FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 1

FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 2

FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 3

• Assist preparers of financial statements in applying Accounting Standards and in dealing with topics that have yet to form the subject
of an Accounting Standard
• Assist the Accounting Standards Board in the development of future Accounting Standards and in its review of existing Accounting
Standards
• Assist the Accounting Standards Board in promoting harmonisation of regulations, accounting standards and procedures relating to
the preparation and presentation of financial statements by providing a basis for reducing the number of alternative accounting
treatments permitted by Accounting Standards
• Assist auditors in forming an opinion as to whether financial statements conform with Accounting Standards
• Assist users in interpretation of Financial Statements.
• Provide those who are interested in the work of the Accounting Standards Board with information about its approach to the formulation
of Accounting Standards

EXAMPLE
Dee Co wants to obtain a working capital loan from a bank. Its Finance Director, Deacon, knows that the working capital borrowing amount
(drawing power) depends on the value of net current assets, especially trade receivables, inventory and trade payables.
Required: Give an example as to how he can manipulate the figures to obtain a higher working capital loan.
1. Deacon could book a sale earlier than he should, to show higher receivables
2. He could artificially inflate inventory, by changing the valuation method
3. He could state that he has paid some creditors, to reduce payables A
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 4

The frameworks can be applied on all kinds of (E.g., prospectuses and computations prepared for
general purpose financial statements (including taxation purpose) are outside the scope of this
consolidated financial statements) irrespective Framework. Nevertheless, the Framework may be
of period for which it is being prepared (e.g., applied in the preparation of such special purpose
quarterly or annually). reports where their requirements permit.

The Framework applies to the financial

FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 5
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 6

Elements of Financial Statements are the broad classes through which the Financial Statements portray the financial effects of transactions
and other events by grouping them according to their economic characteristics.

Elements directly related to Elements directly related to

measurement of Financial measurement of performance
Position in the Balance Sheet in the Statement of Profit and
• Assets Loss
• Liabilities • Income
• Equity • Expenses
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 7

• Information about the • Information about the Performance of

• Economic Resources an entity (i.e. Profitability)
The objective of financial statements is
• Financial Structure of the • To predict capacity to Generate cash
to provide information about the flow from existing resource base.
entity
financial position, performance and
• Liquidity and Solvency • To form Judgments about effectiveness
cash flows of an entity that is useful to with which additional resources might
• Capacity to adapt changes
a wide range of users in making be employed.
economic decisions.

• To assess its investing, financing and • Notes and other statements present
operating activities supplementary information explaining
• To assess ability to Generate cash and cash different items of financial statements.
equivalents and the need of the entity to • They include various other disclosures such
utilize those cash flows as disclosure of accounting policies,
segment reporting, related party
disclosures, earnings per share, etc.
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 8
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 9

SOURCE : CHENNAI SUPER KING ANNUAL REPORT 2020-2021

FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 10

ACCRUAL
Example
a) A trader purchased article A on credit in period 1 for ` 50,000.
b) He also purchased article B in period 1 for ` 2,000 cash.
c) The trader sold article A in period 1 for ` 60,000 in cash.
Under this basis, the effects of transactions and other events are:
d) He also sold article B in period 1 for ` 2,500 on credit.
• Recognized when they occur (and not as cash or its equivalent is received or paid)
Profit and Loss Account of the trader by two basis of accounting are shown below. A look at the cash basis Profit and Loss Account will convince any
• Recorded
reader in the accounting
of the irrationality records
of cash basis and reported in the financial statements of the
of accounting.
periods to which they relate.
• Financial
SOLUTION 1 SOLUTION
statements prepared on the accrual basis inform users not only of2past
Cash basis
eventsof involving
accountingthe payment and receipt of cash but also of obligations
Accrual basis of accounting
to pay
Cash purchase of article
cash in the futureBand
andofcash sale of that
resources articlerepresent
A is recognised
cash toinbe
period Credit
received purchase
in the future.of article A and cash purchase of article B and cash sale
1 while purchase of article A on payment and sale of article B on receipt is of article A and credit sale of article B is recognised in period 1 only.
recognised in period 2.
Profit and Loss Account Profit and Loss Account
` ` ` `
Period 1 To Purchase 2,000 Period 1 prepared
By Sale on the 60,000 InPeriod
order1 toToachieve comparability
Purchase 52,000of thePeriod
financial
1 Bystatements
62,500
The financial statements are normally
To Net Profit 58,000is a going concern and will____ _ of an enterprise through time, the accountingSale
policies are
assumption that an entity To Net Profit 10,500
followed consistently from one period to another.
continue in operation 60,000
for the foreseeable future. If an 60,000 62,500 62,500
An Accounting policy can be changed if the change is required:
intention
Period 2 ToorPurchase
need to liquidate
50,000 or Period
curtail2materially
By Sale exists, 2,500
the financial statements may have to be prepared on a • By a statue or,
_______ By Net Loss 47,500
different basis and, if so, the basis used is disclosed. • By an Accounting Standard or
50,000 50,000
• For more appropriate presentation of Financial
Statements.
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 11

