OVERVIEW
Objective
¾
To explain the need for guidance on reporting performance.¾
To prescribe the classification, disclosure and accounting treatment of certain items in the statement of comprehensive income.INTRODUCTION
PRIOR PERIOD ERRORS ACCOUNTING
POLICIES
¾ Scope
¾ Definitions
¾ Selection and application ¾ Consistency of accounting
policies
¾ Changes in accounting
policy
¾ Disclosure
CHANGES IN ACCOUNTING
ESTIMATE
¾ Introduction
¾ Accounting treatment
¾ Disclosure
¾ Introduction
¾ Accounting treatment
¾ Disclosures
BACKGROUND ¾¾ Performance Disaggregation
1
BACKGROUND
1.1
Performance
¾
The objective of financial statements is to provide information about the financial position, performance and cash flows of an entity that is useful to a wide range of users in making economic decisions.¾
The economic decisions that are taken by users of financial statements require an evaluation of the ability of an entity to generate cash and cash equivalents and of the timing and certainty of their generation.¾
Users are better able to evaluate this ability to generate cash and cash equivalents if they are provided with information that focuses on the financial position, performance and cash flows of an entity.¾
Information about the performance of an entity, in particular its profitability, is required in order to: assess potential changes in the economic resources that it is likely to control in the future,
predict the capacity of the entity to generate cash flows from its existing resource base, and
form judgements about the effectiveness with which the entity might employ additional resources.
¾
Information about variability of performance is important in this respect.1.2
Disaggregation
¾
In order to make economic decisions users of the accounts need to understand the composition of figures in as much detail as possible. There is a trend in reporting to provide more detailed information about the composition of key elements of the financial statements. In short the information may be analysed, either on the face of the statements or in notes to the accounts, into component parts to better aidunderstanding.
¾
For example: Disclosure of material and unusual items which are part of ordinary activities, Information on discontinued operations, and
Segmental reporting.
1.3
Reporting aspects of performance
Relevant standards are:
¾
IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors¾
IAS 1 – Presentation of Financial Statements¾
IFRS 8 – Operating Segments¾
IAS 7 – Statement of cash flows¾
IFRS 5 – Non-current Assets Held for Sale and Discontinued OperationsIn considering the reporting of financial performance the following areas need to be covered:
¾
The form and content of the statement of comprehensive income Structure (IAS 1)
Which items must be taken through the statement of comprehensive income (IAS 1) Classification of material items (IAS 1)
Disclosure in respect of discontinued operations (IFRS 5)
¾
Other statements of performance Operating Segments (IFRS 8) Statement of cash flows (IAS 7)
Statements showing changes in equity (IAS 1)
¾
Other non mandatory disclosures Operating and financial reviews
¾
Corporate governanceCommentary
Note that many of these areas are covered elsewhere in this system. All of these areas need to be incorporated into an understanding of how international GAAP provides information to enable users to understand performance.
2
INTRODUCTION
2.1
Scope
2.2
Definitions
¾
Accounting policies are the specific principles, bases, conventions, rules andpractices applied by an entity in preparing and presenting financial statements.
¾
Changes in accounting estimate are adjustments to the carrying value of anasset or liability, or the amount of annual consumption of an asset, that results from the assessment of the present status of, and expected future benefits and obligations associated with, assets and liabilities. These changes arise due to new information or developments and therefore are not to be classed as correction of errors.
Examples of changes in accounting estimate are:
A receivable balance that is subsequently not recovered. Changes to the useful life of a depreciable non-current asset
¾
International Financial Reporting Standards are Standards andInterpretations adopted by the IASB. They comprise: International Financial Reporting Standards; International Accounting Standards;
International Financial Reporting Interpretations Committee pronouncements; and
Standing Interpretations Committee pronouncements
¾
Prior period errors are omissions and misstatements, relating to the financialstatements of previous periods arising from a failure to use, or misuse, information that:
Was available when those financial statements were authorised for issue
Could reasonably be expected to have been obtained and taken into account in the preparation and presentation of the financial
statements.
