Advanced Financial Reporting

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JOMO KENYATTA UNIVERSITY
OF
AGRICULTURE & TECHNOLOGY
SCHOOL OF OPEN, DISTANCE AND eLEARNING
P.O. Box 62000, 00200
Nairobi, Kenya
E-mail: elearning@jkuat.ac.ke
HBAA 3202 Advanced Financial Reporting

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This presentation is intended to covered within one week.
The notes, examples and exercises should be supple-
mented with a good textbook. Most of the exercises have
solutions/answers appearing elsewhere and accessible by
clicking the green Exercise tag. To move back to the same
page click the same tag appearing at the end of the solu-
tion/answer.
Errors and omissions in these notes are entirely the re-
sponsibility of the author who should only be contacted
through the Department of Curricula & Delivery
(SODeL) and suggested corrections may be e-mailed to
elearning@jkuat.ac.ke.
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LESSON 1
International Financial Reporting
Standards:
1.1. A Framework-Based Perspective IFRS:
• A Framework-based Perspective links broad concepts and
general accounting principles to the specific requirements
of IFRS to help students develop and understand the judg-
ments required in using a principle-based standard. Al-
though it is still unclear whether the US will adopt IFRS,
the global business environment makes it necessary for ac-
counting students and professionals to be bilingual in both
US GAAP and IFRS. This comprehensive textbook offers:
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• A clear presentation of the concepts underlying IFRS A
conceptual framework to guide students in interpreting
and applying IFRS rules A comparison between IFRS and
US GAAP to develop students understanding of the re-
quirements of each standard Real world examples and case
studies to link accounting theory to practice, while also-
exposing students to different interpretations and applica-
tions of IFRS A future developments section to explain
current issues on the IASB s active agenda, respective
stages of development, and expected outcomes.
• End of chapter material covering other aspects of finan-
cial reporting, including international auditing standards,
international ethics standards, and corporate governance
and enforcement, as well as emerging topics, such as inte-
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HBAA 3202 Advanced Financial Reporting
grated accounting, sustainability and social responsibility
accounting and new forms of financial reporting Burton &
Jermakowicz have crafted a thorough and extensive tool
to give students a competitive edge in understanding, and
applying IFRS. A companion website provides additional
support for both students and instructors.
Outline
1.1.1. Why global standards?
• The progress
• Structure and governance
• Understanding principle-based standards
• Common misunderstandings
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• Framework-based understanding of IFRSs
• Framework-based teaching of IFRSs
1.1.2. The reality
• Capital markets are global – New York, London, Luxem-
burg, Hong Kong, Singapore
• World’s economies are interdependent – the financial crisis
– SMEs integrated into the global economy
• Accounting and auditing needs strengthening – World Bank
ROSCs – corporate failures – standard setters work pro-
grammes
• High-quality information facilitates the allocation of global
capital
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• Benefits of global standards
1. Efficient allocation of capital globally – attracting invest-
ment through transparency – reducing the cost of capital
– increasing world-wide investment
2. Reducing costs and increased efficiency – facilitates stan-
dardising information systems – eliminates wasteful recon-
ciliations – audit efficiencies – education and training
1.2. Role of the Conceptual Framework
1. Conceptual Framework sets out agreed concepts that un-
derlie financial reporting – objective, qualitative charac-
teristics, element definitions, . . .
2. IASB uses Conceptual Framework to set standards – en-
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hances consistency across standards – enhances consis-
tency over time as Board members change – provides bench-
mark for judgments
3. Preparers use Conceptual Framework to develop account-
ing policies in the absence of specific standard or interpre-
tation
1.3. Objective of financial reporting
• Provide financial information about the reporting entity
that is useful to existing and potential investors, lenders
and other creditors in making decisions about providing
resources to the entity.
• Investors’, lenders’ and other creditors’ expectations about
returns depend on their assessment of the amount, timing
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and uncertainty of (the prospects for) future net cash in-
flows to the entity. – Decisions by investors about buying,
selling or holding equity and debt instruments depend on
the returns that they expect from an investment in those
instruments, eg dividends, principal and interest payments
or market price increases. – Decisions by lenders about
providing or settling loans and other forms of credit de-
pend on the principal and interest payments or other re-
turns that they expect.