GOING CONCERN
Illustration 1
Balance sheet of a trader on 31st March, 20X1 is given below:
Liabilities Assets
Capital 60,000 Property, Plant and Equipment 65,000
Prof. & Loss A/c 25,000 Stock 30,000
10% Loan 35,000 Trade receivables 20,000
Trade payables 10,000 Deferred expenditure 10,000
Bank 5,000
1,30,000 1,30,000
Additional information:
a) The remaining life of Property, Plant and Equipment is 5 years. The
pattern of use of the asset is even. The net realisable value of Property,
Plant and Equipment on 31.03.X2 was ` 60,000.
b) The trader’s purchases and sales in 20X1-X2 amounted to ` 4 lakh and
` 4.5 lakh respectively.
c) The cost and net realisable value of stock on 31.03.X2 were ` 32,000 and
` 40,000 respectively.
d) Expenses (including interest on 10% Loan of ` 3,500 for the year)
amounted to ` 14,900.
e) Deferred expenditure is amortised equally over 4 years.
f) Trade receivables on 31.03.X2 is ` 25,000, of which ` 2,000 is doubtful.
Collection of another ` 4,000 depends on successful re-installation of
certain product supplied to the customer.
g) Closing trade payable is ` 12,000, which is likely to be settled at 5%
discount.
h) Cash balance on 31.03.X2 is ` 37,100.
i) There is an early repayment penalty for the loan ` 2,500.
You are required to prepare Profit and Loss Accounts and Balance Sheets of
the trader in both cases (i) assuming going concern (ii) not assuming going
concern.
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 12
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 13

EXAMPLE
Sollato Co operates in the field of mining. There was an estimate total of 1,000,000 MT of the mineral dynasia, out of which it had extracted
600,000 MT to date. During the current year, the local government had declared a limit on production, since new research had confirmed grave
health hazards associated with dynasia.
The government gave companies one year to stop extracting dynasia. Sollato managed to extract only 200,000 MT in that year. It did not report
in the financial statements the fact that the government had stopped production.
Has Sollato violated any principles? If so, which ones?
SOLUTION
1. Relevance – as the non-disclosure could affect users’ decisions
2. Reliability – asset valuation of mine incorrect

Financial statements are required to show a true and fair view of the performance, financial position and cash flows of an
enterprise. The framework does not deal directly with this concept of true and fair view, yet application of the principal
qualitative characteristics and appropriate accounting standards normally results in financial statements portraying true and
fair view of information about an enterprise.
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 14

Recognition is the process of incorporating in the Financial Statements (Balance Sheet or Profit and Loss Account), an
item that meets the definition of an element and satisfies the criteria for recognition.
An Item which satisfies the definition of an element should be recognized only if:
• It is probable that any future economic benefits associated with the item will flow to or from the entity
• The item has a cost or value that can be measured with reliability.
[Probable: Probable has not been defined by the framework, however it has been defined by ‘AS 29- Provisions, Contingent
Liabilities and Contingent Assets’ as “more likely than not” which means there are more chances of happening the
inflow/ outflow rather it does not.]
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 15
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 16

SOURCE : REAL MADRID ANNUAL REPORT 2021-2022

FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 17

“A liability is a present obligation of the entity arising from past events, the
settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefits”
A liability is recognized in the balance sheet
Note:
when it is probable that an outflow of
A) Liability cannot be booked on the basis of Future expected obligation.
resources embodying economic benefits will
B) Liabilities, where timing and amount are not certain, but meets the recognition
result from the settlement of a present
criteria, then the amounts are being estimated using some techniques and shown
obligation and the amount at which the
as ‘Provisions’.
settlement will take place can be measured
reliably.