3
ACCOUNTING POLICIES
3.1
Selection and application
¾
When an IFRS applies to a transaction, the accounting policy or policies applied to that transaction shall be determined by applying the relevant IFRS along with any relevant implementation guidance issued by the IASB.¾
If there is no applicable IFRS relating to a transaction, management shall use its judgement in developing and applying an accounting policy resulting in information that: is relevant to the economic decision making needs of users is reliable
represents faithfully
reflects the economic substance of the transaction is neutral
is prudent
is complete in all material aspects.
¾
Management when making judgement may well consider requirements of accounting standards dealing with similar transactions, the definitions and recognition criteria in the Framework, recent pronouncements of other standard-setting bodies that use a similar conceptual framework, and any other accounting literature denoting best practice within a particular industry.Illustration 1
Kitty has recently purchased a Van Gogh painting to display in their client reception area, with the hope it will lead to more contracts and that the painting will appreciate in value.
There is no specific accounting standard that deals with these types of asset, but IAS 40 Investment Property does deal with a particular type of asset that is being held for capital appreciation.
It would therefore seem appropriate to use IAS 40 as justification to value the painting at fair value year on year.
3.2
Consistency of accounting policies
¾
An entity shall be consistent in selection and application of accounting policies to transactions of a similar nature.3.3
Changes in accounting policy
3.3.1
When
¾
An entity shall only change its accounting policy if: it is required to do so by an IFRS; or it would result in the financial statements providing more relevant and reliable information.
¾
As users of financial statements will wish to see trends in an entity’s financial statements it would not be appropriate for an entity to change its accounting policy whenever it wishes.¾
If an entity decides to adopt the revaluation model of IAS 16 Property, Plant andEquipment this would be classed as a change in accounting policy.
3.3.2
How
¾
If a new accounting standard is issued the transitional provisions of that standard will be applied to any change of accounting policy. When IAS 39 Financial Instruments,Recognition and Measurement was first issued it required entity’s to value and recognise
all derivative instruments in an entity’s statement of financial position with effect from 1 January 2001.
¾
If the new standard does not have any transitional provisions, or it is a voluntary change in policy, then the entity shall apply the change in policy retrospectively.¾
When a change is applied retrospectively, an entity shall adjust the opening balance ofeach affected part of equity for the earliest period presented and the comparative amounts disclosed for each prior period as if the new policy had always been applied.
¾
If it is not practicable to apply the effects of a change in policy to prior periods then thestandard allows the change of policy to be made from the earliest period for which retrospective application is practicable.
3.3.3
IAS 1 presentation
3.4
Disclosure
3.4.1
Change due to new IFRS
¾
Title of new IFRS and the nature of the change in policy.¾
When applicable, that the change is made in accordance with the IFRS’s transitional provisions, a description of those provisions and the effect that the provisions might have on future periods.¾
For the current period and each prior period presented the amount of the adjustment for each line item affected within the financial statements.¾
The amount of the adjustment relating to periods before those presented.¾
If retrospective restatement is not practicable, the circumstances that led to the existence of the condition and a description of how and from when the change has been applied.3.4.2
Voluntary change in policy
¾
Nature of the change in policy¾
Reasons why the new policy provides more reliable and relevant information.¾
For the current period and each prior period presented the amount of the adjustment for each line item affected within the financial statements.¾
The amount of the adjustment relating to periods before those presented.Illustration 2
Alpha, an incorporated entity has previously followed a policy of capitalisation of development expenditure. It has recently decided to adopt the provisions of IAS 38 Intangible Assets, for the year ending 31st December 2007. Alpha has been advised by their auditors that the expenditure previously capitalised does not qualify for capitalisation under the recognition criteria set out in the
standard.
The notes to the accounts for the year ended 31st December 2006 in respect of the deferred development expenditure was as follows:
$ Balance at 1st January 2006 1,000
Additions 500
Amortisation (400)
______ Balance at 31st December 2006 1,100 ______
During the year ended 31st December 2007 the company has expensed all expenditure in the period on projects, in respect of which, expenditure had previously been capitalised, and no amortisation has been charged in the statement of comprehensive income in 2007.
