IAS 1 Q&A - Lecture notes 1 PDF

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Q&A on IAS1...

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1.

Describe the eight general principles to be applied in the presentation of financial statements. Which principles are more subjective? Explain your answer.

The eight general principles are: 1. Fair presentation and compliance with IFRSs – that financial statements should be faithfully represent the transactions, events and conditions of the entity in accordance with the definitions and recognition criteria specified in the Conceptual Framework, and that compliance with IFRSs is presumed to result in fair presentation (IAS 1 para. 15). 2. Going concern – that financial statements should be prepared on a going concern basis, unless management intends to liquidate or cease trading, or has no realistic alternative but to do so (IAS 1 para. 25). 3. Accrual basis of accounting – applied to financial statements other than the statement of cash flows, which is prepared on a cash basis. 4. Materiality and aggregation – that each material class of similar items should be presented separately in the financial statements, with material items being defined as those items for which omission or misstatement could individually or collectively influence the economic decisions of users (IAS 1 para. 29). Further, an entity should not obscure material items by aggregating them with immaterial items (IAS para. 30A). 5. Offsetting – of assets and liabilities, and income and expenses, shall not be offset unless required or permitted by an IFRS, but income and expenses are presented on a net basis, when this presentation reflects the substances of the transactions or events (IAS 1 para. 32). 6. Frequency of reporting – that financial statements should be presented at least annually, with paragraph 36 requiring additional disclosure where the length of the reporting period is affected by a change of the end of the reporting period. 7. Comparative information – must be presented for all financial statement items unless an IFRS permits otherwise (IAS 1 para. 38). 8. Consistency of presentation – that the presentation and classification of financial statements items should be consistent from one period to the next, unless changes are required by Accounting Standards or in the interests of more reliable and relevant presentation of financial information as may arise when there is a significant change in the nature of the entity’s operations (IAS para. 45). Most of these principles have some degree of subjectivity. IFRS are principles-based standards and their application often requires the exercise of professional judgment. For instance there is subjectivity in assessing whether transactions, events and conditions are represented faithfully because there are numerous ways in which they can be represented. See, for example, the alternative ways that certain financial instruments could be measured (refer chapter 7). The going concern assumption involves a subjective assessment of whether the entity is a going concern. Materiality is defined subjectively, based on judgments about whether it the omission or misstatement would influence users’ decisions, rather than objectively, such as a quantified test.

2.

Why is it important for entities to disclose the measurement bases used in preparing the financial statements?

It is important for entities to disclose the measurement bases used in preparing the financial statements because Accounting Standards permit alternatives – such as cost or fair value for PP&E. Therefore users need to know which alternatives the entity has chosen so as to understand how items are measured and for purposes of comparison with the financial statements of other entities.

3. How do the presentation and disclosure requirements of IFRS Standards reflect the objectives of financial statements? Illustrate your argument with examples from IAS 1, IAS 8 and IAS 10. As stated in paragraph OB2 of the Conceptual Framework the objective of financial statements is to provide financial information about the reporting entity that is useful to current and prospective investors and creditors in making decisions about providing resources to the entity. IAS 1 requires financial statements to present fairly the financial position, financial performance and cash flows of the entity because this type of information is considered useful to decision making. Paragraph 97 of IAS 1 requires separate disclosure of the nature and amount of material items of income and expense. Material items are defined as those items for which omission or misstatement could individually or collectively influence the economic decisions of users. The requirement to present items of income and expense that could influence users’ decisions is consistent with the decision-usefulness objective of financial statements. The requirements in IAS 10 to make adjustments or disclosures in relation to events occurring after the reporting period provide more timely and comprehensive information to users of financial statements. This is consistent with the decision-useful objective of financial statements because the timeliness and comprehensiveness of information enhances its usefulness for decision making. IAS 8 requires the restatement of comparative information when there has been a change of accounting policies. This enhances the comparability of an entity’s financial statements over time, facilitating the identification of trends and the use of past accounting numbers in the prediction of future earnings and cash flows. This is of particular importance to the use of financial statements for making decisions about whether to provide resources to an entity, thus reflecting the objective of financial statements. 4.

What is the purpose of a statement of financial position? What comprises a complete set of financial statements in accordance with IAS 1?

The purpose of a statement of financial position is to provide information about an entity’s financial position, by summarising the entity’s assets, liabilities and equity. It thus provides the basic information for evaluating an entity’s capital structure and analysing its liquidity, solvency and financial flexibility and also provides a basis for computing rates of return and measures of solvency and liquidity.

The statement of financial position should be used in conjunction with other financial statements to obtain a more comprehensive understanding of the liquidity, solvency and financial flexibility. A complete set of financial statements comprises:       5.

a statement of financial position a statement of profit or loss and other comprehensive income for the period a statement of changes in equity a statement of cash flows notes, comprising significant accounting policies and other explanatory information comparative information What are the major limitations of a statement of financial position as a source of information for users of general purpose financial statements?