• To assess an entity’s prospects for future net cash inflows,
existing and potential investors, lenders and other cred-
itors need information about: – the resources of the en-
tity; – claims against the entity; and – how efficiently and
effectively the entity’s management and governing board
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have discharged their responsibilities to use the entity’s
resources – eg protecting the entity’s resources from un-
favourable effects of economic factors such as price and
technological changes.
1.3.1. Qualitative characteristics
• If financial information is to be useful, it must be relevant
and faithfully represent what it purports to represent (ie
fundamental qualities). – Financial information without
both relevance and faithful representation is not useful,
and it cannot be made useful by being more comparable,
verifiable, timely or understandable.
• The usefulness of financial information is enhanced if it is
comparable, verifiable, timely and understandable (ie en-
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hancing qualities—less critical but still highly desirable) –
Financial information that is relevant and faithfully rep-
resented may still be useful even if it does not have any of
the enhancing qualitative characteristics.
1.3.2. Fundamental qualitative characteristics
• Relevance: capable of making a difference in users’ deci-
sions – predictive value – confirmatory value – materiality
(entity-specific)
• Faithful representation: faithfully represents the phenom-
ena it purports to represent – completeness (depiction in-
cluding numbers and words) – neutrality (unbiased) – free
from error (ideally) Note: faithful representation replaces
reliability.
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1.3.3. Enhancing Qualitative Characteristics
• Comparability: like things look alike; different things look
different
• Verifiability: knowledgeable and independent observers could
reach consensus, but not necessarily complete agreement,
that a depiction is a faithful representation
• Timeliness: having information available to decision-makers
in time to be capable of influencing their decisions
• Understandability: Classify, characterise, and present in-
formation clearly and concisely.
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1.3.4. Pervasive constraint
• Reporting financial information imposes costs, and it is
important that those costs are justified by the benefits
of reporting that information. • Benefits include more
efficient functioning of capital markets and a lower cost of
capital for the economy.
• Costs include collecting, processing, verifying and dissemi-
nating financial information and the costs of analysing and
interpreting the information provided.
• In applying the cost constraint, the IASB assesses whether
the benefits of reporting particular information are likely
to justify the costs incurred to provide and use that infor-
mation. Those assessments are usually based on a combi-
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nation of quantitative and qualitative information.
• Reporting financial information that is relevant and faith-
fully represents what it purports to represent helps users
to make decisions with more confidence (ie financial infor-
mation must possess the fundamental qualitative charac-
teristics).
• IFRS requirements must be cost-beneficial
• Applying the enhancing qualitative characteristics is an
iterative process that does not follow a prescribed order.
Sometimes, one enhancing qualitative characteristic may
have to be diminished to maximise another qualitative
characteristic.
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1.3.5. Elements
• Asset: Resource controlled as a result of past events and
from which future economic benefits are expected to flow
• Liability: Present obligation arising from past events, the
settlement of which is expected to result in outflow of re-
sources embodying economic benefits
• Equity: Assets minus liabilities
• Income (expense): Increases (decreases) in economic ben-
efits during period from inflows or enhancements (outflows
or depletions) of assets (liabilities) or decreases (incur-
rences) of liabilities from in increases (decreases) in equity,
other than contributions from (distributions to) equity
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1.3.6. Recognition
• Accrual basis of accounting – recognise element (eg asset)
when satisfy definition and recognition criteria
• Recognise item that meets element definition when – prob-
able that benefits will flow to/from the entity – has cost
or value that can measured reliably
What does probable mean?
• The meaning of probable is determined at the standards
level. Therefore, inconsistent use across IFRSs
What does measure reliably mean?
• To a large extent, financial reports are based on estimates,
judgements and models rather than exact depictions.
Framework-based understanding provides:
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• a cohesive understanding of IFRSs – Framework facilitates
consistent and logical formulation of IFRSs
• a basis for judgement in applying IFRSs – Framework es-
tablished the concepts that underlie the estimates, judge-
ments and models on which IFRS financial statements are
based
• a basis for continuously updating IFRS knowledge and
IFRS competencies.