The following are extracts from the draft accounts for the year ended 31st December 2007.
Statement of comprehensive incomes 2007 2006
(as previously published)
$ $
Revenue 1,200 1,100
Expenses (800)
______ ______ (680)
Profit for the year 400 420
______ ______ Statement of changes in equity (extract) $ $ Balance as at 1st January 3,000 2,580
Profit for the year 400
______ ______ 420 Balance as at 31st December 3,400
______ ______ 3,000
Required:
Show how the statement of comprehensive income and statement of changes in equity would appear in the financial statements for the year ended 31st
Solution
Statement of comprehensive incomes 2007 2006
(as restated)
$ $
Revenue 1,200 1,100
Expenses (800)
______ ______ (780)
Profit for the year 400 320
______ ______
Statement of changes in equity (extract) $ $
Balance as at 1st January 2007
As previously stated 3,000 2,580
Prior period adjustment (1,100)
______ ______ (1,000)
1,900 1,580
Profit for the year 400
______ ______ 320 Balance as at 31st December 2007 2,300
______ ______ 1,900 Notes
1 The entity amortised $400 in 2006 but spent $500. The policy would have been to write off the amount of expenditure directly to the statement of comprehensive income, therefore the entity needs to adjust last year’s figures by an extra $100 expense.
The adjustment against last year’s statement of comprehensive income ($100) has the effect of restating it to what it would have been if the company had been following the same policy last year. This is important because the statement of comprehensive incomes as presented shall be prepared on a comparable basis. 2 The balance left on the deferred expenditure account at the end of the previous
year (1,100) is written off against the accumulated profit that existed at that time. This 1,100 is made up of an amount that arose last year (the difference between the amount spent ($500) and the amount amortised ($400), and the balance that existed at the beginning of the previous year ($1,000)).
4
CHANGES IN ACCOUNTING ESTIMATE
4.1
Introduction
¾
Many items recognised in the financial statements must be measured with an element of estimation attached to them. Receivables may be measured after allowing for a general bad debt allowance Inventory is measured at lower of cost or net realisable value but must provide for
obsolescence
A provision under IAS 37 by its very nature may be an estimation of future economic benefits to be paid out
Non-current assets are depreciated, the charge takes into account the expected pattern of consumption of the asset and its expected useful life. The consumption pattern and expected life are estimates.
4.2
Accounting treatment
¾
As soon as a change in circumstances occur which affect the estimates previously made, the effect of that change shall be recognised prospectively by including in the current and future (where relevant) periods profit or loss. A change in estimate is not an error or a change in accounting policy and therefore does not impact upon prior period statements.¾
If the change in estimate affects the measurement of assets or liabilities then the change shall be recognised by adjusting the carrying amount of the asset or liability.4.3
Disclosure
¾
The nature and amount of a change in estimate that has an effect in the current period or is expected to have an effect in future periods.¾
If it is not possible to estimate the effects on future periods then that fact must be disclosed.5
PRIOR PERIOD ERRORS
5.1
Introduction
5.2
Accounting treatment
¾
The amount of the correction of an error that relates to prior periods shall be reported by adjusting the opening balance of retained earnings and restating comparative information.¾
The financial statements of the current period are presented as if the error had been corrected in the period in which the error was originally made. However, an entity does not reissue the financial statements of prior periods.¾
If it is not practicable to determine the period specific effects of an error on comparative information for prior periods presented, the entity shall restate the opening balances for the earliest period practicable.5.3
Disclosures
¾
Nature of the error¾
For each prior period presented the amount of the correction for each line item affected within the financial statements¾
The amount of the correction at the beginning of the earliest period presented.¾
If retrospective restatement is not practicable, the circumstances that led to the existence of the condition and a description of how and from when the error has been corrected.FOCUS
You should now be able to:
¾
distinguish between changes in accounting policies and changes in accounting estimates and describe how accounting standards apply the principle of comparability where an entity changes its accounting policies;