The major limitations of a statement of financial position as a source of information about an entity’s financial position are: (a) The optional measurement of certain assets, such as property, plant and equipment at historical cost or depreciated historical cost (where the asset has a limited useful life) rather than a current value. Hence there may be a lack of comparability between the statement of financial position of one entity with the statement of financial position of another. Further, the use of cost/depreciated cost as the basis of measurement leads to the statement of financial position not giving a view of a current value of recognised assets. (b) The mandatory omission of intangible self-generated assets (such as brand names and mastheads and goodwill) from the statement of financial position as required by IAS 38 Intangible Assets. (c) The omission of various rights and obligations (such as non-cancelable operating leases) from the statement of financial position. This is particularly important as their omission results in off-balance sheet liabilities and assets that distort the reported leverage of the entity. As a consequence of these limitations, the statement of financial position of an entity does not purport to present a total picture of the real worth of the entity, nor does it purport to report all assets controlled by the entity and all the obligations of the entity. 6. Under what circumstances are assets and liabilities ordinarily classified broadly in order of liquidity rather than on a current/non-current classification? The presentation of the statement of financial position based on liquidity, rather than on a current/non-current basis is adopted when a presentation based on liquidity is considered to provide more relevant and reliable information. This situation is largely confined to entities such as financial institutions which do not have a clearly identifiable operating cycle, as does a manufacturer or a retailer.

7.

Can an asset that is not realisable within 12 months ever be classified as a current asset? If so, under what circumstances?

One of the criteria for classifying an asset as current under IAS 1 is that it is expected to be realised, or is intended for sale or consumption, in the entity’s normal operating cycle. Thus, if an entity’s operating cycle is longer than 12 months it is possible for an asset that is not realisable within 12 months to be classified as a current asset. Examples of operating cycles that may extend beyond 12 months include property development, construction, wine and cheese making. 8.

What is the objective of a statement of changes in equity?

The main purpose of a statement of changes in equity is to report transactions with equity holders, such as new share issues and the payment of dividends, and any retrospective adjustments to the opening balances of components of equity.

9.

Why is a summary of accounting policies important to ensuring the understandability of financial statements to users of general purpose financial statements?

A summary of accounting policies is important to ensuring the understandability of financial statements to general users of financial statements for the following reasons:  

Various options exist in certain IFRSs (such as the option to revalue property, plant and equipment as an alternative to using historical costs) and therefore it is essential that the summary of accounting policies identify which options have been adopted (where relevant). Under IFRSs various assets of an entity (such as internally generally brand names and selfgenerated goodwill) and rights and obligations (such as non-cancelable operating leases) are not recognised in an entity’s statement of financial position. The summary of accounting policies helps ensure users of financial statements are aware of these omissions.

10. Provide an example of a judgement made in preparing the financial statements that can lead to estimation uncertainty at the end of the reporting period. Describe the disclosures that would be required in the notes. Some of the more important judgements that can lead to uncertainty required in the preparation of financial statements concern:     

Useful life of plant and equipment for depreciation purposes; Residual value of plant and equipment; Useful life of intangible assets, including whether the assets have an indefinite life or a finite life; Assessment as to whether there is any indication that an asset is impaired and, if so, the measurement of the recoverable amount of the asset, including estimating future cash flows and the appropriate discount rate for value in use measures; Estimation of the fair value of assets and liabilities acquired in a business combination;

   

Estimation of the fair value of equity instruments forming share-based payments in transactions with employees; Estimation of provisions such as provisions for long service leave and provisions for restructuring; Estimation of the net realisable value of inventory.

Paragraph 125 of IAS 1 requires that the notes disclose information about the assumptions made concerning the future and other major sources of estimation uncertainty at the end of the reporting period, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year (for example, assumptions used in performing significant asset impairment tests). The entity should disclose the nature and carrying amount of the assets and liabilities concerned.

11. What disclosures are required in the notes in regard to accounting policy judgements? An entity is required by paragraph 122 of IAS 1 to disclose judgements that management has made in the process of applying accounting policies that have the most significant effect on the amounts recognised in the financial statements, e.g.:     

12.

Assessment of the business model employed for managing financial assets (refer IFRS 9); Whether certain transactions are sales of goods or are in substance financing arrangements; Whether an active market exists for certain intangible assets to support the adoption of the fair value basis of measurement (refer IAS 38); Determining the functional currency of net investments in foreign operations, as required by IAS 21; Whether the actions of management and the Board in relation to a restructuring have been such as to constitute a constructive obligation and therefore justify the recognition of a provision for the costs of the restructuring (refer IAS 37).

What is the difference between an accounting policy and an accounting estimate? Provide an example of each.

An accounting policy is a principle or conventions applied in preparing financial statements, typically in recognising and measuring the financial effects of transactions and events. For example, recognising assets at the lower of cost and recoverable amount is an accounting policy. An accounting estimate is an estimation used in the application of accounting policies. For example, the measurement of the value-in-use of an asset requires estimation of the future cash flows to be derived from using the asset. The estimation of the depreciable amount of an asset requires an estimation of the residual value of the asset at the end of its useful life....