1.3 PURPOSE OF FINANCIAL STATEMENTS 8
1.4 COMPONENTS OF FINANCIAL STATEMENTS 9
1.5 USERS AND THEIR INFORMATION NEEDS 11
1.5.1 Principal users of the financial statements 12
1.5.2 Objective of financial statements 14
1.5.3 Financial position, performance and changes in financial position 15
1.6 UNDERLYING CONCEPTS AND ASSUMPTIONS 16
1.6.1 Fair presentation 16
1.6.2 Accounting policies 18
1.6.3 Accrual basis of accounting 19
1.6.4 Going concern 19
1.6.5 Consistency of presentation 20
1.7 QUALITATIVE CHARACTERISTICS 20
1.7.1 Understandability20
1.7.2 Relevance21
1.7.3 Reliability24
1.7.4 Comparability27
1.7.5 Constraints on the presentation of relevant and reliable information 28
1.8 ELEMENTS OF THE FINANCIAL STATEMENTS 29
1.8.1 Description of the elements 29
1.8.2 Recognition of the elements of financial statements 34
1.8.3 Measurement of the elements of financial statements 37
1.9 SELF-ASSESSMENT38
Learning unit 2: GRAP 1: Presentation of financial statements41
2.1 INTRODUCTION41
2.2 OBJECTIVE OF GRAP STANDARD 1 42
2.3 SCOPE OF GRAP STANDARD 1 42
2.4 BASIC INFORMATION 42
2.5 COMPONENTS OF FINANCIAL STATEMENTS 43
2.6 BALANCE SHEET 44
2.6.1 Objective44

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2.6.2 Distinction between current and non-current items 45
2.6.3 Current and non-current assets 45
2.6.4 Current and non-current liabilities 46
2.6.5 Refinancing of current liabilities 47
2.6.6 Information on face of balance sheet 47
2.7 INCOME STATEMENT 53
2.7.1 Objective53
2.7.2 Information on the face of the income statement 53
2.7.3 Information in the notes 53
2.8 CASH FLOW STATEMENT 55
2.9 NOTES TO THE FINANCIAL STATEMENTS 55
2.9.1 Objective55
2.9.2 Structure of notes to financial statements 55
2.9.3 Information in notes to financial statements 56
2.10 APPENDICES TO THE FINANCIAL STATEMENTS 57
2.10.1 Objective57
2.10.2 Structure of appendices to the financial statements 57
2.10.3 Information in appendices 58
2.10.4 Identification of segments 61
2.11 ACCOUNTING POLICIES 62
2.11.1 Presentation of accounting policies 62
2.11.2 Inappropriate treatments not rectified by disclosure 63
Learning unit 3: GRAP 2: Cash flow statements65
3.1 GENERAL DISCUSSION ON CASH FLOW STATEMENTS 65
3.2 REQUIREMENTS OF A CASH FLOW STATEMENT 67
3.2.1 Definitions67
3.2.2 Format of the cash flow statement 69
3.2.3 Presentation of cash flow statement 69
3.3 OPERATING ACTIVITIES 70
3.4 REPORTING CASH FLOWS FROM OPERATING ACTIVITIES 71
3.5 INVESTING ACTIVITIES 72
3.6 FINANCING ACTIVITIES 73
3.7 REPORTING CASH FLOWS FROM INVESTING AND FINANCING
ACTIVITIES74
3.8 FINANCE LEASES 74
3.9 REPORTING CASH FLOWS ON A NET BASIS 74
3.10 FOREIGN CURRENCY CASH FLOWS 75
3.11 EXTRAORDINARY ITEMS 75
3.12 INTEREST AND DIVIDENDS 76
3.13 ACQUISITIONS AND DISPOSALS OF SUBSIDIARIES AND
OTHER LOCAL GOVERNMENT BODIES OR SERVICES 77
3.14 NON-CASH TRANSACTIONS 78
3.15 COMPONENTS OF CASH AND CASH EQUIVALENTS 79
3.16 OTHER DISCLOSURES 80
Theme 2: GRAP STANDARDS 12, 17 AND 25 83
Learning unit 4: GRAP 12: Inventories87
4.1 INTRODUCTION87

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4.4 DEFINITIONS AND IDENTIFICATION 88
4.5 INITIAL RECOGNITION OF INVENTORIES 90
4.6 INITIAL MEASUREMENT OF INVENTORIES 92
4.6.1 Purchase costs 92
4.6.2 Conversion costs 93
4.6.3 Other costs 95
4.6.4 Costs of inventories of a service provider 95
4.6.5 Cost of agricultural produce harvested from biological assets 96
4.6.6 Techniques for the measurement of cost 97
4.6.7 Inventory acquired through a non-exchange transaction 97
4.7 COSTING FORMULAE 97
4.8 SUBSEQUENT MEASUREMENT 98
4.8.1 Net realisable value 98
4.9 RECOGNITION AS AN EXPENSE 99
4.10 DISCLOSURE REQUIREMENTS 101
4.11 SUMMARY101
4.13 REFERENCES103
Learning unit 5: GRAP 17: Property plant and equipment104
5.1 INTRODUCTION104
5.4 DEFINITIONS107
5.5 RECOGNITION OF PROPERTY, PLANT AND EQUIPMENT 108
5.6 CLASSIFICATION OF PROPERTY, PLANT AND EQUIPMENT 110
5.7 INITIAL MEASUREMENT OF PROPERTY, PLANT AND EQUIPMENT 110
5.7.1 Components of cost 110
5.7.2 Exchanges of assets 111
5.7.3 Subsequent expenditure 112
5.8 MEASUREMENT SUBSEQUENT TO INITIAL RECOGNITION 114
5.8.1 Benchmark treatment 114
5.8.2 Allowed alternative treatment for property 114
5.8.3 Revaluations of land and buildings 115
5.9 DEPRECIATION116
5.10 REVIEW OF USEFUL LIFE 118
5.11 REVIEW OF METHOD OF DEPRECIATION 118
5.12 RECOVERY OF THE CARRYING AMOUNT 118
5.12.1 Impairment118
5.12.2 Subsequent increase in recoverable amount: benchmark treatment 119
5.12.3 Retirements and disposals 119
5.13 DISCLOSURE REQUIREMENTS 120
5.14 SUMMARY123
5.16 REFERENCES125
Learning unit 6: GRAP 25: Employee benefits126
6.1 INTRODUCTION126

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6.4 DEFINITIONS130
6.5 SHORT-TERM EMPLOYEE BENEFITS 133
6.5.1 All short-term employee benefits 133
6.5.2 Short-term compensated absences 133
6.5.5.1 Bonus, incentive and performance-related payments 136
6.6 POST-EMPLOYMENT BENEFITS 139
6.6.1 Multi-employer plans 140
6.6.2 Defined benefit plans where the participating municipalities are
under common control 142
6.6.3 State plans 143
6.6.4 Composite social security programmes 143
6.6.5 Insured benefits 144
6.7 POST-EMPLOYMENT BENEFITS: DEFINED CONTRIBUTION PLANS 145
6.7.1 Recognition and measurement 145
6.8 POST-EMPLOYMENT BENEFITS: DEFINED BENEFIT PLANS 145
6.8.8.1 Accounting for the constructive obligation 147
6.8.8.2 Statement of financial position 147
6.8.8.3 Asset recognition ceiling 147
6.8.8.4 Asset recognition ceiling: When a minimum funding requirement
may give rise to a liability 148
6.8.8.5 Statement of financial performance 149
6.8.2 Recognition and measurement: present value of defined benefit
obligations and current service cost 149
6.8.8.1 Actuarial valuation method 149
6.8.8.2 Attributing benefit to periods of service 151
6.8.8.3 Actuarial assumptions 155
6.8.8.4 Actuarial assumptions: Discount rate 156
6.8.8.5 Actuarial assumptions: Salaries, benefits and medical costs 156
6.8.8.6 Actuarial gains and losses 158
6.8.8.7 Past service cost 158
6.8.3 Recognition and measurement: Plan assets 159
6.8.8.1 Fair value of plan assets 159
6.8.8.2 Reimbursements160
6.8.8.3 Return on plan assets 160
6.8.4 Transfer of functions and mergers 162
6.8.5 Curtailments and settlements 162
6.8.6 Presentation164
6.8.8.1 Offset164
6.8.8.2 Current/non-current distinction 164
6.8.8.3 Financial components of post-employment benefit costs 164
6.9 DISCLOSURE164
6.10 OTHER LONG-TERM EMPLOYEE BENEFITS 167
6.11 TERMINATION BENEFITS 169
6.11.1 Recognition169
6.11.2 Measurement170
6.12 SUMMARY171
6.14 REFERENCES173

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Theme 3: WORKED EXAMPLES 175
Learning unit 7: Annual financial statements: A worked example176
7.1 INFORMATION AT OUR DISPOSAL 176
Learning unit 8: Preparing the financial statements of a
municipality: A relatively simple example180
8.1 INTRODUCTION180
8.2 ANNEXURES194
8.2.1 Annexure A 194
8.2.2 Annexure B 195
8.2.3 Annexure C 196
Learning unit 9: Example of cash flow statement197
9.2.1 Example 9.1 198
Learning unit 10: Asset classification decision tree199
FEEDBACK ON ACTIVITIES AND SELF-ASSESSMENT QUESTIONS203
(A) FEEDBACK ON ACTIVITIES 203
(B) FEEDBACK ON SELF-ASSESSMENTS 209
Learning unit 1: Self-assessment answers 209

CONTENTS
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ICONS USED IN THE STUDY GUIDE
The following icons are used to help you identify certain types of learning content:
ICON MEANING
FAST FACT –
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or indicates that additional information on the specific
topic will be provided.
TAKE NOTE
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which is additional to the specific discussion. It is aimed at
drawing the attention of the student to ensure they take
note of the very important information.
ACTIVITY –
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and revision of the study unit content.
EXAMPLE –
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CONNECT WITH US –
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studies.

