FR Chaps 1-5

asset

a present economic resource controlled by the entity as a result of past events

liability

a present obligation of the entity to transfer an economic resource as a result of past events

equity

the residual interest in the assets of the entity after deducting all its liabilities

economic resource

a right that has the potential economic benefits

going concern

ssuming a business will remain operational, profitable, and able to meet its financial obligations for the foreseeable future

why is the Accounting Standard Board (ASB) not an accounting regulator

they don’t have authority to enforce any implementation of IFRS standards

what should be disclosed in the CFS

• the legal form of the enterprise, its country of incorporation and the address of the registered office (or principal place of business if different from the registered office)

• the nature of the entity’s operations and principal activities

• the name of the parent enterprise and the ultimate parent enterprise of the group

• either the number of employees at the end of the period or the average for the period.

what notes should be included in the CFS in order

• statement of compliance with IASs/IFRSs

• measurement basis/bases used in preparing the financial statements

• each specific accounting policy necessary for a proper understanding of the financial statements

• supporting information for items presented on the face of each financial statement (in the same order of presentation there)

• other disclosures, including contingencies, commitments and other financial, and non-financial, disclosures

what are the notes meant to do in the CFS

• present information about the basis of preparation of the financial statements and specific policies used for significant transactions and events

• disclose information required by the standards that is not presented in the financial statements

• provide additional information not presented on the face of the statements that is relevant for understanding the statements.

what should be disclosed in the notes for SOCE

• the amount of dividends proposed or declared before the financial statements were authorised for issue but which were not recognised as a distribution to owners during the period and the related amount per share

• the amount of any cumulative preference dividends not recognised.

what the reconciliations in the SOCE should include

PnL, OCI, transactions with owners, showing separate contributions by, and distributions to, owners and changes in ownership interests in subsidiaries that do not result in a loss of control

what the statement of changes in equity (SOCE) should include

• the total comprehensive income for the period, showing separately amounts attributable to owners of the parent and to non-controlling interest

• effects of any retrospective application of accounting policies or restatements, separate for each component of comprehensive income

• reconciliations between carrying amounts at the beginning and end of the period for each component of equity, separately:

recycling

when unrealized gains in the OCI are reclassified into realized gains in the PnL. when reclassified in the PnL it should be deducted from the OCI to avoid double counting. IFRS 9 forbids recycling in equity instruments

what the other comprehensive income (OCI) includes in the IS

unrealized gains and losses arising from changes in the fair values of assets and liabilities

what should be included in a SoFP

current liabilities should

• expected to be settled in the entity’s normal operating cycle

• held primarily for the purpose of being traded

• due to be settled within 12 months after the date of the statement of financial position

• the entity does not have an unconditional right to defer settlement of the liability for at least 12 months after the date of the statement of the financial position.

current assets should

• expected to be realised in the entity’s normal operating cycle

• held primarily for the purpose of trading

• expected to be realised within 12 months after the end of the reporting period

• cash and cash equivalents (unless restricted in use).

• Note that this is a departure from what had become the conventional way of defining current assets (where reference is made to settlement being expected within one year).

what IAS 1 says an SoFP should include

classify assets into current and non-current and must not set off assets against liabilities, expected settlement within 12 months

what IAS 1 requires

disclosure of comparative information in respect of the previous period for all amounts reported in the financial statements, both on the face of the financial statements and in the notes, unless this contradicts clearly the requirements of another international accounting standard

basic standards for financial statements

• should be presented for a 12-month period. exceptions should be explained.

• those claiming to follow IASs/IFRSs have to be clearly distinguished from any other infor included in the same published document

• includes prescription in relation to key statements including the SoFP, IS, OCI and SOCE

APB's 5 ethical standards

1.       integrity, objectivity and independence

2.       financial, business, employment and personal relationships

3.       long association with the audit engagement

4.       fees, remuneration and evaluation policies, litigation, gifts and hospitality

5.       non-audit services provided to audit clients.

IFAC’s 5 threats to compliance code

1.       self-interest might impact judgement and behaviour

2.       self-review might mollify or badly mediate the evaluation of prior judgements or work done by members of one’s own firm or employer

3.       advocacy might encourage a professional accountant to promote a client’s or employer’s position, compromising professional objectivity

4.       familiarity may encourage too much sympathy for, or acceptance towards, client practices

5.       intimidation may impact behaviour.

