2019 Conceptual Framework, Elements, IAS1 Notes,Questions and Answers PDF

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FINANCIAL ACCOUNTING: FIA213S/FIA214STHE CONSEPTUAL FRAMEWORK &INTERNATIONAL ACCOUNTING STANDARD 1INTERNATIONAL FINANCIAL REPORTING STANDARS (IFRS)IFRSs are principles that are applied by accountants when they:  Record transactions and other financial information (accounting information) an...

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FINANCIAL ACCOUNTING: FIA213S/FIA214S THE CONSEPTUAL FRAMEWORK & INTERNATIONAL ACCOUNTING STANDARD 1 INTERNATIONAL FINANCIAL REPORTING STANDARS (IFRS) IFRSs are principles that are applied by accountants when they:  Record transactions and other financial information (accounting information) and  Prepare financial statements for external users (external reporting). IFRSs are issued by the International Accounting Standards Board. (IASB) IFRSs are developed within the International Accounting Standards Board (IASB) or by the IFRS International Committee (IFRISIC). Standards do have a IAS or a IFRS prefix. If the standard was developed by the original Accounting Standards Committee (IASC) it will have an IAS prefix. If the standard was developed by the current International Accounting Standards Board (IASB) it will have a IFRS prefix. IAS’s developed: 41 but only 25 of them are still used. (The others were replaced by newly written IFRSs.) So far IASB have developed 17 new standards. (Referred to as IFRSs.) Read more about the development of exposure drafts, standards, interpretations and annual improvements in Gripping GAAP Chapter 1. THE CONCEPTUAL FRAMEWORK (CF) The Conceptual Framework (CF) is the foundation on which all IFRSs are build. The original CF were issued in 1989. During 2010 the 1989 CF were partly revised since the 1989 version of the CF were incomplete and outdated. On 29 March 2018 the International Accounting Standards Board (IASB) has published its revised 'Conceptual Framework for Financial Reporting'. Included in the 2018 CF are:  Revised definitions of an asset, a liability, an income and an expense.  Revised recognition criteria,  as well as new guidance on measurement and derecognition, presentation and disclosure. The new Conceptual Framework does not constitute a substantial revision of the previous issues of the Conceptual Framework but instead the IASB focused on topics that were not yet covered or that showed obvious shortcomings that needed to be dealt with.

2 Why do we need a Conceptual Framework in accounting? (What is the purpose of the Conceptual Framework?) The CF is basically a tool that has three purposes: 1. To help the IASB in developing IFRSs, 2. To help those preparers of financial statements who may need to create their own accounting policies (when a suitable IFRS does not exist or an existing IFRS allows an alternative policy) and 3. To help all parties to understand and interpret the IFRSs.

THE QUALITIVE CHARACTERISTICS AND CONSTRAINTS For financial statements to be useful to its users, it must have certain qualitative characteristics. The Conceptual Framework separates the qualitative characteristics into the following two types: (Refer to Gripping GAAP 2019 Pg. 46-51) Fundamental qualitative characteristics Those that are essential for financial information to be useful for users are:  Relevance In order for information to be relevant one could consider whether it could make a difference in users’ decision-making. 

Faithful representation “Substance over form.” In order to achieve faithful representation, the financial information given to users must be complete, neutral an free from error.

Enhancing qualitative characteristics Those that improve usefulness are:  Comparability  Verifiability  Timeliness  Understandability

3 ELEMENTS OF THE FINANCIAL STATEMENTS (Refer to Gripping GAAP 2019 Pg. 52-65) Transactions and events are grouped according to their economic characteristics. These groupings are called elements. The Conceptual Framework identified 5 main elements: Assets, Liabilities, Income, Expenses and Equity. The following definitions are relevant: An asset is:  A present economic resource Note 1  Controlled by the entity  Resulting from past events Note 1: An economic resource is defined as:  A right that has  The potential to produce economic benefits A liability is:  A present obligation Note 2  To transfer an economic resource Note 1  Resulting from past events Note 2: An obligation is:  A duty that the entity has  No practical ability to avoid.

Equity is:  The residual interest in the entity’s assets  After deducting all its liabilities (Residual interest = A - L) An expense is:  A decrease in assets or increase in liabilities  Resulting in a decrease in equity  Other than distributions to holders of equity claims. An income is:  An increase in assets or a decrease in liabilities  Resulting in an increase in equity  Other than contributions from holders of equity claims.