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THEME 1
INTRODUCTION TO GENERALLY
RECOGNISED ACCOUNTING PRACTICES
(GRAP)
Welcome to PUB3714
The purpose of this module is to equip you with the knowledge and skills to
successfully master important aspects of the Generally Recognised Accounting
Practices (GRAP), as applied in the local government financial sphere in South
Africa.
This study guide consists of three themes with ten learning units in total.
Theme 1 provides an introduction to the presentation of financial statements
by municipalities and municipal entities. It also focuses on the GRAP Framework
Statement,financialstatementsandcashflowstatements(asspecificallyexplained
in GRAP Standards 1 and 2). The study guide turns to Theme 2, which consists of
a discussion on three standards of GRAP, namely, GRAP 12, GRAP 17 and GRAP
25. These have been identified as the most generally used and most applicable
to local government financial statements. The final theme, Theme 3, provides
you with a visual representation of two worked examples in regard to preparing
the financial statements, followed by examples of cash flow statements, and
concludes with an Asset Classification Decision Tree. Please note that you will
not be assessed on Theme 3 and that it merely serves to inform and practically
represent the theory provided in the first two themes.
It must be noted that this course does not exhaust all the Standards of GRAP and
that students should familiarise themselves with the GRAP concepts. The basis
of the discussion in this study guide will be on the GRAP Accounting Standards
as set by the Accounting Standards Board. These are the recognised standards
for all local government accountants and will therefore guide the discussion
in this study guide. In terms of assessment, however, the focus will fall on the
Standards of GRAP covered in this study guide. All further information on GRAP
can be found on the Accounting Standards Board website.
Although it is not absolutely essential, you should preferably be familiar with
section I of Local Government Finance II.

THEME 1: INTRODUCTION TO GENERALLY RECOGNISED ACCOUNTING PRACTICES (GRAP)
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K E Y C O N C E P T S
To understand the content of Theme 1 better, we first need to differentiate
between the following concepts:
•
• Generally Recognised Accounting Practice (GRAP) – The GRAP Framework
Statementsetsouttheconceptsthatunderliethepreparationandpresentation
of municipal financial statements. GRAP is, therefore, a set of concepts that
functions as guidelines for the accounting processes in local government.
•
• Financial statements – These are a structured financial representation of
the events that affect a municipality and the transactions undertaken by it
during the financial year to which these statements relate.
•
• Accrual basis of accounting – A municipality should prepare its financial
statements on the accrual basis of accounting. This means that assets, liabilities,
revenues and expenses are recognised in the books of account when the
transactions relating to them take place; not when cash is received or paid.
In addition, the relevant transactions are recorded in the books of account
and reported in the financial statements during the financial year to which
they relate.
•
• Income statement – A municipality’s income statement must report its
financial performance for the relevant reporting period in a way that enables
users to understand the various aspects of that performance. The income
statement must be presented in a manner which highlights the various
elements of the municipality’s financial performance that are necessary to
constitute a fair presentation.
•
• Balance sheet – The balance sheet reports the municipality’s financial
position at the stated reporting date, in a manner that enables users to
understand the municipality’s economic resources and its financial structure.
The balance sheet also provides information about liquidity and solvency,
which is clearly useful in predicting the ability of the municipality to meet
its financial commitments as they fall due.
•
• Cashflowstatement – In terms of the requirements of GRAP, municipalities will
have to prepare their cash flow statements in accordance with the provisions
of GRAP 2. The requirement is that only amounts received in cash or cash
equivalents must be included in the cash flow statement.
•
• Notes to the financial statements – These will include both narrative
descriptions and more detailed analyses of amounts shown on the face of
the balance sheet, income statement and cash flow statement. Cash flow
information is useful for assessing the municipality’s investing, financing and
operating activities during the reporting period.

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1LEARNING UNIT 1
1GRAP framework for the preparation and
presentation of financial statements
L E A R N I N G O B J E C T I V E S
After studying this learning unit, you should be able to:
•
• apply the accounting principles and prescribed accounting practices relevant
totheframeworkwithinwhichtheannualfinancialstatementsofmunicipalities
must be prepared and presented
•
• list the required components of the financial statements
•
• identify and meet the information needs of users of the statements
•
• explain the underlying concepts and assumptions on which the statements
must be prepared and presented
•
• explain the qualitative characteristics of good statements
•
• define the elements of the statements
•
• explain the recognition of elements in the financial statement
•
• explain the differences between the bases for measuring the elements of
financial statements
1.1 INTRODUCTION TO GENERALLY RECOGNISED
ACCOUNTING PRACTICES (GRAP) FRAMEWORK
Historically, municipalities prepared financial statements based on fund
accounting, whilst municipal entities used to apply the Standards of Generally
Accepted Accounting Practice (GAAP). Fund accounting is a specialised basis of
accounting with limited use outside local government. Accordingly, the users of
financial statements of municipalities usually had very limited knowledge and
experience in interpreting and analysing these financial statements. This resulted
in it being almost impossible to compare the financial statements of municipalities
with other entities or organisations. Thus, owing to the differences between
accounting bases of municipalities and municipal entities, it was impossible to
prepare meaningful consolidated financial statements.
With the implementation of the Municipal Finance Management Act (MFMA),
Act No 56 of 2003, significant reforms were introduced in the manner in
which municipalities and municipal entities record and present their financial
transactions and events in their financial statements. As part of the phased-in
approach to implementing the MFMA, high capacity municipalities had to

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prepare Generally Accepted Municipal Accounting Practice (GAMAP) financial
statements for the 2005/2006 financial year.
In 2006, the Minister of Finance approved the first three Standards of GRAP for
implementation by constitutional institutions and Schedule 3A and 3C public
entities. During May 2008, another 17 Standards of GRAP were approved for
implementation for the financial years starting from 1 April 2009, which resulted
in a stable platform of Standards of GRAP.
1.1.1 Public entities
Public entities are thus required to formulate an accounting policy using the
following Standards:
•
• GRAP 21, GRAP 26, IPSAS 21 and IAS 36 for cash generating or non-cash
generating assets.
•
• GRAP 23 for revenue from non-exchange transactions.
•
• GRAP 104, IAS 32, IAS 39 and IFRS 7 for financial instruments.
•
• Entities may also choose to develop an accounting policy using GRAP for
heritage assets.
1.1.2 Municipalities
As mentioned earlier, municipalities used fund accounting when preparing their
financial statements. During 1997, work started on developing an accounting
framework specific to municipalities, which resulted in Statements of Generally
Accepted Municipal Accounting Practice (GAMAP) based on SA GAAP. As a result
of the harmonisation of SA GAAP with the International Financial Reporting
Standards (IFRS), a number of SA GAAP Statements, on which GAMAP was based,
were withdrawn or amended. Municipalities are thus now required to comply
with GRAP.
The GRAP Framework Statement sets out the concepts that underlie the
preparation and presentation of municipal financial statements. As such, it does
not differ significantly from the framework statement which was applied in local
government in the past, and which in turn was closely based on the Generally
Accepted Accounting Practice (GAAP) requirements concerned.
GRAPis,therefore,asetofconceptsthatfunctionsasguidelinesfortheaccounting
processes. This is the public counterpart of the GAAP, which is a set of rules used
by private entities.
AlthoughGRAPandGAAPareusedindifferentspheresofbusinessandaccounting,
they basically have the same function. GRAP establishes the standards used in
various accounting activities so that agencies in the public sphere are able to
record and report their financial activities accurately, consistently and reliably.
These accounting activities consist of the creation and presentation of financial
statements, as well as reports on cash flow. The GRAP also ensures that the same
processes are followed when dealing with areas which can easily be sources of
ambiguity, for example the estimation and management of errors. This ensures
transparency in the handling of funds by public entities. It is therefore essential
that all covered public entities strictly observe and comply with the GRAP.