“Equity is the residual interest in the assets of the entity

after deducting all its liabilities” equity represents owners’
claim consisting of items like capital and reserves, which
are clearly distinct from liabilities,
Notes:
1) Equity is divided into many sub parts: Security
Premium, Reserve Fund, Retained Earnings etc. The
segregation eventually describes the capacity of an entity
to pay dividends in the future. The existence of some funds
within the equity sometimes are required by the law and it
provides an insight to the user of financial statements.
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 18

“Income is increase in economic benefits during the accounting period in the form of inflows or enhancements of
assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from
equity participants.”

Gains represent other items that meet the definition

of income and may or may not, arise in the course of
Revenue arises in the course of the ordinary the ordinary activities of an entity. Gains are often
activities of an entity. reported net of related expenses. The definition of
income includes unrealized gains.

Example: Gain on sale of Investment, Gain on sale of

Example: Sales, Commission income on sale, Interest Building, Gain on Legal Settlement, and Gain on early
extinguishment of debt.

Recognition of Income: Income is recognized in the statement of profit and loss when an increase in future economic benefits related to an increase
in an asset or a decrease of a liability has arisen that can be measured reliably.
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 19

“Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions
of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to
equity participants.”

Losses represent other items that meet the

definition of expenses and may or may not,
Expenses that arise in the course of the
arise in the course of the ordinary activities of
ordinary activities
the entity.

Example: Loss from fire, Loss from flood, Loss on sale of

Example: cost of sales, wages and depreciation
securities, Loss on sale of buildings
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 20

Recognition of Expense:
Expenses are recognized in the statement of profit and loss when a decrease in future economic benefits related to a decrease in an asset
or an increase of a liability has arisen that can be measured reliably.
i. Matching costs with revenue generated: It involves simultaneous or combined recognition of revenues and expenses that result directly
and jointly from the same transactions or other events.
Example: The various components of expense making up the cost of goods sold are recognised at the same time as the income derived
from the sale of the goods.
ii. Economic benefit to arise in one or more accounting periods:
When economic benefits are expected to arise over several accounting periods and the association with income can only be broadly or
indirectly determined, expenses are recognised in the statement of profit and loss on the basis of systematic and rational allocation
procedures.
E.g., Amortization and Depreciation
iii. Immediate recognition of expense:
An expense is recognised immediately in the statement of profit and loss when an expenditure produces no future economic benefits.
An expense is also recognised to the extent that future economic benefits from an expenditure do not qualify, or cease to qualify, for
recognition in the balance sheet as an asset.
iv. Recognition of Liability with an expense:
An expense is recognised in the statement of profit and loss in those cases also where a liability is incurred without the recognition of
an asset.
E.g., In the case of a liability under a product warranty.
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 21

EXAMPLE
Suppose at the beginning of an accounting period, aggregate values of assets, liabilities and equity of a trader are ` 5 lakh, ` 2 lakh and `
3 lakh respectively.
Also suppose that the trader had the following transactions during the accounting period.
1. Introduced capital ` 20,000.
2. Earned income from investment ` 8,000.
3. A liability of ` 31,000 was finally settled on payment of ` 30,000.
4. Wages paid ` 2,000.
5. Rent outstanding ` 1,000.
6. Drawings ` 4,000.
SOLUTION
Balance sheets of the trader after each transaction are shown below:
Assets Liabilities Equity
Transactions – =

Opening 5.00 – 2.00 = 3.00

(a) Capital introduced 5.20 – 2.00 = 3.20
(b) Income from investments 5.28 – 2.00 = 3.28
(c) Settlement of liability 4.98 – 1.69 = 3.29
(d) Wages paid 4.96 – 1.69 = 3.27
(e) Rent Outstanding 4.96 – 1.70 = 3.26
(f) Drawings 4.92 – 1.70 = 3.22
The example given above explains the definition of expense. The equity decreased by ` 7,000 from ` 3.29 lakh to ` 3.22 lakh due to (i)
Drawings ` 4,000 and (ii) Expenses incurred ` 3,000 (Wages paid + Rent).
Expenses therefore result in decrease of equity without drawings. Also note that expenses incurred is accompanied by either decrease of
asset (Cash paid for wages) or by increase in liability (Rent outstanding).
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 22

