Module 02 Version 2011 8 Concepts and Pervasive Principles
Module 02 Version 2011 8 Concepts and Pervasive Principles
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This training material has been prepared by IFRS Foundation education staff. It has not been approved by the International Accounting Standards Board (IASB). The training material is designed to assist those training others to implement and consistently apply the IFRS for SMEs. For more information about the IFRS education initiative visit http://www.ifrs.org/Use+around+the+world/Education/Education.htm. IFRS Foundation 30 Cannon Street | London EC4M 6XH | United Kingdom Telephone: +44 (0)20 7246 6410 | Fax: +44 (0)20 7246 6411 Email: [email protected] Web: ww.ifrs.org Copyright 2011 IFRS Foundation Right of use Although the IFRS Foundation encourages you to use this training material, as a whole or in part, for educational purposes, you must do so in accordance with the copyright terms below. Please note that the use of this module of training material is not subject to the payment of a fee. Copyright notice All rights, including copyright, in the content of this module of training material are owned or controlled by the IFRS Foundation. Unless you are reproducing the training module in whole or in part to be used in a stand-alone document, you must not use or reproduce, or allow anyone else to use or reproduce, any trade marks that appear on or in the training material. For the avoidance of any doubt, you must not use or reproduce any trade mark that appears on or in the training material if you are using all or part of the training materials to incorporate into your own documentation. These trade marks include, but are not limited to, the IFRS Foundation and IASB names and logos. When you copy any extract, in whole or in part, from a module of the IFRS Foundation training material, you must ensure that your documentation includes a copyright acknowledgement that the IFRS Foundation is the source of your training material. You must ensure that any extract you are copying from the IFRS Foundation training material is reproduced accurately and is not used in a misleading context. Any other proposed use of the IFRS Foundation training materials will require a licence in writing. Please address publication and copyright matters to: IFRS Foundation Publications Department 30 Cannon Street London EC4M 6XH United Kingdom Telephone: +44 (0)20 7332 2730 Fax: +44 (0)20 7332 2749 Email: [email protected] Web: www.ifrs.org The IFRS Foundation, the authors and the publishers do not accept responsibility for loss caused to any person who acts or refrains from acting in reliance on the material in this publication, whether such loss is caused by negligence or otherwise.
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Contents
INTRODUCTION __________________________________________________________ Learning objectives ________________________________________________________ IFRS for SMEs ____________________________________________________________ Introduction to the requirements_______________________________________________ 1 1 2 2
REQUIREMENTS AND EXAMPLES ___________________________________________ 4 Scope of this section _______________________________________________________ 4 Objective of financial statements of small and medium-sized entities __________________ 5 Qualitative characteristics of information in financial statements ______________________ 6 Financial position _________________________________________________________ 17 Performance _____________________________________________________________ 26 Recognition of assets, liabilities, income and expenses ___________________________ 29 Measurement of assets, liabilities, income and expenses __________________________ 30 Pervasive recognition and measurement principles _______________________________ 32 Accrual basis ____________________________________________________________ 34 Recognition in financial statements ___________________________________________ 35 Measurement at initial recognition ____________________________________________ 39 Subsequent measurement __________________________________________________ 39 Offsetting _______________________________________________________________ 40 SIGNIFICANT ESTIMATES AND OTHER JUDGEMENTS _________________________ 42 COMPARISON WITH FULL IFRSs ___________________________________________ 45 TEST YOUR KNOWLEDGE ________________________________________________ 46 APPLY YOUR KNOWLEDGE _______________________________________________ Case study 1 ____________________________________________________________ Answer to case study 1 ____________________________________________________ Case study 2 ____________________________________________________________ Answer to case study 2 ____________________________________________________ Case study 3 ____________________________________________________________ Answer to case study 3 ____________________________________________________ 51 52 53 54 55 56 57
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INTRODUCTION
This module focuses on the agreed concepts that underlie financial reporting in accordance with the IFRS for SMEs. The concepts in Section 2 are taken from the IASBs Framework for the Preparation and Presentation of Financial Statements which, in 2010, was renamed the Conceptual Framework for Financial Reporting when parts of it were updated. The concepts in the Conceptual Framework are derived from the objective of financial reportingto provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing recourses to the entity. Many of the notes presented in this module are derived from the Basis for Conclusions on the Conceptual Framework. The objective of general purpose financial statements of a small or medium-sized entity is to provide information about the entitys financial position, performance and cash flows that is useful for economic decision-making by a broad range of users (eg existing and potential investors, lenders and other creditors) who are not in a position to demand reports tailored to meet their particular information needs. The IASB uses the concepts to set financial reporting requirements. This enhances the consistency across IFRS requirements and provides a benchmark for making judgements. Preparers of financial statements also use the concepts in applying the IFRS for SMEs. When the IFRS for SMEs does not cover a topic they are dealing with, preparers must use the concepts to guide them in deciding how to deal with that topic. The concepts may assist auditors in forming an opinion on whether financial statements comply with the IFRS for SMEs. The main concepts in Section 2 that flow from the objective of general purpose financial statements are the qualitative characteristics of financial information and the definitions of the elements. Section 2 also provides pervasive principles for the recognition and measurement of those elements. This module introduces the learner to the subject, guides the learner through the official text, develops the learners understanding of the requirements through the use of examples and indicates significant judgements that are required in applying Section 2. Furthermore, the module includes questions designed to test the learners knowledge of the requirements as well as case studies to develop the learners ability to apply the qualitative characteristics of the financial information, as well as the recognition and measurement of the elements of financial statements, in accordance with the IFRS for SMEs.