1.3.7. Classification, assets and claims
• Information about the nature and amounts of a report-
ing entity’s economic resources and claims can help users
to identify the reporting entity’s financial strengths and
weaknesses.
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• That information can help users to:
1. – assess the reporting entity’s liquidity and solvency
2. – its needs for additional financing and how successful it
is likely to be in obtaining that financing.
• Information about priorities and payment requirements of
existing claims helps users to predict how future cash flows
will be distributed among those with a claim against the
reporting entity.
1.3.8. Classification, liability
• Which IFRS classification of liability are?
• obligation to pay current tax
• metered power used but not yet billed by supplier
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• ‘normal’ warrantee obligation to make good manufacturing
defect
• warrantee obligation to compensate for manufacturing de-
fects by settling in compensation in cash
• extended warrantee obligation.
1.3.9. Classification, assets
• Different types of economic resources affect a user’s as-
sessment of the reporting entity’s prospects for future cash
flows differently. – Some future cash flows result directly
from existing economic resources (eg accounts receivable
and investment property). – Other cash flows result from
using several resources in combination to produce and mar-
ket goods or services to customers (eg PPE and intangible
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assets).
• Although those cash flows cannot be identified with indi-
vidual economic resources (or claims), users of financial
reports need to know the nature and amount of the re-
sources available for use in a reporting entity’s operations.
• Asset classification
Which IFRS classification of asset are?
• investment in ordinary shares
• gold
• land
• land planted with plantation
• farm implements
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• bird breeder’s birds
• birds in a zoological garden
• birds in a bird breeding zoo
• owner-occupied building held for sale
• owner-occupied building decided to abandon.
1.3.10. Recognition
• Accrual basis of accounting – recognise element (eg asset)
when satisfy definition and recognition criteria
• Recognise item that meets element definition when – prob-
able that benefits will flow to/from the entity – has cost
or value that can measured reliably
• Unit of account (unit of measure for recognition)
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• Materiality
• Recognition, examples
Recognise the asset?
• a hospital’s backup backup generator (expect never to use
it)
• an oil explorer’s exploration rig
• an oil extractor’s unproven reserves
• an oil extractor’s proven reserves
• advertising expenditure
• research and development expenditure
• internally generated brand
• lessee—short-term car rental agreement
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• firm order to acquire gold, cannot settle net.
1.3.11. Measurement ‘concepts’
• Measurement is the process of determining monetary amounts
at which elements are recognised and carried.
• To a large extent, financial reports are based on estimates,
judgements and models rather than exact depictions. The
Conceptual Framework establishes the concepts that un-
derlie those estimates, judgements and models
• Measurement part of Conceptual Framework is weak
• A number of different measurement bases are employed
to different degrees and in varying combinations in finan-
cial statements, including – historical cost – current cost
– realisable (settlement) value – present value (CF.4.55)
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• IASB guided by objective and qualitative characteristics
when specifying measurements.
1.3.12. Presentation and disclosure
• Presentation: financial statements portray financial effects
of transactions and events by: – grouping into broad classes
(the elements, eg asset) – sub-classify elements (eg assets
sub-classified by their nature or function in the business)
• IAS 1 – application of IFRSs with additional disclosures
when necessary results in a fair presentation (faithful rep-
resentation of transactions, events and conditions) – don’t
offset assets & liabilities or income & expenses
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• Allocating depreciation: principle
• Depreciation is the systematic allocation of the deprecia-
ble amount of an asset over its useful life (IAS16.6). –
essentially a cost allocation technique (IAS16.BC29)
• Systematic allocation (application guidance): – Deprecia-
tion method must closely reflects the pattern in which the
asset’s future economic benefits are expected to be con-
sumed by the entity. – Unit of measure for depreciation is
different from that for an item of PPE. By depreciating sig-
nificant parts of an item of PPE separately, depreciation
more faithfully represents the consumption of the assets
service potential.
• Depreciable amount = – cost model: historical cost less
residual value – revaluation model: fair value less residual
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value
• Residual value = – amount that the entity would currently
obtained from disposal of asset (less estimated disposal
costs) if the asset were already of the age and in the con-
dition expected at the end of its useful life
• Useful life (entity specific) = – the period over which the
asset is expected to be available for use by the entity; or –
the number of production or similar units expected to be
obtained from the asset by the entity.