IFAC expects accountants to conduct themselves with

•         integrity

•         objectivity

•         professional competence and due care

•         confidentiality

•         professionalism.

why ethical issues may occur in practice

requests by clients to effectively manipulate accounting numbers to mislead shareholders/prospective investors, to conceal or disclose false information, or to participate in insider dealing operations

accounting professional ethical codes/guidelines

establish the standard of behavior expected of a professional accountant. they help professional accountants to meet these obligations by providing them with ethical guidance.

what does ethical behavior from accountants ensure

public confidence in financial reporting and business practices and upholding the reputation of the accounting profession

the 3 types of ethics

normative, practical and meta ethics

normative ethics

provides theories about what is the right thing to do and why this is so

practical ethics

about what is the right thing to do in a specific situation

meta ethics

considers the very concepts of ‘right’ and ‘wrong’ and where they come from

who or where can experience ethical pressures and influences from

family, social group, peers, religion and profession

conceptual framework

a constitution, a coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function and limits of financial accounting and financial statements

US FASB, IASB and UK ADB aim

to give principles for standards but not detailed rules. IASB tries to be more neutral while the other two are more aligned with their respective countries

qualitative characteristics of accounting

• relevance

• reliability

• comparability

• Understandability.

CPPA method to find revalued amount

historical cost x (current CPI / original CPI)

main objectives of HCA

transactions are recorded at their original money (or nominal) cost, objective and factual figures used and includes profit and income using the revenue and expenses

hard measurement system

generate verifiable facts by justifiable rules in a rigid system which allows only a unique set of rules for a given situation

HCA advantages

more objective/factual/verifiable and reliable as its ‘hardness‘ reduces the ability to disagree with the accounting figures

alternatives to HCA

current purchasing power (CPP), replacement cost (RC), net realizable value (NRV), present value (PV), deprival value

HCA disadvantages

it's subjective as it requires a lot of estimations, can be irrelevant to the economic needs of users, holding and operating gains are confused at a price change as HCA records them when they're realized and not occurred

current value accounting (CVA)

records assets and liabilities at their present market value or replacement cost rather than their original purchase price

types of current value accounting

current purchasing power and net realizable value

current purchasing power (CPP)

focuses on the effects of general price changes on specific prices and current values

what is net realizable value also known as

current exit value

Index (RPI2)

measure the effect of inflation (the general tendency of prices to rise) on an individual’s purchasing power

why is CPP not used anymore

because inflation isn’t so high now and it’s best used in a hyper inflationary economy given it focuses on price changes

1.       people prefer to keep its wealth in non-monetary assets

2.       people regard monetary amounts not in terms of the local currency but rather a stable foreign currency.

3.       sales and purchases on credit take place at prices high enough to compensate for the expected loss of purchasing power

4.       Interest rates, wages and prices are linked to a price index

5.       cumulative inflation rate over three years is approaching or exceeds 100%

aims of CPP

separating the accounts of monetary and non-monetary items and identifying and reflecting the gain or loss of holding these monetary items

how to convert HCA to CPP

1. each HCA item in the IS needs to be indexed, which involves multiplying the HCA values by the change in the relevant general index (such as the RPI)

2. find the gains and losses on monetary items

3. convert the non monetary items in the balance sheet

change in relevant index

index of stabilization / index of transaction

advantages of CPP

• easy to convert HCA to CPP

• expressed items in CPP (corrects time errors)

• easy to compare between companies

• easy for shareholders to understand as profit is presented

disadvantages of CPP

• CPP is based on HCA and not current values so it’s not up to date

• trouble in interpretation

• difficult finding an appropriate index

• RPI may not be a good representative of inflation

reproduction cost

the amount that would currently have to be paid to purchase an asset identical to the one currently owned

3 replacement costs

reproduction cost, cost of replacing with best alternative asset, replacement of service potential

replacement cost accounting (RCA)

all the assets are entered in the financial statements at the cash- equivalent value of what it would cost the organisation to replace them (also known as entry costs)

net realizable value method

the value of an asset is the estimated amount that could be raised from its sale (net of selling expenses)

advantages of net realizable value (NRV)

• measures the economic sacrifice made by continuing to hold and use the asset

• enables users to compare the return earned with the return available on investing those funds elsewhere

• reflects the adaptability of the company.

disadvantages of PV

may lack reliability as all the future cash flows are mostly estimated with a discount rate

deprival value (DV)

the amount of the loss which a business would suffer if that asset was lost or destroyed, assuming that the owner takes optimal action on deprival. can be found with the lower RC or higher NRV/NPV

financial capital maintenance in money terms

capital to maintain is the shareholders’ opening interest in the company as shown in the financial statements. so holding gains would be part of your income

physical/operating capital maintenance

maintenance of the company’s operating capability. if holding gains isn’t part of your income and if it can’t maintain its operating capability, then there is no profit

holding gains (HG) formula

CVA - HCA

fair value

the price that would be received to sell an asset or paid on a transfer a liability in an orderly transaction between market participants at the measurement date

exceptions to the requirement of fair value

share based payments, leasing and impairment of assets

fair value hierarchy framework

1. inputs based on quotes prices of active markets

2. inputs based on observable prices if not quoted

3. unobservable inputs

when does official policy (IASB/ASB) introduce standards regarding cost benefits

when benefits > costs and prefers gradual rather than revolutionary change as this reflects the “balanced” mainstream view and the UK’s historical cautious approach

why do imperfect markets create a case for regulation?

