Chapter-3
Chapter-3
Section overview
• There are limitations inherent in financial statements, including the fact that they are:
– a conventionalised representation, involving classification, aggregation and the
allocation of items to particular accounting periods;
– historical (backward-looking); and
– based almost exclusively on financial data.
• The formation of the ISSB and the development of IFRS Sustainability Disclosure
Standards will help in overcoming some of these limitations.
Section overview
It is important that you are familiar with the Code and the following information regarding
fundamental principles, threats and safeguards. In the exam, you will be provided with a
scenario and you will need to apply your knowledge of the Code to the information
presented. Ensure that your answer is relevant to the given scenario and not a generic
answer regarding ethical behaviour.
7.2.1 Integrity
Definition
Integrity: To be straightforward and honest in all professional and business relationships.
Integrity also means that members must not knowingly be associated with misleading
information.
7.2.2 Objectivity
Definition
Objectivity: Not to compromise professional or business judgements because of bias,
conflict of interest or undue influence of others.
The professional accountant needs to remain impartial and independent, and not let the
potential for any financial, professional or personal gain affect their judgement. Objectivity
also requires the accountant to not be affected by undue influence of others, such as a
dominant superior or client interests.
Definition
Professional competence and due care: To attain and maintain professional knowledge and
skill at the level required to ensure that a client or employing organisation receives
competent professional service, based on current technical and professional standards and
The Code requires the professional accountant to be diligent in monitoring their requirements,
either on learning new skills or monitoring their progress on assignments in the workplace.
Professional competence may be divided into two separate phases:
• Attainment of professional competence – initial professional development
• Maintenance of professional competence – continuing professional development (CPD)
It is important that the accountant only undertakes work that they are qualified to do,
including ensuring that they have sufficient time and resources to do the work to the best of
their abilities. It may be that additional training from a team member or supervisor is required,
or a more realistic deadline.
CPD is a requirement for the Chartered Accountant, as it ensures that technical updates and new
accounting requirements are learnt and understood for application either in business or in
practice.
Definition
Professional behaviour: To comply with relevant laws and regulations and avoid any conduct that
the professional accountant knows or should know might discredit the profession.
A professional accountant should not engage in a business occupation or activity that impairs, or
might impair, the profession. They must avoid any actions, both professionally and personally,
that could bring the profession into disrepute.
7.2.5 Confidentiality
Definition
Confidentiality: To respect the confidentiality of information acquired as a result of professional
and business relationships. Confidential information must not be disclosed outside the
organisation without authority, unless there is a duty or right to disclose, or disclosure is in the
public interest and permitted by law.
The professional accountant must maintain confidentiality even in a social environment and
even after employment with the client/employer has ended. It is also vital that there is no
inadvertent breach of confidentiality, such as if you have two clients in a similar industry,
there is a risk that information gained on one could be used to inform or influence the other,
however unintended.
Exceptions to this principle are when the professional accountant is permitted by law or due
to a right to disclose to breach confidentiality:
• quality review undertaken by a professional body (such as Quality Assurance (QA) review
for those in public practice);
• in order to respond to an investigation by a professional or regulatory body (such as FCA);
• during legal proceedings against the accountant;
• to comply with technical and professional standards, including ethics requirements; or
• disclosure is required by law (such as Money Laundering disclosures in a Suspicious
Activity Report (SAR) or resulting from a criminal investigation of fraud).
Definitions
Threats: Threats to compliance with the fundamental principles might be created by a broad
range of facts and circumstances. The threats to compliance with the fundamental principles fall
into one more of the following categories: self-interest, self-review, advocacy, familiarity and
intimidation threats.
Safeguards: Safeguards are actions, individually or in combination, that the professional
accountant takes that effectively reduce threats to compliance with the fundamental principles
to an acceptable level.
Compliance with these fundamental principles may potentially be threatened by a broad range of
circumstances.
The Code provides details of a number of different threats, together with potential
safeguards which the professional accountant would need to implement in order to reduce
the risk of those threats to an acceptable level.
Where the threats cannot be reduced to an acceptable level, the professional accountant
should consider resignation from the role or the client.
The following table gives the five key threats identified by the Code, together with examples of
when the threats may arise (and the fundamental principle being threatened). Potential
safeguards are then proposed.
This list is not exhaustive and reference to the Code will provide further examples and guidance.
In your exam, a good approach to answering questions which present an ethical problem would
be to:
• Identify the fundamental principle in question.
• Identify the threat.
• Suggest safeguards, relevant to the scenario.
Solution
Consider the fundamental principles most at risk in the scenario:
• Objectivity – Your objectivity is at risk (there is a self-interest threat) due to the
domineering personality of the manager and the fact that a bonus is available if
objectives are met.
• Professional competence and due care – if you are concerned that revenue has not
been recognised in accordance with technical and professional standards, your
professional competence may be called into question.
You should not comply with your manager’s request. You should politely decline to recognise
revenue per his instructions and try to explain your reasoning by reference to the IFRS
Standards. If your manager does not agree, you should escalate it within your organisation or
contact the ICAB helpline.
1 Knowledge diagnostic
Before you move on to question practice, confirm you are able to answer the following
questions having studied this chapter. If not, you are advised to revisit the relevant
learning from the topic indicated.