Measurement is the process of determining the monetary amounts at which the elements of Financial Statements are
to be recognized and carried in the balance sheet and Profit and Loss Account.
There are several measurement methods as defined / required by respective accounting standards. Brief description of
the same is as follows:

Historical Cost means the transaction value that has been given or received at the time of recognizing such element in the financial
statements together with all attributable costs incurred or expected to be incurred.
Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire them
at the time of their acquisition.
Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example,
income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of
business.
Expenses therefore result in decrease of equity without drawings. Also note that expenses incurred is accompanied by either decrease
of asset (Cash paid for wages) or by increase in liability (Rent outstanding).
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 23

EXAMPLE
Mr. X purchased a machine on 1st January, 20X1 at ` 7,00,000. As per historical cost basis, he has to record it at ` 7,00,000 i.e. the acquisition
price. As on 1.1.20X6, Mr. X found that it would cost ` 25,00,000 to purchase that machine. Mr. X also took loan from a bank as on 20X1 for
` 5,00,000 @ 18% p.a. repayable at the end of 15th year together with interest. As per historical cost, the liability is recorded at` 5,00,000
at the amount of proceeds received in exchange for obligation and asset is recorded at ` 7,00,000.

Current Cost means the value of an element which has been recognized at its recent paid / received
price.

Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same
or an equivalent asset were acquired currently.

Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required
to settle the obligation currently.

EXAMPLE
A machine was acquired for $ 10,000 on deferred payment basis. The rate of exchange on the date of acquisition was ` 49 per $. The payments
are to be made in 5 equal annual instalments together with 10% interest per year. The current market value of similar machine in India is `
5 lakhs.
Current cost of the machine = Current market price = ` 5,00,000.
By historical cost convention, the machine would have been recorded at ` 4,90,000.
To settle the deferred payment on current date one must buy dollars at ` 49/$. The liability is therefore recognised at ` 4,90,000 ($ 10,000 ×
` 49). Note that the amount of liability recognised is not the present value of future payments. This is because, in current cost convention,
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 24

Present value means present discounted value of the future

Realizable Value means the value of an element which are required to be net cash inflows / outflows that the item is expected to
recognized at the value which is to be received/ paid by selling or for generate / settle in the normal course of business. The
immediate settlement. calculated value will represent its current value.

Assets are carried at the amount of cash or cash equivalents that could Assets are carried at the present value of the future net
currently be obtained by selling the asset in an orderly disposal. Liabilities cash inflows that the item is expected to generate in the
are carried at their settlement values, that is, the undiscounted amounts of normal course of business. Liabilities are carried at the
cash or cash equivalents expected to be required to settle the liabilities in present value of the future net cash outflows that are
the normal course of business. expected to be required to settle the liabilities in the normal
course of business.

EXAMPLE
Carrying amount of a machine is ` 40,000 (Historical cost less depreciation). The machine is expected to generate ` 10,000 net cash inflow.
The net realisable value (or net selling price) of the machine on current date is ` 35,000. The enterprise’s required earning rate is 10% per
year.
The enterprise can either use the machine to earn ` 10,000 for 5 years. This is equivalent of receiving present value of ` 10,000 for 5 years at
discounting rate 10% on current date. The value realised by use of the asset is called value in use. The value in use is the value of asset by
present value convention.
Value in use = ` 10,000 (0.909 + 0.826 + 0.751 + 0.683 + 0.621) = ` 37,900
Net selling price = ` 35,000
The present value of the asset is ` 37,900, which is called its recoverable value. It is obviously not appropriate to carry any asset
at a value higher than its recoverable value. Thus the asset is currently overstated by ` 2,100 (` 40,000 – ` 37,900).
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 25

CONCEPT OF CAPITAL MAINTENANCE AND DETERMINATION OF

PROFIT:
Financial capital maintenance at historical cost: Under this convention, opening and closing assets are stated at respective historical costs to

ascertain opening and closing equity. If retained profit is greater than or equals to zero, the capital is said to be maintained at historical costs.