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LEARNING UNIT 1: GRAP framework for the preparation and presentation of financial statements
By contrast, GAAP deals with the accounting conventions applicable in the
private sector. This allows the public to make reliable and valid comparisons
among various private corporations. This is possible because the application of
the same accounting standards translates to producing data of the same quality.
The accounting frameworks or basis of preparation applicable to various entities
are summarised in the following table.
TABLE 1.2
Accounting frameworks
CATEGORY OF ENTITIES FRAMEWORK FOR FINANCIAL YEAR
National and provincial departments Modified cash basis of accounting
Parliament and the provincial
legislature
Standards of GRAP
Constitutional institutions Standards of GRAP
High-capacity municipalities Standards of GRAP
Medium-capacity municipalities Standards of GRAP
Low-capacity municipalities Standards of GRAP
Municipal entities Standards of GRAP
Source: Adapted from Deloitte (2014:8)
The framework is not in itself a statement of accounting practice, and therefore
does not define standards for any particular measurement or disclosure issues. It
should be noted that nothing in the framework may be interpreted in a manner
which overrides any specific provision contained in GRAP. The regulatory body will
recognise that, in a limited number of instances, there may be a conflict between
the framework statement and a specific provision contained elsewhere in GRAP.
In these specific cases, the requirements of the GRAP provision must prevail over
the particular item in the framework statement. However, the regulatory body will
be guided in its future activities by the framework in the development of future
standards and in its review of existing accounting standards, and therefore the
number of cases of conflict between the framework and specific GRAP provisions
(in so far as they may exist at all) will decrease over time.
1.2 SCOPE OF THE FRAMEWORK STATEMENT
In terms of section 89 of the Public Finance Management Act (PFMA), the
Accounting Standards Board (ASB) is required to formulate standards of GRAP
to be applicable to the following entities:
•
• National and provincial departments
•
• Public entities as listed in the PFMA
•
• Certain constitutional institutions
•
• Municipalities and all entities under their ownership control
•
• Parliament and provincial legislatures

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The ASB publishes its Standards in a series of pronouncements called Standards
of Generally Recognised Accounting Practice (GRAP). However, entities applying
Standards of GRAP need to comply with the wider GRAP reporting framework, as
set out under Directive 5 issued by the ASB. The reporting framework comprises
the Standards of GRAP, guidelines and directives issued by the ASB and the
standards and pronouncements of other standard setters.
Generally, entities within the public sector have a service delivery objective
rather than a profit-orientated objective. The Standards of GRAP were therefore
developed to reliably account for the service potential as opposed to the future
economic benefits embodied in the entity. As trading entities (as defined in the
PFMA), major public entities and government business enterprises provide goods
and/or services in accordance with ordinary business principles with a profit
objective, as well as the ASB approved application of South African Statements
of Generally Accepted Accounting Practice (SA GAAP), as issued by the South
African Institute of Chartered Accountants (SAICA).
The GRAP reporting framework is concerned with general purpose financial
statements, including consolidated financial statements where applicable.
These financial statements are prepared and presented at least annually, and
must be directed toward the common information needs of a wide spectrum
of potential users. Some of these users may require, and may have the ability
to obtain, information additional to that presented in the Annual Financial
Statements (AFS). Many users, however, will have to rely on the presented financial
statements as their major source of financial information about the municipality
concerned. The statements should therefore be prepared and presented with
their needs in view.
GRAP consists of a number of accounting statements that set out an interpretation
of the accounting framework to ensure that all municipalities disclose similar
types of transactions in their financial statements on the same basis. Financial
statementsformaveryimportantpartofthegeneralprocessoffinancialreporting
in local government. A complete set of financial statements includes a balance
sheet, an income statement, a statement of changes in the financial position
of the reporting entity, as well as notes and other statements and explanatory
material which are an integral part of the financial statements. The AFS may also
include supplementary schedules and information based on or derived from
(and expected to be read with) these statements.
The framework explicitly applies to the financial statements of all municipalities.
For purposes of GRAP, a reporting municipality is a municipality for which there
are users who rely on the financial statements as their major source of information
about the municipality concerned.
1.2.1 The GRAP reporting framework
Directive 5 determines the GRAP reporting framework for a given financial year.
The directive sets out which standards must be used by the entities for the year.
Directive 5 is updated regularly to reflect new Standards, which become effective
after having been approved by the Minister of Finance.

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In the absence of a Standard of GRAP for a particular topic, the pronouncements
of the following standard-setting bodies should be used, in descending order,
to develop an appropriate accounting policy:
•
• International Public Sector Accounting Standards Board (IPSASB)
•
• International Accounting Standards Boards (IASB), including the Framework
for the preparation and Presentation of Financial Statements
•
• Accounting Practices Board (APB)
•
• Accounting Practices Committee (APC) of the South African Institute of
Chartered Accountants (SAICA)
Thus, as a result, the reporting framework for a given financial year may consist
of a combination of
•
• Standards of GRAP issued by the ASB
•
• Interpretations of Standards of GRAP (iGRAP) issued by the ASB
•
• Directives issued by the ASB
•
• Guidelines of Standards of GRAP issued by the ASB
•
• International Public Sector Accounting Standards (IPSAS) issued by the IPSASB
•
• International Financial Reporting Standards (IFRS) issued by the IASB,
which include IFRS Standards, IAS Standards, IFRIC interpretations and SIC
interpretations
With reference to the above, directives are issued by the ASB to deal with specific
practical issues that entities may encounter when applying Standards of GRAP.
An example of this is the transitional provisions and the application of deemed
cost by entities when adopting Standards of GRAP. Guidelines are issued by the
ASB and give guidance on accounting for certain public sector specific issues,
such as for public-private partnerships.
These standards were developed to prevent corruption and discrepancies
from occurring with regard to financial statements and procurement, as has
unfortunately been the prevailing case in South Africa in recent years. This ensures
that accountants follow specific standardised guidelines when compiling their
financial statements and that the financial statements of different entities are
easily comparable. A more detailed discussion on this will follow in the rest of
this theme.
The following reporting framework must be applied by public entities,
municipalities, constitutional institutions and municipal entities for financial
periods beginning on or after 1 April 2010.
Standards of GRAP
GRAP NO. GRAP NAME
GRAP 1 Presentation of Financial Statements
GRAP 2 Cash Flow Statements
GRAP 3 Accounting Policies, Changes in Accounting Estimates and Errors
GRAP 4 The Effects of Changes in Foreign Exchange Rates

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Standards of GRAP
GRAP NO. GRAP NAME
GRAP 5 Borrowing Costs
GRAP 6 Consolidated and Separate Financial Statements
GRAP 7 Investments in Associates
GRAP 8 Interests in Joint Ventures
GRAP 9 Revenue from Exchange Transaction
GRAP 10 Financial Reporting in Hyperinflationary Economics
GRAP 11 Construction Contracts
GRAP 12 Inventories
GRAP 13 Leases
GRAP 14 Events After the Reporting Date
GRAP 16 Investment Property
GRAP 17 Property, Plant and Equipment
GRAP 19 Provisions, Contingent Liabilities and Contingent Assets
GRAP 25 Employee Benefits
GRAP 100 Non-current Assets Held for Sale and Discontinued Operations
GRAP 101 Agriculture
GRAP 102 Intangible Assets
Source: ASB GRAP Homepage (2018: online).
It is important to note that this study guide (due to its credit allocation) will only
focus on GRAP 1, GRAP 2, GRAP 12, GRAP 17 and GRAP 25. These have been
identified as the most generally used and most applicable to local government
financial statements.
1.3 PURPOSE OF FINANCIAL STATEMENTS
Financial statements may be defined as a structured financial representation of
the events that have an impact on a municipality and the transactions undertaken
by it during the financial year to which these statements relate.
TAKE NOTE
In broad terms, the purpose of financial statements is to provide information
about the financial position, performance and changes in the financial position
(net assets or liabilities) of a municipality in a manner that is useful to a wide
range of potential users, with the purpose of enabling them to make economic,
financial and political decisions.

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In addition, the financial statements are the physical demonstration of
management’s compliance with the principle of accountability: the statements
reflect the financial and other results of management’s function of stewardship
over the resources of the municipality.
To fulfil this broad purpose, the financial statements must provide information
that will assist users in forecasting the municipality’s future cash flows and the
timing and certainty of the generation of cash and cash equivalents.
To provide this information meaningfully, the financial statements must contain
information about
•
• the assets (the amount owned by the municipality) – bearing in mind that
these assets are sources of probable future cash inflows, service provision
and other economic benefits
•
• the liabilities (the amount owed) of the municipality – which are sources of
probable future outflows of cash and other economic benefits
•
• thenetrevenuesofthemunicipality–representingthechangeintheeconomic
resources and obligations of the municipality between the beginning and
the end of the accounting period concerned
•
• the historical cash flows of the municipality – as an indicator of probable
future cash flow patterns
1.4 COMPONENTS OF FINANCIAL STATEMENTS
The component parts of the financial statement are interrelated because they
reflect different aspects of the operations. Although each statement provides
information that is different from others, no single statement alone provides all
the information necessary for the particular needs of users.
TAKE NOTE
A complete set of financial statements comprises
•
• the balance sheet
•
• the income statement
•
• the cash flow statement
•
• notestothefinancialstatements,includinganexplanationoftheaccounting
policies adopted
•
• appendices to the financial statements
•
• the additional information set out in (a) to (c) below
One of the benefits of GRAP is that the users of municipal financial statements
will obtain a better understanding of the operating results, financial position
and cash flows of municipalities. Many South African municipalities are complex
undertakings, which are involved in the provision of a wide range of sophisticated
services. To make the financial statements as meaningful as possible to as many
users as possible, current thinking dictates that municipalities should not be
content to provide only financial statements which are technically complete
and correct and which comply with all stated accounting principles, but should
strive to provide additional information to assist users in gaining a proper
understanding of the municipality’s activities.