Learning objectives
Upon successful completion of this module the learner should understand the objective of general purpose financial statements and the concepts and pervasive principles that flow from
IFRS Foundation: Training Material for the IFRS for SMEs (version 2011-8)
to demonstrate an understanding of the objective of general purpose financial statements and the concepts and pervasive principles that flow from that objective. to use your judgement in developing and applying an accounting policy that results in information that is both relevant to the economic decision-making needs of users and is reliable(1).
the Basis for Conclusions, which summarises the IASBs main considerations in reaching the conclusions in the IFRS for SMEs. the dissenting opinion of an IASB member who did not agree with the issue of the IFRS for SMEs. a preface, which provides a general introduction to the IFRS for SMEs and explains its purpose, structure and authority. implementation guidance including illustrative financial statements and a disclosure checklist.
In the IFRS for SMEs the Glossary is part of the mandatory requirements. In the IFRS for SMEs there are appendices in Section 21 Provisions and Contingencies, Section 22 Liabilities and Equity and Section 23 Revenue. Those appendices are non-mandatory guidance.
(1)
In September 2010 the IASB issued the Conceptual Framework for Financial Reporting. In that Conceptual Framework the IASB
replaced the term reliability with faithful representation. Faithful representation in the Conceptual Framework differs from that in the Framework (1989) in two significant ways. First, it uses the term faithful representation instead of the term reliability because the term reliability was widely misunderstood (in particular, many respondents descriptions of reliability more closely resembled the IASBs notion of verifiability). Second, substance over form, prudence (conservatism) and verifiability, which were aspects of reliability in the Framework (1989), are not considered aspects of faithful representation. Substance over form and prudence were removed for the reasons described in paragraphs BC3.26BC3.29. Verifiability is now described as an enhancing qualitative characteristic rather than as part of this fundamental qualitative characteristic.
IFRS Foundation: Training Material for the IFRS for SMEs (version 2011-8)
IFRS Foundation: Training Material for the IFRS for SMEs (version 2011-8)
Notes(2)
IFRSs are based on the IASBs Conceptual Framework, which addresses the concepts underlying the information presented in general purpose financial statements. The objective of the Conceptual Framework is to facilitate the consistent and logical formulation of IFRSs. It also provides a basis for the use of judgement in resolving accounting issues (paragraph P6 of the preface to the IFRS for SMEs). To a large extent, financial reports are based on estimates, judgements and models rather than exact depictions. The Conceptual Framework establishes the concepts that underlie those estimates, judgements and models. The concepts are the goal towards which the Board and preparers of financial reports strive. Section 2 of the IFRS for SMEs was developed from the concepts in the Conceptual Framework. Because other aspects of Section 2 flow logically from the objective of general purpose financial statements of small and medium-sized entities, a good understanding of the objective is fundamental to understanding the standard.
(2)
In September 2010, after the IFRS for SMEs was issued, the IASB issued the Conceptual Framework for Financial Reporting. That
Conceptual Framework replaced the Framework (1989) on which the requirements in Section 2 are based. The Conceptual Framework clarifies the objective of general purpose financial reporting and the qualitative characteristics of useful financial information. The Conceptual Framework also includes unaltered (except for renumbering the paragraphs) the text of the other requirements of the Framework. Many of the notes in Module 2 are taken from from the Conceptual Framework and the Basis for Conclusions on Chapters 1 and 2 of the Conceptual Framework.