4 Recognition criteria: Assets, liabilities, equity, income and expenses may only be recognised in the financial statements if they meet the definition as well as the recognition criteria. According to the 2010 conceptual framework the recognition criteria were:  

The flow of future economic benefits caused by this asset/liability are probable, and This asset/liability has a cost/value that can be reliably measured.

According to the 2018 conceptual framework the recognition criteria is: Assets and liabilities, and any resulting income expenses or changes in equity will be recognised if the information provided by the elements is useful for the user. Thus: An element will be recognised if the information which is provided is  Relevant and  A faithful representation.

Measurement of elements: The term “measurement” refers to the process of deciding or calculating the amount to be used in our financial statements. There are a number of different methods (or possible measurement basis) that may be used to measure the amounts of individual elements (assets/liabilities) recognised in the financial statements. Some of the different methods are listed below: (Pg. 68 of Gripping GAAP) The historical cost The current value  Current cost  Fair value  Value in use The realisable value method (Pg. 69) NOTE: You must keep in mind that an asset or liability can only be recognised in the balance sheet if its meets the respective asset or liability definitions as well as the recognition criteria.

5 ASSET CHECK LIST: Yes

No

Yes

No

? Does a present economic resource exist? Is there a “right” that exist? ? Does the right have the potential to produce economic benefits? Economic benefits could be:  Inflow of cash, (accounts receivable)  The right to use an asset, (PPE; intangible asset)  the right to rent the asset out, (PPE; intangible asset)  The right to sell an asset. (PPE; intangible asset; inventory0 ? Is the right controlled by the business? ? Does the right exists at the reporting date because of a past event? IS THE ITEM INDEED AN ASSET? ? Is the information provided relevant? ? Is the information provided a faithful representation? SHOULD THE ASSET BE RECOGNISED IN THE STATEMENT OF FINANCIAL POSITION? ? Does the right have the potential to produce economic benefits be within the next twelve months? IS THIS A CURRENT OR A NON-CURRENT ASSET? LIABILITY CHECK LIST: ? Does the entity have a present obligation? Is there a duty to pay a supplier/a law form/ the bank? Does the entity have no practical ability of avoiding the duty due to …? ? Does the obligation have the potential to result in a transfer of an economic resource? (most cases … cash will have to be transferred) ? Did a past event happen? What happened? (Cause) What is the result? (Effect) Cause: Inventory was purchased. Effect: The potential transfer of economic resources.

IS THE ITEM INDEED A LIABILITY? ? Is the information provided relevant? ? Is the information provided a faithful representation? SHOULD THE LIABILITY BE RECOGNISED IN THE STATEMENT OF FINANCIAL POSITION? ? Will the anticipated transfer of an economic resource be within the next twelve months? IS THIS A CURRENT OR A NON-CURRENT LIABILITY?

6 QUESTION 1

(14 MARKS)

Sellati Limited is a retail business which has a financial year end on 31 December. On 30 November 2018 the accountant recorded the following journal entry and it was posted to the ledger: Debit 2018 Nov 30

Inventory

Credit

20 000

Sugar Wholesalers Ltd

20 000

The amount of R20 000 represents the purchases of merchandise from Sugar Wholesalers Ltd, a supplier of sugar products to retail businesses. REQUIRED: 1.1 Identify the element of financial statements which was debited in the above journal entry. Element debited: (1) 1.2

Explain the element you have chosen in 1.1. Your explanation/motivation should refer only to the definition criteria of this element in accordance to the conceptual framework of 2018. Thus, "Inventory" is a/an ………………… because: (6)

1.3 Identify the element of financial statements which was credited in the above journal entry. Element credited: (1) Explain the element you have chosen in 1.3. Your explanation/motivation should refer only to the definition criteria of this element in accordance to the conceptual framework of 2018. Thus, "Sugar Wholesalers Ltd" is a/an ………………… because: (6) ANSWER QUESTION 1: 1.4

1.1 1.2 1

Element debited:

Asset ü

Motivation : Thus, "Inventory" is an asset because: Inventory is a present economic resource: ü Sellati Limited has the right to sell the inventory. ü There is the potential to produce economic benefits through the inflow of cash (or another economic resource), when the inventory is sold. ü

2

The inventory is controlled through legal ownership. ü

3

There was a past event.