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Such additional information may be classed into three main categories:
(a) General information about the municipality
–
– the registered office, postal address, telephone and fax numbers
–
– the name and address of the bank or bankers
–
– the name and address of the legal advisors
–
– the name and address of the auditors acting on behalf of the Auditor-
General (where applicable)
–
– the name and address of the internal auditors (where this function is
contracted out)
–
– the grading of the municipality
–
– relevant information about councillors – this should include, at the very
least, the names and (where applicable) portfolios of the members of
the executive committee, the mayor, the chairperson of council (if this
is a person other than the mayor), the names of committee chairpersons
who are not on the executive committee (e.g. the tenders committee or
town planning tribunal) and the size and composition of the council (i.e.
the number of directly elected and proportionally elected councillors)
(b) Treasurer’s report
This report should give an overview of the financial performance of the
municipality during the financial year in question, and should at least
strive to provide the following:
–
– key financial ratios and statistics
–
– a comparison between the operating and capital budgets and the actual
results obtained, with appropriate comments on the reasons for any
material variations between these amounts
–
– an overview of the coming year’s operating and capital budgets, with
a brief comment on the salient features of these budgets
–
– a comment on the treatment of any accumulated surpluses or deficits
(if not already covered under any of the previous headings)
–
– the extent to which the municipality has used and is dependent on
external grants and subsidies
–
– any post-balance sheet events which have a material bearing on the
financial position of the municipality or on any of the information in
the financial statements
(c) Review of operations by the municipal manager (chief executive officer)
As is the case with the treasurer’s report, the chief executive officer
(CEO) should report as at the date on which the financial statements are
finalised, and should therefore cover all matters which are relevant up
to the date of his or her report. In other words, although the main focus
of this report will clearly be the activities of the municipality during the
financial year reported on, post-balance sheet events of any significance
should also be noted in the report.

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The chief matters to be covered in this report should at least include the following:
•
• The main events and considerations which determined the municipality’s
performance during the financial year in question, as well as those likely to
influence current and future performance; the municipality’s ability to sustain
and expand service delivery must clearly feature in this comment
•
• The management structure of the municipality, preferably including the names
and qualifications of at least the most senior officials (the chief executive
officer, the treasurer and the head of engineering services)
•
• The objectives of the municipality as formulated in terms of its integrated
development plan (IDP), with a note on the long-term capital budget
requirements necessitated by the IDP
•
• Any relevant good governance matters, preferably including a comment on
the status and activities of the municipality’s audit committee
1ACTIVITY 1.1
1Answer each of the following questions as comprehensively as possible:
(1) Are the component parts of the financial statements interrelated?
(2) Define the term “financial statements”.
(3) What is the purpose of the Standards of GRAP?
(4) How can the Standards of GRAP address prevalent issues in South
Africa such as corruption and financial mismanagement?
1.5 USERS AND THEIR INFORMATION NEEDS
Theobjectiveoftheframeworkistosetouttheprinciplesandconceptsunderlying
the Standards of GRAP for financial periods commencing on or after 1 April 2010.

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Financial statements are used to satisfy various information needs of users,
including Parliament, the public who receive the services and pay taxes and
levies, present and potential financiers, creditors, economists and employees.
Municipalities cannot possibly provide information to satisfy the needs of each
and every potential user. Nor can they be expected to present the information in
a format which is understandable to every possible potential user. It is therefore
assumed that the users of the information provided by the municipality are
acquainted with the basic functions of local government in South Africa, as well
as the broad legal and constitutional framework within which municipalities
operate, and have at least a basic level of financial literacy. This will ensure that
citizens will be able to understand the financial activities of their municipality
and hold the municipality accountable.
1.5.1 Principal users of the financial statements
•
• The local community
Municipalities are accountable to the community, not only to meet the
expectations of the community in respect of the provision of services but also
to ensure that the income and capital raised have been used in the best interests
of all stakeholders. This includes local voters and residents and generally all
users and consumers of the municipality’s services. The community is in fact the
collective owner of the resources of the municipality, the latter holding these
resources in stewardship. Of course, the published financial statements are
available for scrutiny by the public at large, but arguably it is the public in the
form of the local community that will have a primary interest in these statements.
•
• Provincial and central government departments and their agencies
Bear in mind that in terms of the Constitution of the Republic of South Africa,
1996, and various other statutes, both the provincial and central governments are
charged with certain responsibilities relating to local government. Municipalities
must inform their counterparts, provincial and national organs of state about
any material, financial and budget matters that may have a direct or indirect
impact on them. This is especially important as municipalities deal with citizens at
grassroots level and are viewed as the government sphere closest to the people.
•
• Investors
These include all people or entities who have invested or may in future invest
money in the municipality. The financial statements will give these investors
and potential investors a good indication of whether their investments are or
will be sound and secure. In South Africa this is currently very important, owing
to the change in the country’s leadership and the current drive for international
investment in the country.
•
• Employees
These include both employees themselves and their unions. The financial
statements will provide information on whether there is any scope for improving
remuneration levels in future, whether current remuneration and employment

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levels can be sustained, and whether the municipality as an employer is likely
to expand or contract its staff complement in future years.
•
• Trade creditors
These include both current suppliers and prospective tenderers. The financial
statements will give them an indication of whether they are likely to be paid
in full and on time in terms of the contractual agreement they have with the
municipality. In addition, the financial position of the municipality and its current
and expected performance will obviously influence suppliers in their decision
as to whether to attempt to secure future tenders.
•
• The media
Although in general the quality of the press’s financial reporting on local
government is poor (and we could even say that the financial statements,
no matter how well prepared, will more often than not provide a source of
disinformation to the media), the importance of providing the kind of additional
information mentioned in the preceding section is very relevant in this context.
The reports of both the treasurer and the municipal manager (chief executive
officer) can explain the significant financial features and general performance of
the municipality in terms accessible to the intelligent layman, and thus provide
a sound source of information for media reports on the financial statements.
•
• Economic and financial analysts
The significant role of local government in the national economy is enjoying
much more attention nowadays than was the case in the past. This attention
extends not only to levels of expenditure and taxation, but also to the need
for capital investment in local infrastructure. Analysts are therefore concerned
with mapping out likely trends relating to the maintenance and expansion of
municipal infrastructure (with the associated impact on the local or regional
economy), the fiscal impact of increases in municipal rates and service charges,
and the accessibility or otherwise of capital markets to municipal borrowers. At
present the matter of continuing poor payment levels in respect of municipal
taxes and service charges is the subject of extensive analysis, as is the possibility
of outsourcing major areas of municipal service provision to some form of
public–private sector partnership.
In broad terms the information needs of the above spectrum of users tends to
focus on the following three areas:
•
• Stewardship and compliance: Accountability for the use of public funds and
the safekeeping of the entity’s resources are essential. Finance reporting is an
integral part of fulfilling the duty to be publicly accountable for the collection
of taxation and other revenue, and also the use of such funds for the purpose
of rendering public services. The accounting officer, accounting authority or
municipal manager of an entity has the primary responsibility to prepare and
present the financial statements of the entity.
Users wish to know whether the municipality is operating within the
parameters of its approved budgets, and whether it is exercising proper

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custody of the resources entrusted to it (which will include the adequate
maintenance of fixed assets).
•
• State of finances: Users wish to know the general financial condition of the
municipality, and in this context want to know whether the municipality’s
revenues were sufficient to meet its expenditure requirements, what its
current and future cash flows are, how much it has borrowed and will need
to borrow in future, how it allocates its resources generally, and whether the
sources of revenue available to it are adequately exploited.
•
• Performance: Users will wish to know whether the municipality’s actual use
and allocation of its resources have complied with its stated plans. Citizens
will be guided in determining this by viewing the Integrated Development
Plan (IDP) of the municipality and comparing what has been promised to
that which has been delivered.
It should be noted that the Municipal Finance Management Act (MFMA) 56 of
2003 is based on the adoption by the municipality of a performance system.
Section 17 of the MFMA stipulates that the budget of the municipality must
contain performance targets and measurable objectives, which are set out at
the beginning of the financial year.
1.5.2 Objective of financial statements
Financial reporting plays a large role in fulfilling an entity’s duty to be publicly
accountable in a democratic society. Citizens have a right to receive openly
declared facts that may lead to public debate. To summarise, therefore, the
objective of financial statements is
•
• to fulfil an entity’s duty to be accountable and should enable users to access
that accountability
•
• to evaluate the operating results of the entity for the financial year
•
• to assess the level of services which the entity can provide and its ability to
meet its obligations as they become due
•
• to provide information about the financial position. and
•
• to provide information on performance and changes in the financial position
of the municipality, in a manner which demonstrates accountability, and which
is useful to a wide range of known potential users in making their economic,
financial or political decisions
The financial statements fulfil this purpose by providing the following basic
information:
•
• The extent to which resources were obtained and used in compliance with
the approved budgets
•
• Whether resources were obtained and used in compliance with any legal
and contractual obligations
•
• The sources, allocations, costs, uses and outcomes of resources
•
• Howthemunicipalityfinanceditsactivitiesandmanageditscashrequirements
•
• The effectiveness of the municipality’s credit control measures
•
• The general financial condition of the municipality and any changes in this
condition

