21. ACCA SBR EDs, DPs & Practice Statements PDF

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ACCA SBR EDs, DPs & Practice Statements 1. Management Commentary (IFRS Practice Statement) Management commentary: A narrative report that relates to financial statements that have been prepared in accordance with IFRSs. Management commentary provides users with historical explanations of the amounts presented in the financial statements, specifically the entity's financial position, financial performance and cash flows. It also provides commentary on an entity's prospects and other information not presented in the financial statements. Management commentary also serves as a basis for understanding management's objectives and its strategies for achieving those objectives. IFRS Practice Statement 1 Management Commentary is a non-binding guidance document rather than an IFRS. ! It is intended to be applied by entities that present management commentary that relates to financial statements prepared in accordance with IFRSs. It is designed for publicly traded entities, but it is left to regulators to decide which entities are required to publish management commentary and how frequently they should report. ! This approach avoids the adoption hurdle, ie that the perceived cost of applying IFRSs increases. This perceived extra cost could dissuade jurisdictions/countries that have not already adopted IFRS from requiring its adoption, especially where IFRS requirements differ significantly from existing national requirements.! Principles for the preparation of management commentary Management should present commentary that is consistent with the following principles from Practice Statement 1 ! (a) To provide management's view of the entity's performance, position and progress; and ! (b) To supplement and complement information presented in the financial statements.! In aligning with these principles, management commentary should include : ! (a) Forward-looking information (including prospective results); and ! (b) Information that possesses the qualitative characteristics described in the revised Conceptual Framework for Financial Reporting. !

Presentation ! The form and content of management commentary will vary between entities, reflecting the nature of their business, the strategies adopted by management and the regulatory environment in which they operate . ! Therefore, Practice Statement 1 does not require a fixed format, nor does it provide application guidance or illustrative examples, as this could be interpreted as a floor or ceiling for disclosures.! Elements of management commentary The particular focus of management commentary will depend on the facts and circumstances of the entity. However, Practice Statement 1 requires a management commentary to include information that is essential to an understanding of : ! (a) (b) (c) (d) (e)

The nature of the business Management's objectives and its strategies for meeting those objectives ! The entity's most significant resources, risks and relationships The results of operations and prospects ! The critical performance measures and indicators that management uses to evaluate the entity's performance against stated objectives!

Elements of management commentary FRS Practice Statement 1: Management Commentary has provided a table relating the five elements to its assessments of the needs of the primary users of a management commentary (existing and potential investors, lenders and creditors).! Elements of management commentary Management Commentary has provided a table relating the five elements to its assessments of the needs of the primary users of a management commentary (existing and potential investors, lenders and creditors).!

Advantages & Disadvantages of Management Commentary

2. Making Materiality Judgements (IFRS Practice Statement) There is some concern that company accounts may have excessive disclosure, so that users can no longer ‘see the wood for the trees’. Therefore the Practice Statement gives guidance on how to determine what is ‘material’.! Learn the 4 steps that an entity should follow in assessing what is material for inclusion in the financial statements.! 1. 2. 3. 4.

Identify information that may be material for primary users – providers of finance.! Assess whether this information is actually material by size or nature.! Present the information clearly and concisely.! Stand back and look at the information as a whole to see what may need to be added or deleted.!

Materiality, as defined and applied, was identified by the IASB as a contributing factor to the disclosure problem. In response, the IASB:! (1) Issued IFRS Practice Statement 2: Making Materiality Judgements in 2017! (2) Revised the definition of 'material' in 2018.! Material: 'Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial reports make on the basis of those reports, which provide financial information about a specific reporting entity. In other words, materiality is an entity-specific aspect of relevance based on the nature or magnitude, or both, of the items to which the information relates in the context of an individual entity's financial report.'!

The IASB has amended the definition of 'material' to make it clear that obscuring information has the same effect as omitting or misstating it. Obscuring information means making the information so difficult to find or so difficult to understand, that it may as well have been omitted.! This addresses the issue that too much information can be just as problematic as the omission or misstatement of information.! Practice Statement 2 was developed in response to concerns that some companies were unsure how to make materiality judgements. The effects of this are seen in:! (1) Excessive disclosure of immaterial information - important information is obscured or missed out! (2) Use of IFRS Standards disclosure requirements as a 'checklist' - making all disclosures listed, whether they are material or not.! The aim of the IASB in issuing Practice Statement 2 is to encourage greater application of judgement in the preparation of financial statements. The guidance is not mandatory.! General characteristics of materiality (a) Preparers of financial statements make materiality judgements when applying IFRSs! Recognition and measurement The recognition and measurement criteria only need to be applied when the effect of applying them is material.! For example, an entity may choose to capitalise items of property, plant and equipment only when the cost of an individual item exceeds, say $1,000, on the basis that capitalising items below this amount will not have a material effect on the financial statements.! Presentation & Disclosure Disclosure criteria: if the information provided by a certain disclosure requirement is not material, the entity does not need to make that disclosure, even if that disclosure is part of a list of minimum required disclosures in an IFRS Standard.! However, the entity should consider whether it also needs to disclose information not specifically required by an IFRS Standard if that information is needed to understand the financial statements.! (b) Financial statements provide financial information to primary users that is useful to them when making decisions about providing resources to the entity.! Primary users are investors, lenders and other creditors, both existing and potential.! General purpose financial statements cannot meet all of the information needs of primary users. Instead the entity should aim to meet the information needs common to all investors, all lenders and all other creditors.! The entity is not required to meet the information needs of other stakeholders, or the individual requirements of particular primary users.!