1 Ensure you can state the two fundamental qualitative characteristics and the four
enhancing qualitative characteristics in the Conceptual Framework. Can you explain
what these terms mean? (Topic 3)
2 How do the concepts of materiality, prudence and going concern work with the
Conceptual Framework, and can you define what is meant by these terms? (Topic 3)
3 What is the IASB and what are the four main stages to issuing a new IFRS Standard?
(Topic 4)
4 Can you explain how the convergence of accounting standards can help the
international investor? (Topic 5)
5 Can you give three examples of the inherent limitations of financial reporting, and
provide suggestions for improving the usability of financial statements for potential
investors? (Topic 6)
6 Can you define and explain the five fundamental ethical principles defined in the ICAB
Code of Ethics? (Topic 7)
7 Can you explain the different threats to the fundamental principles and what
safeguards could be applied to mitigate those threats? (Topic 7)
2 Question practice
Aim to complete all self-test questions at the end of this chapter. The following self-test
questions are particularly helpful to further topic understanding and guide skills application
before you proceed to the next chapter.
Tattenhoe plc This tests your knowledge and understanding of the definitions of true
and fair, fair presentation and substance over form.
An ethical dilemma A brief scenario asks for your comments regarding the ethical
principles, threats and actions which should be taken.
Darlat plc This looks at the impact of changing accounting standards and
some of the ethical issues which may arise.
Once you have completed these self-test questions, it is beneficial to attempt the following
questions from the Question Bank for this module. These questions have been selected to
introduce exam-style scenarios to help you improve knowledge application and professional
skills development before you start the next chapter.
Giyani plc (part Short test of your knowledge of the definitions of elements (5 marks,
4 only) 7-8 minutes).
Laderas plc Question requiring you to explain the limitations of financial statements
(parts 4 and and a discussion of the ethical issues in the scenario (total of 9 marks, 16
5 only) minutes suggested timing).
Once you have attempted these questions, you can continue your studies by moving onto the
next chapter where you will be using the knowledge gained in Chapter 1.
5 Underlying assumption
Financial statements are normally prepared on the assumption that the reporting
entity is a going concern and will continue in operation for the foreseeable future –
Conceptual Framework (3.9)
7 Recognition
• An asset or a liability should be recognised in financial statements if it meets the
definition of an element – Conceptual Framework (5.1, 5.6)
• The cost constraint also affects the recognition decisions, and assets or liabilities are
recognised if the benefit of the information provided is likely to justify the costs of
providing and using that information – Conceptual Framework (5.8)
• Derecognition normally occurs when the item no longer meets the definition of an
asset or liability – Conceptual Framework (5.26, 5.27)
8 Measurement
• Historical cost – Conceptual Framework (6.4-6.9)
• Current value: Fair value – Conceptual Framework (6.12-6.16)
• Value in use – Conceptual Framework (6.17-6.20)
• Fulfilment value – Conceptual Framework (6.17-6.20)
• Current cost – Conceptual Framework (6.21-6.22)
• Present value – Conceptual Framework (4.55)
11 Fair presentation
• Financial statements are required to give a fair presentation of the financial position,
financial performance and cash flows of an entity – IAS 1 (15)
12 IASB
• Objectives of IASB – IFRS Foundation Constitution 2018 (para. 2)
3 An ethical dilemma
You are preparing the end of year financial statements for Book and Barter Ltd. This
requires the collation of divisional information in respect of revenue and costs. Your
colleague, Jago, has mentioned that this collation of data can be made more efficient
by uploading the information to a cloud-based service provider which is integrated with
a social media platform and releases information directly to the public via social media
posts. This cloud-based service provider is relatively new and not yet authorised for use
by Book and Barter Ltd as it cannot confirm that it complies with data protection laws.
Jago has suggested this method as the current tools for sharing the divisional
information is slow and causes a heavy workload.
Requirements
3.1 Referring to the ICAB Code of Ethics, explain the ethical principles that are at risk here.
3.2 State what actions could be appropriate in this circumstance to reduce the risk
to the ethical principles.
Accounting policies
It is essential that the accounting policies selected when implementing IFRS Standards
result infinancial statements that give a fair presentation. The application of the principle
of substanceover form is integral in achieving this.
The choice of accounting policies is a matter of judgement and careful consideration is
requiredparticularly where you wish to override the requirements of an accounting standard.
The finance director wishes to discuss the above extract with you. The finance director has a
strong personality and is adamant that non-compliance with IFRS Standards may be justified
where it does not give a true and fair view.
Requirements
4.1 Prepare notes for your meeting with the finance director:
(a) Explaining the concept of ‘fair presentation’ and comparing it with ‘true and fair view’.
(b) Explaining the concept of ‘substance over form’ and its relationship to
‘faithful representation’.
(c) Explaining the circumstances in which non-compliance with the detailed provisions of
an IFRS Standard is justified.
4.2 Identify the ethical issues and actions, from the above scenario, that you should consider
arising from the adoption of IFRS Standards and your professional relationship with the
finance director.
Question Answer
Oak plc has purchased a licence for This is an intangible asset, as the licence does
CU25,000. The licence gives the company not have physical substance and is a right that
the use of robotic delivery drones which has the potential to produce economic
will save CU60,000 a year for the next five benefits as a result of holding that licence – in
years. Should Oak plc classify the licence as this case, the costs savings.
an asset?
Pear Ltd acts as a trustee for shares held by No, these shares cannot be classified as an
Piper Ltd. Piper Ltd retains the voting rights asset by Pear Ltd as Piper Ltd retains the right
as well as receiving the dividends from the to the economic benefits (the dividends) and
shares. Pear Ltd receives a fee for the trustee the control of the shares.
services they provide to Piper Ltd. Can Pear
Ltd classify these shares as assets?
Sycamore Ltd provides a standard warranty These are liabilities which must be
with the purchase of every laptop it sells. recognised by Sycamore Ltd. The business
These standard warranties are not paid for has an obligation to fulfil the terms of the
by the purchaser and are valid for a period warranty within that post sale (24 month)
of 24 months from the date of sale. Does period and the liability would be recognised
Sycamore Ltd have to recognise these when the warranty is issued, as this is when
warranties as liabilities? Sycamore’s obligation arises, rather than
when a claim is made.