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•
• Information useful in evaluating the municipality’s ability in future to finance
its activities and meet its cash requirements
•
• Information useful in evaluating the municipality’s future ability to provide
services in accordance with the community’s requirements
•
• Information sufficient to allow an evaluation of the municipality’s performance
in terms of service costs, efficiency and achievements
2FAST FACT
1Financial statements are prepared on the assumption that
•
• the entity is a going concern; thus that the entity will
•
• continue in operation and meet its statutory obligations for the
foreseeable future
1.5.3 Financial position, performance and changes in financial
position
It was mentioned earlier that the decisions taken by users of financial statements
are generally based on an assessment of the municipality’s ability to generate
cash and cash equivalents and of the timing and certainty of this generation, i.e.
how the municipality finances its activities and meets cash flow requirements;
and the financial position stating whether it improved or deteriorated as a result
of the year’s operations. Thus, information about the financial performance of
an entity provides an account of stewardship of management and is useful for
assessing the past and anticipated financial performance of the entity.
Users are best able to make such an assessment if they are provided with
information clarifying the financial position, performance and changes in the
financial position of the municipality.
A municipality’s financial position is governed by the economic resources it
controls, its financial structure, its liquidity, solvency and sustainability, and its
ability to adapt to changes in its operating environment. Information about the
resources controlled by the entity and its capacity in the past to modify these
resources is useful in predicting the ability of the entity to sustain its service
delivery in the future.
Information concerning changes in the cash flows of an entity is useful as it
provides the user with a basis to assess the ability of the entity to generate cash
and cash equivalents and the needs of the entity to utilise those cash flows.
TAKE NOTE
This information about the financial position is principally contained in the
balance sheet.
Information about the municipality’s performance is necessary in order to assess
whether potential changes in economic resources are likely, and whether, in short,
the municipality is able to sustain its current level of operations. This information

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will also indicate whether the municipality is likely to generate adequate future
cash flows from its existing resource base, and whether it will effectively be able
to employ additional resources in future years.
TAKE NOTE
The information about performance is primarily provided in the income
statement.
Information about changes in the financial position of the municipality is
important if the user wishes to evaluate the investing, financing and operating
activities during the financial year in question. This information provides users
with the basis for assessing the ability of the municipality to generate future
cash and cash equivalents, as well as the future cash requirements (cash flow
management) of the municipality.
TAKE NOTE
The information about the changes in the financial position of the municipality
is provided in the cash flow statement.
In short, the component parts of the financial statements are closely interrelated
in that they provide information on different aspects of the same transactions
or events. Although each statement provides a unique range of information, it
is unlikely that any one component on its own will provide all the information
required by a particular user.
3FAST FACT
1The need for users to read the different components in conjunction with
one another cannot be emphasised enough.
TAKE NOTE
Information concerning changes in the cash flows of an entity is useful when
assessing its investing, operating and financing activities during the reporting
period.
1.6 UNDERLYING CONCEPTS AND ASSUMPTIONS
The effect of transactions and other events are recognised when they occur and
are reported in the financial statements of the period to which they relate and
not when cash is received or paid.
1.6.1 Fair presentation
Financial statements must present fairly the financial position, performance and
cash flows of the municipality. In general, this will mean that these statements will

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have to be compiled in accordance with the principles set out in the Standards
of Generally Recognised Accounting Practice (GRAP). However, where the
municipality is aware that compliance with GRAP does not entail disclosures
sufficient to result in a fair presentation, additional disclosures should be made
to correct the situation.
Where no applicable GRAP standard exists in respect of a particular transaction
or activity, the municipality should apply the principles set out in 1.6.2 below.
In addition, the municipality should always bear in mind that the qualitative
characteristics of relevance, reliability, understandability and comparability are
the attributes that make the information provided in the financial statements
useful to users. We will return to these attributes later in these notes.
4ACTIVITY 1.2
Which of the following is the correct option?
(1) The accounting system used in local government is known as:
(a) GAAP
(b) GAMAP
(c) GRAP
(2) Financial statements do not have to present the financial position
of the municipality fairly, only their performance and cash flows.
(a) True
(b) False
(3) In which of the following statements should the change in the cash
position of a municipality be presented?
(a) GRAP standards
(b) Cash flow statements
(c) GAMAP standards
(4) What is the purpose of financial statements?
(5) How do you think adherence to financial statements and clean audits
assist in acquiring international investment in the country?

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TAKE NOTE
It is very important to remember that broad compliance with GRAP does not
result in fair presentation. In preparing all the components of the financial
statements, including the notes and disclosures, fair presentation will be
achieved only if the statements comply in all material respects with the
requirements of GAMAP.
5FAST FACT
1Fair presentation refers to the faithful representation of the effects of
transactions, other events and conditions in accordance with the definitions
and recognition criteria for assets, liabilities, revenue and expenses.
1.6.2 Accounting policies
In line with GRAP, the MFMA also gives effect to the constitutional principles that
recognise that the local sphere of government is “distinctive” and “independent”,
with the power to determine its own budget and policies.
Accounting policies may be defined as the specific principles, bases, conventions,
rules and practices that a municipality adopts in preparing and presenting its
financial statements.
The GRAP standards have been developed with the purpose of striking an
appropriate balance between the qualitative characteristics of relevance,
reliability, comparability and understandability. Where GRAP does not cover a
specific transaction or activity, the management of the municipality must exercise
its judgement in developing an accounting policy which will fairly represent this
transaction or activity, in a manner which provides the most useful information
to users of the financial statements (the guidelines or standards to follow in this
instance were discussed earlier). In exercising its judgement, management must
have recourse to
•
• the principles contained in GRAP standards which deal with comparable or
related transactions or activities
•
• the definitions, qualitative characteristics and other principles set out in the
remainder of these notes, and
•
• established practices in use in other municipalities
To comply with the underlying assumption of fair presentation in the financial
statements, a municipality must select and apply its accounting policies in
accordance with the principles of GRAP, but municipalities should not hesitate to
go beyond the requirements of GRAP if fair presentation necessitates this. At all
times, the principles of relevance, reliability, comparability and understandability
must inform the adoption and application of accounting policies.

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TAKE NOTE
Inappropriate accounting treatments are not rectified by disclosure of the
accounting policies used, or by notes or explanatory material.
1.6.3 Accrual basis of accounting
A municipality must prepare its financial statements, with the exception of
the cash flow statement, on the accrual basis of accounting. A municipality is
required to prepare its financial statements, except for cash flow information,
by applying the accrual basis of accounting.
6FAST FACT
1The accrual basis of accounting means that assets, liabilities, revenues and
expenses are recognised in the books of account when the transactions
relating to them take place, not when cash is received or paid. In addition,
the relevant transactions are recorded in the books of account and reported
in the financial statements during the financial year to which they relate.
In essence, accrual accounting entails that all the accounting effects of a
transaction or event are recognised in the financial statements in the accounting
period (financial year) in which this transaction or event takes place.
In the operating account this means that (what is described as) a matching
of revenues and expenses occurs – the income generated from the sale of
electricity, for example, is recognised in the same accounting period in which
the expenditure connected with the provision of this service is incurred.
1.6.4 Going concern
It is assumed that a municipality prepares its financial statements as a going
concern, that is, it will continue with more or less its existing level of operations
into the future. This does not mean, however, that incremental changes in the
scale of operations cannot take place without the going concern principle being
violated.
The assumption that municipalities should be treated as going concerns seems
to be dictated by common sense. In practice, it is highly unlikely, under normal
conditions, that the basic range of services provided by the municipality could
be readily terminated.
However, in cases where the municipality is aware of a known or likely future
change in its scale of operations, or in its functional structure, this should be
disclosed in the financial statements (either in the report of the CEO or the
treasurer or in an appropriate note). This type of event could occur when, for
example, a particular service – such as the provision of water or the collection of
refuse – is to be entirely privatised, or taken over by another entity (for instance
an association established for this purpose by the municipality), or where re-