(1)

7 The inventory was purchased (cause) and Sellati Ltd gained the economic benefits of the inventory (result/effect) ü on 30 November 2018 which was before the financial year end of 31 December 2018. ü (6) 1.3 Identify the element of financial statements which was credited in the above journal entry. Element credited: Liabilty ü (1) 1.4

1

Explain the element you have chosen in 1.3. Motivation: Thus, "Sugar Wholesalers Ltd" is a liability because: Sugar Wholesalers Ltd (the trade payable) is a present obligation, because: ü Sellati Limited has the duty to pay the supplier. ü Sellati Limited has no practical ability of avoiding the duty due to the legal contract of purchase. ü

2

The obligation has the potential to result in a transfer of an economic resources. Sellati Limited will have to transfer cash to meet the obligation. ü

3

There was a past event. The inventory was purchased (cause) and Sellati Ltd gained the economic benefits of the inventory (result/effect) ü on 30 November 2018 which was before the financial year end of 31 December 2018. ü

(6)

8 QUESTION 2

(7 MARKS)

Sellati Limited is a retail business which has a financial year end on 31 December. On 30 November 2018 the accountant recorded the following journal entry and it was posted to the ledger: Debit 2018 Nov 30

Equipment

Credit

5 000

Bank

5 000

The amount of R5 000 represents the purchases of equipment which will be used to manufacture inventory. The bank had an unfavorable balance at that date. REQUIRED: 2.1

Explain/Motivation why equipment is an asset. Refer only to the definition criteria of an asset in accordance to the conceptual framework of 2018. (6)

2.2

Explain/Motivation why the bank overdraft is a liability. Refer only to the definition criteria of a liability in accordance to the conceptual framework of 2018. (6)

ANSWER: 2.1

1

Motivation: The "Equipment" is an asset because: The equipment is a present economic resource: ü Sellati Limited has the right to direct the use of the equipment. ü (Direct = when, how, keep or sell the equipment)

There is the potential to produce economic benefits through the manufacture of inventory. (inflow of other economic resources) ü 2

The equipment is controlled through legal ownership. ü

3

There was a past event. The inventory was purchased (cause) and Sellati Ltd obtained control of the equipment (result/effect) ü on 30 November 2018 which was before the financial year end of 31 December 2018. ü (6)

9

2.2

Motivation: The bank overdraft is a liability because: The overdraft is a present obligation, because: ü

1

Sellati Limited has the duty to pay the bank. ü Sellati Limited has no practical ability of avoiding the duty due to the legal nature of the overdraft / credit granted. ü 2

The obligation has the potential to result in a transfer of an economic resources. Sellati Limited will have to transfer cash to meet the obligation. ü

3

There was a past event. Sellati Limited obtained an economic benefit by using the overdraft facility (cause) and it resulted in a potential transfer of economic resources (result/effect). ü The past event happened on 30 November 2018 which was before the financial year end of 31 December 2018. ü (6) QUESTION 3

(3 MARKS)

Sellati Limited is a retail business which has a financial year end on 31 December. On 30 November 2018 the accountant recorded the following journal entry and it was posted to the ledger: Debit 2018 Nov 30

Salaries and wages Bank

Credit

40 000 40 000

The bank had a favorable balance at that date. REQUIRED: 3.1

Explain/Motivation why salaries and wages is an expense. Refer only to the definition criteria of an expense in accordance to the conceptual framework of 2018. (3)

10 3.1

Motivation: The salaries and wages is an expense because:

1

There is a decrease in assets: Sellati’s favorable bank balance was decreased. ü

2

The decrease in assets resulted in a decrease in equity: The transaction decreased the asset but did not change the liabilities, and thus equity does decrease. ü

3

The decrease in equity is not a distribution to a holder of an equity claim: The cash payment was made to employees and not to a holder of an equity claim (e.g. ordinary shareholders) and thus is not a distribution to a holder of any equity claims. ü (3) QUESTION 4

(3 MARKS)

Sellati Limited is a retail business which has a financial year end on 31 December. On 30 November 2018 the accountant recorded the following journal entry and it was posted to the ledger: Debit 2018 Nov 30