market forces can cause uneven information among investors, free-rider problems, adverse selection, managers hiding bad news, and slow market adjustment.
regulation provides comparability, protects the less-informed, and increases overall social welfare

what corporate social responsibility (CSR) and 1975 corporate report focus on

broader “holistic” external accounting that goes beyond pure financial numbers. includes narrative reporting and stakeholder impacts. the 1975 Corporate Report proposed stakeholder-oriented reporting but was never adopted as a standard

what was the IASB–FASB convergence project

a joint effort (strongly encouraged by G20 after 2008 financial crisis) to create one single set of high-quality global accounting standards. progress has been made, but full convergence has not been achieved. G20 statements in 2009 and 2013 pushed for completion by 2011 and 2013 respectively

differences between principles-based and rules-based accounting

UK/IASB approach focuses on principles-based (flexible, judgement required) approach while US GAAP focuses on a more rules-based/prescriptive approach.
this difference is often cited as an obstacle to full IASB–FASB convergence

IAS/IFRS adoption in the EU/UK

from 1 January 2005, all EU-listed companies must use IFRS (IASs/IFRSs) for consolidated group accounts, given statutory force by EU regulation.
UK followed this until Brexit; non-listed companies can still choose UK GAAP or IFRS. Over 100 countries now use IFRS in some form

why were accounting standards introduced in the UK?

major scandals in the late 1960s (GEC takeover of AEI and Pergamon Press profit figures) showed extreme subjectivity in financial reporting which led to creation of ASSC (1970) then ASC (1976) then ASB (1990). scandals continued to drive tighter regulation (e.g. Enron, Carillion)

financial reporting review panel (FRRP)

enforces standards and Companies Act. examines accounts of large companies for material departures. can take a company to court for defective accounts and force revised accounts. authorised by Companies Act to act on behalf of the Secretary of State

financial reporting council (FRC)

UK’s main oversight body (established 1990, took over ASB role in 2012). Made up of users, preparers, and accountants. their responsibilities are to set priorities, finances standards, promotes confidence in reporting and governance. after the Carillion scandal (2018), government proposed replacing it with ARGA for stronger enforcement.

true and fair view (UK law)

overrides legal requirement in Companies Act (s.226): balance sheet and income statement must give a true and fair view. if a standard conflicts with true and fair in special circumstances, directors must depart and explain. Mary Arden QC: compliance with standards is normally required, but true and fair can override.

edey’s 4 types of accounting standards

1. tell people what you have done (basic disclosure).
2. uniform presentation (consistent formats).
3. disclosure of specific matters (required notes in certain cases).
4. detailed rules (how to value assets/liabilities, recognise income, etc.) more prescriptive = stronger regulation.

adverse selection (“lemons problem”) in financial reporting

managers have incentives to hide bad news. Investors cannot tell good companies from bad ones (“lemons”). this leads to market failure: investors pay less for all shares or avoid investing. Regulation (standards + enforcement) protects investors from fraud and hidden information.

public good characteristics of accounting information

accounting information is a public good, making it non-excludable (hard to stop others using it) and non-rivalrous (one person’s use doesn’t reduce availability to others). this however causes a free-rider problem where market produces too little information, needing regulation.

why is more information not always better?

• information is costly so benefits must exceed costs

• in imperfect markets, extra transparency can harm welfare (Lipsey & Lancaster, 1957), making businesses lose innovation incentives if competitors see everything; monopolies may be strengthened.

what are the 2 broad roles of all accounting

1. decision-making role, providing information for economic decisions.
2. control role, accountability and stewardship (showing how management has used resources)

mainstream economistic view of financial reporting

financial accounting supplies information for better economic decisions by investors, allowing scarce resources are allocated more efficiently, increasing social welfare. this is the dominant view of the IASB and most policy makers. More (and better-quality) information is seen as desirable because it improves transparency and accountability

difference between market regulation vs state/quasi-state regulation

market regulation (free-market view) focuses on reputation, contracting, and competition. companies voluntarily disclose to raise capital while in state/quasi-state regulation focuses on imperfect markets, under-provision, adverse selection, and slow market adjustment. UK uses a mix but leans toward professional standards + legal backing

why regulation involves unavoidable trade-offs

information is costly, markets are imperfect, and both too little and too much disclosure can reduce social welfare