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demarcation results in the municipality absorbing, or being absorbed by. other,
municipalities. The future loss of its electricity distribution function to a regional
electricity distributor would be another appropriate example where the going
concern principle does not apply.
1.6.5 Consistency of presentation
The users of financial statements are entitled to assume that the municipality
presents the relevant information consistently from one accounting period to
another.
Thepresentationandclassificationofitemsinthefinancialstatementsareretained
from one period to the next. If, however, there has been a significant change in
the nature of the municipality’s operations or activities, or management has come
to the conclusion that the information contained in the financial statements can
be presented in a manner which demonstrates greater relevance, a departure
from the principle of consistency may be justified. However, this change in
presentation must be fully disclosed in the relevant financial statements. In
addition, the comparative information shown for the preceding accounting
period will have to be adjusted to comply with the new presentation.
Of course, municipalities should not take any changes lightly on the basis of their
presentation, but where a significant restructuring has occurred, or there is a
fundamental change in operations which is likely to endure for the foreseeable
future, or the municipality has found a truly more relevant way of presenting
aspects of its statements, a blind adherence to the principle of consistency will
in fact violate the other requirements of fair presentation.
TAKE NOTE
Remember that the presentation and classification of items in the financial
statements shall be retained from one period to the next unless another
method would provide information that is reliable and more relevant or the
change is required by a Standard of GRAP.
1.7 QUALITATIVE CHARACTERISTICS
The extent to which financial presentations possess the attributes mentioned
below will determine the extent to which they are useful to potential users. We
have already mentioned the four most important qualitative characteristics:
understandability, relevance, reliability and comparability.
1.7.1 Understandability
Obviously, the financial statements will not fulfil their purpose if they are not
readily understandable by users, therefore it is essential that they perceive the
information as readily understandable. However, the municipality cannot be
expected to present the information in the financial statements in a manner which

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would make it accessible to every possible user. In considering this attribute of
understandability, a municipality is therefore entitled to assume that prospective
users should have a reasonable understanding of local government, economic
activities and accounting principles, and will be prepared to study the information
in the financial statements with reasonable thoroughness.
However, the mere fact that a particular matter is unusually complex, and may
require an above-average understanding of accounting or financial principles,
should not be a reason for excluding an appropriate reference to it from the
financial statements. If such a matter is relevant in terms of accountability or for
the decision-making purposes of a certain range of users, it must be appropriately
disclosed even if certain users may find it too technically complex to be of much
informative value.
1.7.2 Relevance
For information to be useful, it must be relevant to the information needs of
users. Information will be relevant if it allows the user to evaluate the current
performance of the municipality, to confirm or correct any previous evaluation of
its past performance and to predict its likely future performance. The relevance
of information is affected by its nature and materiality. In some cases, the nature
of information alone is sufficient to determine its relevance.
The financial statements do not have to contain anything in the form of a
financial forecast: their predictive value will lie in the presentation of comparative
information relating to the preceding accounting period, and in the separate
disclosure of the financial impact of infrequent and extraordinary events. For
example, the loan repayment profile of the municipality will be relevant to
potential investors. It is therefore important that the municipality disclose the
future accounting periods during which its loans fall due for repayment. An
investor is unlikely to offer the municipality a ten-year loan if it is aware that
75% of the current loan debt will mature in year 10. It is relevant for the investor
to know that these loans mature ten financial years from now, because it is
during that future accounting period (and the periods leading up to it) that the
municipality’s activities will have to be managed in such a manner that sufficient
cash is accumulated to service these loans. However, it should be noted that
it is not usually relevant for the investor to know the exact calendar dates on
which these loans have to be repaid, and the disclosure of this kind of detail
may therefore be unnecessary.
MATERIALITY
The relevance of information is usually determined by its nature and materiality.
In certain instances, the nature of the information alone is sufficient to determine
relevance. For example, the intention of the municipality to construct a new
power station in the very near future is clearly relevant, although there may be
no material financial implications for the municipality in the accounting period
to which the financial statements relate. This intention should therefore be
appropriately disclosed in these statements.

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7FAST FACT
1Information is material if its omission, misstatement or non-disclosure
could influence the decisions of users made on the basis of the financial
statements.
However, in many cases both the nature and materiality of information will be
important factors: for example, disclosure of the municipality’s investment in
each of the main categories of fixed assets – users will be interested to know
why the municipality is investing so much in motor vehicles and office furniture,
and so little in major plant and equipment. This is important as this has formed
the basis of many investigations into corruption at government entities in South
Africa in recent years.
An example of this is the 2013 case of the then Minister of Women, Children
and People with Disabilities, Ms Lulu Zingwana, when it was found that she
had spent R1.1 million of state funds on decorating her head office. While the
department is responsible for purchasing its own furniture, the furniture for the
ministry, and in particular the minister’s office, was found to have been bought
with the budget of the Department of Public Works. It was also found that the
Department had only received quotations from two service providers, instead
of the required three quotations.
TAKE NOTE
Another factor determining materiality would be to decide whether the
omissionormisstatementoftheinformationislikelytoinfluencetheaccounting
of the municipality or the ability of users to take meaningful decisions on the
basis of the financial statements. The need for the municipality to demonstrate
proper public accountability is an important concern in this regard, as any
information which legally or otherwise needs to be disclosed in the public
interest will clearly be material.
Materiality is, of course, a relative concept, and there are no absolute norms to
guide the municipality in this connection. The materiality of information will
clearly depend on the circumstances to which it relates, and what is material
for one municipality need not necessarily be relevant in the case of another.
A municipality which has 100 loans outstanding, with an aggregate value of
R2 000 million, will individually disclose the 60 loans which are all in excess of R30
million each, but may group under “other loans” the remaining 40 with a value
of R5 million each or less. On the other hand, it will definitely be material for a
small municipality with a total outstanding loan debt of R5 million to disclose
each of its loans separately. Of course, the monetary value of the information is
not the only guide to materiality, but it will often be one of the most important
considerations.
AGGREGATION
Amounts which are recognised in the financial statements should be aggregated
with amounts of a similar nature or function into line items and need not be

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separately presented. However, material information should not be further
aggregated with other information. To determine when aggregation should
take place, we may consider information to be individually material if its non-
disclosure could influence the decisions of users taken on the basis of the financial
statements. Here again, materiality will depend on the quantum of the item in
its particular circumstances.
Financial statements are the result of the processing of large quantities of
transactions which are structured for the purposes of presentation by being
aggregated into groups according to their nature and function. It should be
borne in mind that financial statements are a summary of the annual financial
records of the local municipality, providing a picture of the functioning of the
municipality in monetary terms. The final stage in the process of aggregation and
classification is the presentation of condensed and classified information in the
form of line items, either on the face of the financial statements or in the notes.
Materiality will be the determining factor in deciding whether a particular line
item is reported separately on the face of the financial statements, or whether
it is further aggregated with other items of a similar kind. If a line item is not
considered to be separately material, whether as an asset, liability, revenue or
expense, it may be aggregated with other items presented on the face of the
financial statements. As we mentioned before, nature and size are the important
factors in assessing materiality.
Materiality is also the guiding factor in deciding whether the implications or
existence of a specific transaction or event should be disclosed in the notes to the
financial statements. In certain instances, the size of a particular transaction may
not warrant separate disclosure in a line item, but its nature may be sufficiently
material to necessitate disclosure in the notes. For example, the payment of
special travel allowances to certain councillors may entail relatively minor financial
implications, and these transactions may therefore be aggregated with other
travel allowances as a line item in the income statement. Compliance with the
requirements of proper accountability may nevertheless warrant the separate
disclosure of these payments in a note to the income statement.
ROUNDING OFF
The concept of materiality really represents a cut-off point for the disclosure
of detailed information. Although it was common practice in the past in some
municipalities to present the financial statements in exact rands and cents, the
principle of materiality dictates the use of properly rounded off information.
However, the extent to which a particular municipality rounds off its information
will depend on its own particular circumstances. A very large municipality, with
annual transactions totalling a few thousand million rand, would be justified
in rounding off its financial statements to the nearest hundred thousand rand.
However, a small municipality, with annual operations to the value of only a
few million rand, may find it material to disclose transactions to the nearest
thousand rand. In this context, materiality is closely related to understandability:
unnecessary detail and precision will make the financial statements less
understandable. Picture, for example, an income statement comprising more
than a thousand individual line items, each fully disclosed in rands and cents,

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or a note to the balance sheet which lists every single fixed asset owned by the
municipality, by type, number and value.
OFFSETTING
Closely related to the question of when information should be aggregated or
separately disclosed is the matter of offsetting. The general rule is that information
should not be offset unless this is explicitly required or permitted by GAMAP.
The only other possible circumstance in which offsetting could be justified is
where the various items of information relating to a particular transaction or
event are immaterial, either separately or in aggregate. In these instances, the
amounts concerned could be aggregated and presented on a net basis if this
presentation is considered to best reflect the substance of the transaction or
event in question. Nevertheless, when revenues and expenses are thus offset,
the municipality should consider the possibility of disclosing the gross amounts
concerned in the notes to the financial statements. It is obviously important
from the point of understandability that assets and liabilities, and revenue
and expenses, when material, be separately disclosed and not offset against
one another. This type of offsetting clearly detracts from the ability of users to
understand the importance of the transactions undertaken and to assess the
future financial position of the municipality.
8FAST FACT
1Offsetting that is permitted by GRAP relates to transactions which are
incidental to the main revenue-generating activities of the municipality.
Examples are gains and losses in respect of foreign exchange transactions,
which may be grouped together and reported on a net basis; gains and losses
arising from financial instruments which are held for trading purposes, which
may similarly be grouped together and reported on a net basis; and gains and
losses from the disposal of operating assets which may be reported by deducting
from the proceeds on disposal both the carrying amount of the asset and related
selling expenses. However, even in these cases, the relevant gains and losses
should not be grouped together or netted out if the size, nature or incidence
of the relevant transaction is sufficiently material to merit separate disclosure
(even if the disclosure is done only by means of a note to the income statement).
1.7.3 Reliability
For information to be useful, it must not only be understandable and relevant,
but it must obviously also be reliable. Information is reliable when it is materially
correct, complete, presented objectively and may be depended on by users to
be a faithful representation of what it purports to represent or could reasonably
be expected to represent. Reliable financial statements help the municipality to
determine the certainty and sustainability of its service delivery.