Water and electricity Cape Town Municipality

Credit

130 000 130 000

The water bill from the municipality was not yet paid since Sellati expected that there was a error in the water consumption calculations for November 2018. REQUIRED: 4.1

Explain/Motivation why “water and electricity” is an expense. Refer only to the definition criteria of an expense in accordance to the conceptual framework of 2018. (3)

11 4.1

Motivation: The “water and electricity” is an expense because: There is an increase in liabilities: The obligation payable to Cape Town Municipality increase Sellati’s liabilities. ü

1

2

The increase in liabilities resulted in a decrease in equity: The transaction increased the liabilities but did not change the assets, and thus equity does decrease. ü

3

The decrease in equity is not a distribution to a holder of an equity claim: This payable involves an amount owed to the municipality and not to a holder of an equity claim (e.g. ordinary shareholders) and thus is not a distribution to a holder of any equity claims. ü (3) QUESTION 5

(3 MARKS)

Sellati Limited is a retail business which has a financial year end on 31 December. On 30 November 2018 the accountant recorded the following journal entry and it was posted to the ledger: Debit 2018 Nov 30

Bank

Credit

8 000 Rent income

8 000

Sellati Limited had an operating lease agreement with a tenant whereby the tenant had to pay each month an amount of R8 000 for the next month. REQUIRED: 5.1

Explain/Motivation why “Rent income” is an income. Refer only to the definition criteria of an income in accordance to the conceptual framework of 2018. (3)

12 5.1

Motivation: The “Rent income” is an income because:

1

There is an increase in assets: The cash payment was made into the bank account and consequently there was an increase Sellati’s assets. ü

2

The increase in assets resulted in a increase in equity: The transaction increased the assets but did not change the liabilities, and thus equity does increase. ü

3

The increase in equity is not a contribution from a holder of an equity claim: This cash receipt involves an amount received from the tenant and not from a holder of an equity claim (e.g. ordinary shareholders) and thus is not a contribution from to a holder of any equity claims. ü (Shareholders did not buy any shares)

QUESTION 6 IGNORE VAT

(9 MARKS)

BB Limited started a business doing renovating jobs. EXTRACT FROM THE PRE-ADJUSTMENT TRIAL BALANCE OF BB LIMITED FOR THE FINANCIAL YEAR ENDING 30 JUNE 2018 2018

2018

DEBIT

CREDIT

Service fee income Cost of sales

800 000 400 000

Additional information: During May 2018 BB Ltd was awarded a R200 000 contract for work to be done. BB Ltd agreed to start on 1 June 2018 and the contract stated it would take 4 months to complete the job and that one quarter of the contract would be completed each month. On 30 June 2018 BB Ltd received a cheque for the full amount of R200 000 which was deposited in the bank. The full R200 000 was recorded as service fee income. REQUIRED: 1.1 Prepare the adjusting general journal entry that BB Limited should process relating to the R200 000 cash received by BB Limited on 30 June 2018 from their client. (Dates and narrations are not required.) 1.2

Explain the element you have chosen to credit in the journal entry in 1.1 above. Refer only to the definition of the element in accordance to the Conceptual Framework of 2018.

(3)

(6)

13 QUESTION 6 - ANSWER 6.1 2018

Debit

JUNE 30 DR Service Fee income (ü)

150 000

CR Income received in advance (ü)

Credit (½) 150 000

(½) (3)

Cr Income received in advance with R150 000. R150 000 of the R200 000 received on 30 June 2018 was a payment in respect of services still to be provided during July, August and September 2018. 6.2

1

"Income received in advance" was credited. " Income received in advance" is a liability because:

Income received in advance is a present obligation, because: ü BB Limited has the duty to deliver the services/ or to pay back the amount to the client ü BB Limited has no practical ability of avoiding the duty due to the legal enforceable contract which was signed. ü

2

The obligation has the potential to result in a transfer of an economic resources. BB Limited will have to supply the services (or transfer/refund cash) to meet the obligation. ü

3

There was a past event. BB Ltd has already gained the economic benefits (cash) for the services not yet performed. ü The cash was received on 30 June 2018 which falls within the financial year ending 30 June 2018 . ü

(6)

14 QUESTION 7

(8 MARKS)

State whether the following statements are TRUE or FALSE: 3.1 IAS 1 does prohibit the off-setting of income and expenses or assets and liabilities. There are however exceptions. On...