Four-step process to making materiality judgements One way of making materiality judgements when preparing the financial statements is to apply the following four-step process:! Step 1: Identify information that is potentially material Consider requirements of IFRS Standards ! Consider common information needs of primary users! Step 2: Assess whether that information is material Could information reasonably be expected to influence primary user ?! Consider qualitative and quantitative factor! Step 3: Organise information into draft financial statements Apply judgment to determine best way to communicate clearly and concisely! Eg: emphasise material matters, explain simply, ! Step 4: Review complete set of draft financial statements On the basis of complete set of financial statements: has all material information been identified?! On the basis of complete set of financial statements: has materiality been considered from a wide perspective and in aggregate?! Assessing whether information is material There are common 'materiality factors' which can be used to help assess whether information is material. These are:! (a) Quantitative factors Consider the size of the effect of the transaction/event against measures of the entity's financial position, performance and cash flows! Consider any unrecognised items (eg contingent liabilities) that could affect primary users' perception.! (b) Qualitative factors These are characteristics that make information more likely to influence the decisions of primary users, they can be internal or external : !

- Internal include: involvement of related parties, uncommon features, unexpected changes in trends!

- External include: geographic location, industry section, state of the economy! Both quantitative factors and qualitative factors should be considered.!

Quantitative factors can be assessed with the help of a threshold – such as 5% of profit.! It is usually more efficient to assess items from a quantitative perspective first: if an item exceeds the quantitative threshold, it is material and no further assessment is required.! If an item is considered immaterial on the basis of the quantitative threshold, qualitative factors should then be considered. The presence of a qualitative factor in a transaction/event, such as the involvement of a related party, lowers the quantitative threshold.! Illustration 1 Information about a related party transaction assessed as material Red has identified measures of profitability as of great interest to the primary users of its financial statements. During the year, Red agreed a five year contract in which Green (a related party), will perform maintenance services for Red for an annual fee of $1.5 million.! Red first assessed whether the information about the transaction was material from a quantitative perspective. A threshold of $2.5 million (3% of net profit) was used. From a purely quantitative perspective, Red assessed that the effect of the contract was not material.! Red then considered the transaction from a qualitative perspective. Having considered that the transaction was with a related party, Red concluded that the impact of the transaction was large enough to reasonably be expected to influence primary users' decisions (eg the presence of a qualitative factor lowered the quantitative threshold).! Red assessed information about the transaction with Green as material and disclosed that information in its financial statements.! The presence of qualitative factors does not mean that information is always material. An entity may decide that, despite the presence of qualitative factors, information is not material because its effect on the financial statements is so small that it could not reasonably be expected to influence primary users' decisions Illustration 2 Information about a related party transaction assessed as immaterial During the year Red sold an almost fully depreciated machine to Blue (a related party) at an amount consistent with the machine's market value.! Red assessed whether the information about the transaction was material. From a purely quantitative perspective, Red initially concluded that the impact of the related party transaction was not material.! However, a qualitative factor exists: the fact that the machine was sold to a related party makes the information more likely to influence the decisions of primary users. Therefore Red further assessed the transaction from a quantitative perspective, but concluded that its impact was too small to reasonably be expected to influence primary users' decisions, even though the transaction was with a related party.!

Red assessed information about the transaction with Blue to be immaterial and did not disclose it in its financial statements.! Stakeholder perspective The IASB hopes that Practice Statement 2 will change the behaviour of preparers and auditors of financial statements. Preparers should put the information needs of the primary users of their financial statements at the centre of their financial statement preparation process. Primary users need information that is relevant to their decision-making and is not obscured by information that cannot reasonably be expected to influence their decisions. The article 'Bin the Clutter' available in the student resources section of the ACCA website provides further discussion on the issue of clarity in financial reporting.!