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Information may be entirely relevant and wholly understandable, but its
representation may be so unreliable that it could seriously mislead users.
An example of unreliability is the full recognition of the financial implications
flowing from events or transactions that contain an element of uncertainty. It
would be inappropriate for a municipality to recognise the proceeds from an
insurance claim which has not been finally settled, or to recognise damages from
a lawsuit which has not been finalised, or to write off government housing loans
before the relevant legislation authorising this has been enacted. The disclosure
of these various events in the notes to the financial statements is material, but
their full recognition in the income statement or balance sheet would be an
example of unreliable information.
FAITHFUL REPRESENTATION
As we have just mentioned, reliable information must faithfully represent the
transactions and events it purports to represent or could reasonably be expected
to represent. A balance sheet should therefore, for example, faithfully represent
the transactions and events that have resulted in the assets, liabilities and own
capital of the municipality at the reporting date concerned.
9FAST FACT
1However, it is accepted that most financial information is to some extent
subject to the risk of being a less than faithful representation of what it
purports to represent. This is not because the preparers of the financial
statements are biased, but because of difficulties which are inherent in
identifying the transactions and events to be measured, or in designing and
applying measurement and presentation techniques that can convey an
impression which corresponds exactly with those transactions and events.
In certain cases, the measurement of the financial effects of items may be so
uncertain that it would be unwise for a municipality to recognise them at all in
the financial statements – an example is the future economic benefits or potential
service delivery flowing from certain heritage assets.
However,inotherinstances,itmayberelevanttorecogniseitems,notwithstanding
an element of uncertainty, but to disclose the probable risk of error surrounding
their recognition and measurement.
SUBSTANCE OVER FORM
The quality of faithful representation requires that transactions and events must
be accounted for and presented in accordance with their substance and economic
reality, and not simply their legal form. The true substance of a transaction is
not always consistent with its apparent legal or contrived form. For example, a
municipality may, for budgetary considerations, choose to sell its athletics stadium
to another party. The legal documentation will pass ownership of the stadium
to that party, but additional documentation may be drawn up to ensure that

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26
the municipality continues to enjoy the full use and future economic benefits
flowing from this stadium. In this instance, the legal form is that of a sale, but in
substance there has effectively been no transaction at all.
NEUTRALITY
For information to be reliable it must be presented in a neutral manner, that
is, free from bias and any intention to influence the user of the information in
any particular way. Neutrality implies that the financial statements have been
presented objectively, and that the information in these statements has not
been selected with the purpose of influencing users in a manner calculated to
achieve a particular result.
PRUDENCE
There are many uncertainties inherent in the transactions and events relating
to the activities of municipalities. For example, depreciation is calculated on the
basis of generically determined useful lives attributed to fixed assets, whereas
the actual useful lives may be quite different. The extent to which a municipality
should provide for bad and doubtful debts is equally uncertain, particularly in
the current climate of poor payment levels. The prudence standard requires
that transactions be calculated with extreme judgement and care, considering
the probable safety of the municipality’s capital as well as the probable income
to be derived.
The reliability of the financial statements will therefore depend on the extent to
which the preparers of the financial statements have been prudent in minimising
these uncertainties and in disclosing the nature and extent of any possible
uncertainties which may remain. The prudent preparation of the financial
statements implies that the preparers will do everything possible to ensure that
assets or revenues are not overstated and liabilities or expenses not understated.
Note, however, that prudence is not synonymous with an excessively cautionary
approach to the preparation and presentation of the financial statements.
Knowingly understating the assets or revenues of the municipality, or overstating
its liabilities or expenses, would render the financial statements useless. Similarly,
the creation of unnecessary, exorbitant or undisclosed reserves or provisions is
not consistent with prudent financial management, but in fact represents an
unreliable picture of the financial position of the municipality.
COMPLETENESS
As we have stated earlier, reliability implies the completeness and correctness
of the information presented. Materiality is a key consideration: the omission
of immaterial information from the financial statements will not affect their
reliability, but material omissions may be seriously misleading to users or may
in fact present a false picture of the municipality’s actual financial position.
Complete and correct information is useful in assessing the anticipated future
financial performance of the municipality. The information is also useful in

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forming judgements about effectiveness, whether there should be any changes
to the way resources are used, or how additional resources might be employed.
To illustrate that municipalities in South Africa do not always provide a faithful
presentation of their financial statements, the Auditor General’s 2017 audit report
called for leadership accountability. This was due to 14 municipalities losing
their clean audit opinions and the fact that only 49 of the 263 municipalities in
South Africa received clean audits, thus approximately 18%. The Auditor General
highlighted the need for, and importance of, accountability in the management
of municipal affairs, thus ensuring appropriate internal control and supervision
to ensure proper financial and performance management.
1.7.4 Comparability
The measurement and display of the financial effect of like transactions and
other events must be carried out in a consistent way throughout an entity and
over time for that entity and in a consistent way for different entities.
TAKE NOTE
The users of financial statements should feel that they may safely compare
the financial statements of a municipality with both its preceding and future
financial statements in order to evaluate trends in its financial position and
performance.
Ideally, users should also feel that they may reliably compare the financial
statements of any one municipality with those produced by other municipalities.
Although many efforts have been made in the past to entrench a degree of
comparability between the financial statements of individual municipalities,
it is only with the advent of the new GAMAP standards that meaningful
comparability between the financial statements prepared and presented by
individual municipalities should be consistently evident in future.
The accounting policies adopted and applied by a municipality will critically
affect the extent to which that municipality produces comparable financial
statements. It is therefore vital that municipalities clearly disclose the extent to
which there have been any changes in these accounting policies, as well as the
effect of these changes on the presentation of the financial statements.
The desirability of incorporating the qualitative characteristic of comparability
in its financial statements should not be an excuse for a municipality to adhere
to accounting policies and practices which, in changing circumstances, are no
longer adequately relevant and reliable.
Relevance and reliability should take precedence over the need for immediate
comparability, but of course reliability will be catered for by the adjustment of
the financial information presented for previous accounting periods to take
account of any such changes in accounting policies.

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10FAST FACT
1To comply with the requirement of comparability, the financial statements
should present comparative information in respect of all numerical items
for the previous accounting periods.
When the presentation or classification of numerical items in the financial
statements is amended, comparative amounts for the preceding period should
be similarly reclassified, unless it is impracticable to do so. Where reclassification
is not undertaken, the municipality must disclose the reason for not presenting
the relevant comparative information, together with some indication of the nature
of the changes that would have resulted if the reclassification had taken place.
1.7.5 Constraints on the presentation of relevant and reliable
information
Undue delays in the reporting of information may cause the information to lose
its relevance. This constraint is to some extent mitigated by the timeframes for
the preparation and completion of financial statements prescribed by legislation.
Because municipalities operate as going concerns, their activities extend beyond
the formal reporting date of any particular set of financial statements. It would
therefore be a self-defeating exercise for the municipality to hold back the final
presentation of its financial statements until it has complete clarity on all material
matters reported on in those financial statements.
TAKE NOTE
In selecting the information to be presented in the financial statements, the
municipality needs to strike a proper balance between benefits and costs.
The likely benefits which users will derive from the disclosure of any particular
information should not exceed the cost of providing it.
Unfortunately, applying this in practice is not so easy, as the determination of
the value of the benefits derived from any particular information is not nearly
as simple to quantify as the expenses involved in providing the information.
Nevertheless, cost represents a genuine constraint, and users of financial
statements need to bear this in mind. For example, a municipality would be
justified in declining the request from ward councillors to present the financial
statements in a format which discloses all relevant financial information broken
down by municipal ward if the likely cost involved in such a presentation would
be extensive.
The presentation of the financial statements may occasionally involve a
professional judgement (prudence) as to which of the qualitative characteristics
should be given preference in regard to a particular transaction. In general,
reliability and understandability will be the most important characteristics, but
as we illustrated above, the inclusion of irrelevant information (or irrelevant
detail about information), however reliable and understandable, may also tend
to counter the ultimate usefulness of the financial statements.