This means the business will have enough funds to replace its assets at historical costs. This is quite right as long as prices do not rise.
Financial capital maintenance at current purchasing power: Under this convention, opening and closing equity at historical costs are restated

at closing prices using average price indices. (For example, suppose opening equity at historical cost is ` 3,00,000 and opening price index is 100.

The opening equity at closing prices is ` 3,60,000 if closing price index is 120). A positive retained profit by this method

Physical capital maintenance at current costs: Under this convention, the historical costs of opening and closing assets are restated at closing
prices using specific price indices applicable to each asset. The liabilities are also restated at a value of economic resources to be sacrificed to

settle the obligation at current date, i.e. closing date. The opening and closing equity at closing current costs are obtained as an excess of

aggregate of current cost values of assets over aggregate of current cost values of liabilities. A positive retained profit by this method ensures

retention of funds for replacement of each asset at respective closing prices.

FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 26

QUESTION
SOLUTION
A trader commenced business on 01/01/20X1 with ` 12,000 represented
Financial Capital Maintenance at historical costs
by 6,000 units of a certain product at` 2 per unit. During the year 20X1
he sold these units at ` 3 per unit and had withdrawn ` 6,000. Let us Closing capital (At historical cost) 12,000
assume that the price of the product at the end of year is ` 2.50 per Less: Capital to be maintained
unit. In other words, the specific price index applicable to the product Opening capital (At historical cost) 12,000
is 125. Introduction (At historical cost) Nil (12,000)
Retained profit Nil
Current cost of opening stock = (` 12,000 / 100) x 125 = 6,000 x ` 2.50
Financial Capital Maintenance at current purchasing power
= ` 15,000
Current cost of closing cash = ` 12,000 (` 18,000 – ` 6,000)
Closing capital (At closing price) 12,000
Opening equity at closing current costs = ` 15,000 Less: Capital to be maintained
Closing equity at closing current costs = ` 12,000 Opening capital (At closing price) 14,400
Retained Profit = ` 12,000 – ` 15,000 = (-) ` 3,000 Introduction (At closing price) Nil (14,400)
The negative retained profit indicates that the trader has failed to Retained profit/(loss) (2,400)
maintain his capital. The available fund of` 12,000 is not sufficient to Physical Capital Maintenance
buy 6,000 units again at increased price of ` 2.50 per unit. The
Closing capital (At current cost) ( 4,800 12,000
drawings should have been restricted to ` 3,000 (` 6,000 – ` 3,000). units)
Had the trader withdrawn ` 3,000 instead of ` 6,000, he would have Less: Capital to be maintained
left with `15,000, the fund required to buy 6,000 units at ` 2.50 per Opening capital (At current cost) (6,000 15,000
units)
unit.
Introduction (At current cost) Nil (15,000)
You are required to compute the Capital maintenance under all three
Loss resulting in non-maintenance of capital (3,000)
bases ie. (i) Historical costs, (ii) Current purchasing power and (iii)
Physical capital maintenance.
FRAMEWORK FOR PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS 27

QUESTION
SOLUTION
Do the following classify as an asset or liability within the definitions i. Machinery - an asset as there is a past event (purchase), control
given by the Framework? Give reasons. (by Mitchell) and future economic benefit (use of the machine to
i. Mitchell Ltd has purchased machinery for $100,000. Also it create income).
purchased a patent for $25,000. The patent will give the company The patent purchased is an (intangible) asset - there is a past
sole use of a particular manufacturing process which will save event, control and future economic benefit through cost savings.
$4,000 a year for the next four years. So, both are assets and will be recognised in the financial
ii. Adams Car Sales has an intention to purchase four imported cars, statements.
in the coming international car show to be held in London. ii. This cannot be classified as an asset Adams Car Sales only has an
iii.Poolwhirl Co provides a warranty with every refrigerator sold. intention to purchase – this intention is only in the mind, not in
hand. In order to recognise an item as an asset, a past event,
control and future economic benefits are required. The intention to
purchase a car cannot become an asset as there is no past event,
no control and no future economic benefits.
iii.This is a liability: the business has taken on a present obligation as
a result of a past event (the sales), there is a probability of future
outflow of economic resources (replacing the fridge) and a reliable
estimate can be made of the obligation (cost of replacing the
fridge). This liability would be recognised when the warranty is
issued rather than when a claim is made.