3. Disclosure of Accounting Policies (ED 2019/6) Currently IAS 1 requires companies to disclose SIGNIFICANT accounting policies. This has, in some cases, led to an excess of disclosure, causing investor confusion, and a lack of understandability.! Material policies would include those:! 1. That have changed in the year! 2. That are selected from a standard that gives a choice – e.g. Investment Properties can be measured using the cost or valuation models.! 3. Where there is no accounting standard.! Background IAS 1 currently requires an entity to disclose in its financial statements its significant accounting policies. However, users of financial statements have told the IASB that accounting policy disclosures are rarely useful .! To be useful to users, disclosure about accounting policies should provide insight into how an entity has exercised judgement in selecting and applying accounting policies. This means that 'boilerplate' disclosure of accounting policies which just regurgitate the requirements of accounting standards are not useful. In fact, including this information may obscure information that is relevant to users.! To try and improve the usefulness of accounting policy disclosures, the IASB proposes to amend IAS 1 so that an entity must disclose its material accounting policies.! Proposed amendments The proposed amendments to IAS 1 state that:! (1) Accounting policies that relate to immaterial transactions/events/conditions are immaterial.! (2) An accounting policy is material if information about it is required to understand other material information in the financial statements.!

(3) Just because an accounting policy relates to a material transaction/event/condition, does not mean that the accounting policy itself is material. The Exposure Draft gives examples of circumstances that may lead an entity to conclude an accounting policy is material, such as where an accounting policy was selected from alternatives within the Standards.! (4) Information on accounting polices is more likely to be useful to primary users if it is entity specific, eg it describes how the entity has applied the recognition and measurement requirements of an IFRS Standard to the entity's own circumstances. Information that only duplicates requirements in IFRS Standards is unlikely to be useful to primary users.! ED 2019/6 also proposes additions to IFRS Practice Statement 2 which includes specific guidance and illustrative examples to help an entity determine whether an accounting policy is material.! The IASB believes that the amendments proposed will help entities to appropriately disclose material information and to eliminate immaterial information from financial statements.!

4. Accounting Policy Changes (ED 2018/1) IFRIC make Agenda Decisions. They tend to be on very technical matters and compliance is voluntary. Examples on link below. Don’t worry – you don’t need to learn them!! The point is that, when agenda decisions are made, companies may choose to change accounting policy – this can be very expensive because they would have to restate comparatives / do a prior year adjustment.! So, the ED proposes that there will be no need to restate comparatives / do a prior period adjustment if COST OUTWEIGHS BENEFIT. Any changes would be adjusted PROSPECTIVELY.! The IASB has proposed limited scope amendments to IAS 8. The amendments are intended to facilitate voluntary changes in accounting policies that result from agenda decisions published by the IFRS Interpretations Committee.! Background The IFRS Interpretations Committee considers issues raised by stakeholders relating to the application of IFRSs. After considering an issue, the IFRS Interpretations Committee often publishes an 'agenda decision' with explanatory material regarding the issue.! The aim of the explanatory material is to facilitate consistency in the application of an IFRS. As agenda decisions are not authoritative, entities are not required to change their accounting policies in response, but can do so voluntarily.! Amendment IAS 8 currently specifies that a change in accounting policy should be applied retrospectively, as if it had always been in place, except where it is impracticable to do so. Retrospective application can be a time-consuming and difficult task. Therefore to encourage voluntary changes in accounting policy as a result of an agenda decision, the IASB proposes that retrospective application need not be applied, subject to a cost-benefit analysis.

Therefore, for a change in accounting policy due to an agenda decision, if the cost of retrospective application outweighs the benefit, the new policy must be applied prospectively. Issues ! Potential issues with the proposed amendments include the following :! (a) Although agenda decisions have non-mandatory status, in practice they are treated as mandatory. Many securities regulators view an accounting policy which is not in agreement with an agenda decision as no longer acceptable. The proposed amendments may exacerbate this situation.! (b) A fundamental issue with agenda decisions is that they are viewed as immediately effective. This presents significant problems if an agenda decision is published close to an entity's reporting date. The proposed amendments do not address this issue. ! (c) There is no conceptual basis for treating voluntary changes in accounting policy resulting from agenda decisions differently to other voluntary changes in accounting policy.! (d) Conducting a cost-benefit analysis is potentially as onerous as applying an accounting policy retrospectively and is inherently subjective.! A common view among stakeholders* in responding to the ED is that instead of amending IAS 8, the IASB should address the underlying issue of the status and effective date of agenda decisions. Ethics note ! This chapter introduced the concept of ethical principles and illustrated some of the ethical dilemmas you could come across in your exam and in practice. You are likely to meet ethics in the context of manipulation of financial statements. Whereas in this chapter the issues were mainly limited to topics you have covered in your earlier studies, you will come across ethical issues in connection with more advanced topics, such as foreign subsidiaries. ! The common thread running through each ethical dilemma is generally that someone with power, for example a company director, wants you to deviate from IFRS in order to present the financial statements in a more favourable light. The answer will always be that this should be resisted, but in each case it must be argued with reference to the detail of the IFRS in question, not just in terms of general principles.!

5. Financial Instruments with the Characteristics of Equity (DP 2018/1) This is a Discussion Paper (which precedes Exposure Drafts, so the project is at a very early stage).! You should learn the proposed definition of financial liability as follows:! ๏ An unavoidable contractual obligation to transfer cash or another financial asset at a specified time other than at liquidation; and/or! ๏ An unavoidable contractual obliga...