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1.8 ELEMENTS OF THE FINANCIAL STATEMENTS
The financial statements portray the financial effects of transactions and events
by grouping these effects into broad classes according to their economic
characteristics. These broad classes are known as the elements of the financial
statements.
The elements which relate to the measurement of the financial position of the
municipality are contained in the balance sheet, and are represented by assets,
liabilities and own capital.
The elements directly relating to the measurement of performance are set out
in the income statement, and are represented by revenues and expenses.
The elements relating to the changes in the financial position of the municipality
are represented by the changes in the elements in both the income statement
and the balance sheet, and are set out in the cash flow statement.
1.8.1 Description of the elements
FINANCIAL POSITION
The elements directly relating to the measurement of the financial position of the
municipality are its assets, liabilities and own capital. An asset is a resource which
is controlled by the municipality as a result of past events and from which future
economic benefits or potential services are expected to flow to the municipality.
A liability is a present obligation of the municipality arising from past events,
the settlement of which is expected to result in a sacrifice of potential service
provision or an outflow of the municipality’s resources.
Own capital is the residual interest in the assets of the municipality after deducting
all its liabilities. Own capital will include unappropriated surpluses, funds and
reserves.
TAKE NOTE
A key consideration in the recognition of assets and liabilities is the relative
certainty of the inflow or outflow of future economic benefits or potential
service provision. Where there is little or no certainty in this regard, the relevant
items should not be recognised in the balance sheet.
In determining whether an item should be recognised as an asset, liability or
own capital, the compiler of the financial statements needs to bear in mind the
principle of substance over form. For example, in the case of a finance lease, the
legal form is that of a lease, but the economic substance of the transaction entails
the use of the leased asset by the municipality for the greater portion of its useful
life in return for entering into an obligation to pay an amount approximating the
fair value of the asset together with the related finance charge. For all practical
purposes, therefore, a finance lease gives rise to a transaction which satisfies
the definitions of an asset and a liability, and should be accordingly recognised
in the balance sheet.

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30
ASSETS
What is meant by future economic benefits or potential service provision
embodied in assets is the potential of those assets to contribute, directly or
indirectly, firstly, to the inflow of cash and cash equivalents to the municipality
and, secondly, to the delivery of services.
The future economic benefits or potential service delivery may flow to the
municipality in various ways. An asset may, for example, be used either on its
own or in combination with other assets to render services, the cost of which
will be recovered from the community or from other beneficiaries; or it may be
exchanged for other assets; or it may be used to settle a liability.
TAKE NOTE
Although most assets have a physical form such as buildings, vehicles and
furniture, this is not an essential requirement for their recognition.
Intangible assets such as licences and patents may, in specific (though rare)
instances, qualify for recognition; for example, where the capitalised costs
relating to town planning schemes or to research and development projects will
definitely result in future economic benefits flowing to the municipality, these
expenses are justifiably recognised as assets.
11FAST FACT
1Although assets are usually associated with legal rights, including the right
of ownership, these are not essential attributes of an asset.
Assets held under a lease agreement are not legally owned by the municipality,
but if it controls the benefits flowing from these assets, they should be duly
recognised for balance sheet purposes.
Although assets are normally associated with the incurring of expenses by the
municipality, whether in acquiring or constructing the assets in question, assets
may arise as the result of donations or other transactions which do not involve
an outflow of benefits.
LIABILITIES
An essential characteristic of a liability is that it must be a present obligation.
Obligations may be legally enforceable as a result of a binding contractual
arrangement or statutory requirement, but obligations may also arise from
normal practice, custom or a desire to maintain good business relationships or
comply with the principles of equity.

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TAKE NOTE
An intention to do something does not constitute a present obligation.
Therefore the adoption of the municipality’s annual budget, representing
an intention to incur certain liabilities, does not in itself actually create these
liabilities.
In the normal course of events, an obligation arises only once an asset is delivered
or services are rendered or consumable goods are received, or the municipality
enters into a legally binding, or otherwise irrevocable, agreement to acquire the
asset, service or goods. In this context, irrevocable must be taken to mean that
the municipality has little discretion in practice as to whether or not it should
honour the obligation in question. This settlement of a present obligation
will normally entail the outflow of resources embodying economic benefits
or potential service provision. This settlement may take a number of forms:
payment by cash, transfer of assets, provision of services, or the replacement
of the obligation with another equivalent obligation. An obligation may also
be settled by the creditor waiving or forfeiting its rights (for whatever reason).
Liabilities, as a rule, arise from past events. For example, if a municipality purchases
goods or uses services from outside suppliers, it incurs trade debts. If it raises a
loan from a financial institution, it incurs an obligation to repay that loan.
Although most liabilities can be accurately measured, in the case of provisions
this measurement may be subject to a substantial degree of estimation. An
example is a provision to cover pension obligations or payments in respect of
accumulated leave. However, as the provision does represent a present obligation
which will entail the likely outflow of economic benefits, it must be recognised
as a liability, even though its measurement is relatively uncertain.
OWN CAPITAL
Earlier we defined own capital as the residual interest represented by the net
assets of the municipality, but this interest may be sub-classified in the balance
sheet. For example, in practice most municipalities will show statutory funds,
non-distributable reserves, unappropriated surpluses and capital maintenance
adjustments separately in the balance sheet. This sub-classification will be
relevant to users of the financial statements in assessing whether the municipality
is able to use its own capital for future service provision or whether there are
legal or other restrictions on this utilisation.
The creation of own capital is sometimes governed by statute, for example in
the case of the reserves which need to be established in terms of the regulations
relating to housing schemes. Transfers to and from reserves must be treated as
appropriations rather than as operating expenses or revenues. The amount at
which own capital is represented in the balance sheet obviously depends on
the measurement of the disclosed assets and liabilities.

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32
PERFORMANCE
Performance measures should be aspects that are appropriate for measurement
and that could be measured, relevant and understood. Profit is frequently used as
the measure of performance. The elements directly related to the measurement of
profit are revenue and expenses. However, profit is not necessarily an appropriate
measure of performance in local government, as the generation of profit should
not be the primary focus of a municipality.
Nevertheless, the recognition of the revenue and expenses of the municipality
should provide users with information necessary to evaluate its financial
performance. This information will enable users to identify the expenses which
the municipality incurred in providing its services during the relevant accounting
period, as well as the extent to which these expenses were recovered from
revenues. In addition, this information should enable users to assess the efficiency
of the municipality’s service delivery, the resources which it needed to conduct
its activities and is likely to need to continue to conduct these activities, and the
extent to which future generations of ratepayers and service consumers may
have to contribute towards the expenses incurred in conducting the activities
relating to the current accounting period. In other words, this information will
assist users to assess the service efforts, costs and accomplishments of the
municipality.
As the Auditor General noted in his 2017 audit report when he stated that if
the basic principles of accountability, built around a strong central theme of
internal control, proper performance managements and good governance, are
in place, municipalities should be well geared to live up to the expectations of
the communities they serve.
12ACTIVITY 1.3
(1) Complete the following sentences:
(a) “An …………………………… is a resource controlled by the
municipality as a result of past events and from which economic
benefits can be derived in the future.”
(b) A liability is a ……….……………….…… of the municipality
arising from past events, the settlement of which is expected
to result in an ………….……. from the entity of resources
embodying economic benefits or service potential.
(c) Thebenefitofprovidinginformationshould………….…….…….
the cost of providing it.
(2) Explain what is meant by “future economic benefits or potential
service provision embodied in assets”?
(3) How can proper performance management and internal control
assist in serving communities?

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Revenue may be defined as the increases in economic benefits or potential
service provision during the accounting period in question, in the form of inflows
or enhancements of assets or decreases in liabilities, resulting in increases in
own capital.
Expenses may be defined as decreases in economic benefits or the consumption
or losses of potential service provision during the accounting period, in the
form of outflows or depletions of assets or the incurring of liabilities, resulting
in decreases in own capital.
REVENUE
It is important to note that the definition of revenue includes both ordinary
operating revenue and gains. This is a significant departure from current local
government accounting practices, in terms of which gains are not normally
recognised as revenue (but are often appropriated to funds or reserves without
passing through the income or appropriation accounts). Revenue will arise in
the course of a municipality’s ordinary activities, and will include property rates,
user charges, interest, rentals, fines, fees and subsidies.
Gains represent items other than these ordinary revenue, and may or may not
arise in the course of the municipality’s ordinary activities. Gains arising, for
example, from the disposal of fixed assets, represent an increase in economic
benefits and for that reason are classified as revenue. Unrealised gains arising
from increases in the carrying amount of long-term assets will rather be disclosed
as non-distributable reserves. When realised gains are recognised in the income
statement, it is good policy to display them separately, because an appreciation
of the extent to which the municipality’s revenues are represented by these gains
is useful for the purpose of making economic, financial and political decisions.
Gains are often reported net of related expenses.
EXPENSES
The definition of expenses encompasses losses as well those expenses that arise
in the course of the ordinary activities of the municipality. Ordinary expenses
include salaries, allowances, office rentals, payment for the purchase of current
from Eskom or water from the regional water authority, interest on loans and
overdrafts, the use or consumption of goods and services, the use of inventory,
and the depreciation of fixed assets. These expenses usually represent an outflow
or depletion of assets such as cash or cash equivalents, inventory, property,
plant and equipment.
Losses are represented by other items meeting the definition of expenses and
may or may not arise in the course of the ordinary activities of the municipality.
Realised losses are decreases in economic benefits, and are, as such, no different
in nature from other expenses. Losses include those resulting from natural or
manmade disasters, as well as those arising from the disposal of fixed assets or
inventory.

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