• Consequently, depreciation continues when idle (if useful
life = period) – example 24
• However, depreciation ceases when classified as held for
sale because IFRS 5 measurement is essentially a process
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of valuation, rather than allocation (IFRS5.BC29)
1.3.13. Derecognition of assets
• Derecognition of an asset refers to when an asset previ-
ously recognised by an entity is removed from the entity’s
statement of financial position – Derecognition require-
ments are specified at the standards level.
• Derecognition does not necessarily occur when the asset
no longer satisfies the conditions specified for its initial
recognition (ie derecognition does not necessarily coincide
with the loss of control of the asset ).
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SUMMARY
The objective of general purpose financial reporting is:
1. provide financial information about the reporting entity
that is useful to existing and potential investors, lenders
and other creditors in making decisions about providing
resources to the entity?
2. to inform government statistics?
3. to support the entity’s tax return?
4. to meet all the information needs of all the users of an
entity’s financial statements?
5. to inform economic decision-making by a broad range of
users (including managers, investors, creditors and pru-
dential regulators)?
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Which of the following could most closely be associated
with the objective of financial reporting:
1. have a bias toward understating assets and income and
overstating liabilities and expenses?
2. transparency and neutrality?
3. financial stability through conservatism/prudence?
4. management discretion in reporting financial information?
The fundamental qualitative characteristics are:
1. comparability and relevance?
2. relevance and reliability?
3. relevance, reliability and comparability?
4. relevance and faithful representation?
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5. comparability, relevance and faithful representation?
Verifiability means knowledgeable and independent ob-
servers:
1. would reach complete agreement that a depiction is a faith-
ful representation?
2. cannot reach consensus that a depiction is a faithful rep-
resentation?
3. could reach consensus, but not necessarily complete agree-
ment, that a depiction is a faithful representation?
Which statement/s are true?
1. Relevance is a fundamental qualitative characteristic.
2. Financial information without both relevance and faithful
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representation is not useful.
3. Financial information without both relevance and faith-
ful representation cannot be made useful by being more
comparable, verifiable, timely or understandable.
4. Financial information that is relevant and faithfully rep-
resented may still be useful even if it does not have any of
the enhancing qualitative characteristics
5. All of the above statements.
6. None of the above statements.
Expenses are recognised in comprehensive income (profit
or OCI):
1. using the matching basis—on the basis of a direct associa-
tion between the costs incurred and the earning of specific
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items of income?
2. using the accrual basis—items are recognised as assets,
liabilities, equity, income or expenses when they satisfy
the definitions and recognition criteria for those items?
3. at the discretion of management?
Recognition criteria determine when to recognise an
item. Measurement is determining the monetary amounts
at which to measure an item. Uncertainties about the
extent of future cash flows:
1. only affect the decision about whether to recognise?
2. only affect the estimation of the amount at which to mea-
sure the item?
3. could affect both recognition and measurement?
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How many measurement bases does IFRSs specify for
the measurement of assets?
1. one—historical cost
2. one—fair value
3. two—historical cost and fair value
4. many—including historical cost, fair value, value in use,
estimated selling price less costs to complete and sell, etc
The Conceptual Framework:
1. is an IFRS?
2. overrides all other IFRS requirements?
3. does not define standards for any particular measurement
or disclosure issue?
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4. is in the hierarchy that management must in the absence
of a specific IFRS requirement apply in developing an ac-
counting policy that results in information that is relevant
and reliable
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Revision questions
Example . Explain the purpose of the Conceptual Frame-
work for Financial Reporting
Solution: The purpose of the Conceptual Framework for Finan-
cial Reporting is:
to assist the IASB in setting IFRSs?
to assist preparers of financial statements in applying IFRSs?
to assist auditors in forming an opinion on whether financial
statements comply with IFRSs?
to assist users of financial statements in interpreting IFRS
financial statements? e. all of the above?
Exercise 1. Describe the expenses are recognised in com-
prehensive income (profit or OCI).
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Exercise 2. Explain the benefits of global accounting stan-
dards.
Exercise 3. Explain the objectives of financial reporting
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