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Notes
General purpose financial statements are not designed to show the equity value of a reporting entity; but they provide information to help users to estimate the equity value of the reporting entity. General purpose financial reports also do not and cannot provide all of the information that users (eg existing and potential investors, lenders and other creditors) need. Those users need to consider pertinent information from other sources, for example, general economic conditions and expectations, political events and political climate, and industry and company outlooks. To assess an entitys prospects for future net cash inflows, existing and potential investors, lenders and other creditors need information about the resources of the entity, claims against the entity, and how efficiently and effectively the entitys management and governing board have discharged their responsibilities to use the entitys resources. For example, in making decisions about providing resources to the entity, existing and potential investors, lenders and other creditors need financial information about the reporting entity that is useful in deciding whether to buy, sell or hold equity and debt instruments, and whether to provide or require settlement of loans and other forms of credit. Regulators and members of the public other than investors, lenders and other creditors may find information in general purpose financial reports useful. Section 2 does not explicitly identify a group of primary users. Individual users have different, and possibly conflicting, information needs and desires. Focusing on common information needs (using investors needs as representative of the needs of a wide range of users) does not prevent the reporting entity from including additional information that is most useful to a particular subset of primary users. In establishing standards for the form and content of general purpose financial statements, the needs of users of financial statements are paramount. Users of financial statements of SMEs may have less interest in some information in general purpose financial statements prepared in accordance with full IFRSs than do users of financial statements of entities whose securities are registered for trading in public securities markets or that otherwise have public accountability. For example, users of financial statements of SMEs may have greater interest in short-term cash flows, liquidity, strength of its statement of financial position and interest coverage, and in the historical trends of profit or loss and interest coverage, than they do in information that is intended to assist in making forecasts of an entitys long-term cash flows, profit or loss, and equity value. However, users of financial statements of SMEs may need some information that is not ordinarily presented in the financial statements of listed entities. For example, as an alternative to the public capital markets, SMEs often obtain capital from shareholders, directors and suppliers, and
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Notes
The objective of financial reporting acknowledges that users make resource allocation decisions as well as decisions as to whether management has made efficient and effective use of the resources provided. Information designed for resource allocation decisions is also useful for assessing managements performance. Information about stewardship is also important for resource providers, who have the ability to vote on, or otherwise influence, managements actions. As well as making decisions on resource allocation, investors, lenders and other creditors make other decisions that are aided by financial reporting information. For example, shareholders who vote on whether to retain directors or replace them, and on how members of management should be remunerated for their services, need information on which to base their decisions. Shareholders decision-making processes may include evaluating how management of the entity performed against management in competing entities in similar circumstances.
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Understandability
2.4 The information provided in financial statements should be presented in a way that makes it comprehensible by users who have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence. However, the need for understandability does not allow relevant information to be omitted on the grounds that it may be too difficult for some users to understand.
Notes
Classifying, characterising and presenting information clearly and concisely makes it understandable. Information that is difficult to understand should be presented and explained as clearly as possible.
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Examplesunderstandability
Ex 1 An entity chooses not to account for deferred tax because its management believes that the users of its financial statements would not understand that financial information. The entity cannot claim compliance with the IFRS for SMEs if it chooses not to account for deferred tax in accordance with Section 29 Income Tax on the grounds that management believes that the users of its financial statements would not understand that financial information. Ex 2 A plan provides a monthly pension of 0.2 per cent of final salary for each year of service. The pension is payable from the age of 65. The entity chooses not to account for the defined benefit plan because its management believes that the users of its financial statements would not understand that financial information. The entity cannot claim compliance with the IFRS for SMEs if it chooses not to account for those pensions in accordance with Section 28 Employee Benefits on the grounds that management believes that the users of its financial statements would not understand that financial information.
Relevance
2.5 The information provided in financial statements must be relevant to the decision-making needs of users. Information has the quality of relevance when it is capable of influencing the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations.
Notes
It is self-evident that financial information is useful for making a decision only if it is capable of making a difference in that decision. Relevance is the term used to describe that capability. It is a fundamental qualitative characteristic of useful financial information. Many decisions by investors, lenders and other creditors are based on implicit or explicit predictions about the amount and timing of the return on an equity investment, loan or other credit instrument. Consequently, information is capable of making a difference in one of those decisions only if it will help users to make new predictions (predictive value), or help users to confirm or correct prior predictions (confirmatory value), or both. Predictive value in this context is not the same as predictability and persistence as used in statistics. Information has predictive value if it can be used in making predictions about the eventual outcomes of past or current events. In contrast, statisticians use predictability to refer to the accuracy with which
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Materiality
2.6 Information is materialand therefore has relevanceif its omission or misstatement could influence the economic decisions of users made on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. However, it is inappropriate to make, or leave uncorrected, immaterial departures from the IFRS for SMEs to achieve a particular presentation of an entitys financial position, financial performance or cash flows.
Notes
Materiality is an aspect of relevance, because immaterial information does not affect a users decision. Financial statement users are assumed to have a reasonable knowledge of business, economic activities and accounting and a willingness to study financial information with reasonable diligence (see paragraph 2.4). Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions of such users made on the basis of the financial statements. Because materiality is an entity-specific consideration, the IASB does not consider materiality when developing standards. Materiality is based on the nature, or magnitude, or both, of the items to which the information relates in the context of an individual entitys financial report. Consequently, the IASB cannot specify a uniform quantitative threshold for materiality or predetermine what could be material in a particular situation. The definition of material implies that an entity need not provide a specific disclosure required by the IFRS for SMEs if the information is not material. Moreover, an entity need not apply its accounting policies when the effect of not applying them is immaterial (see paragraph 10.3). Financial statements result from processing large numbers of transactions or other events that are aggregated into classes according to their nature or function. The final stage in the process of aggregation and classification is the presentation of condensed and classified data, which form line items in the financial statements. If an item is not individually material, it is aggregated with other items either in those statements or in the notes. An item that is not sufficiently material to warrant separate presentation in those statements may warrant separate presentation in the notes.
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Examplesmaterial items
Ex 5 The facts are the same as in example 3. However, in this example, if the error had been corrected the entity would have breached a borrowing covenant on a significant long-term liability. The error is materialit could influence the economic decisions of users made on the basis of the financial statements. Ex 6 In 20X9, before the entitys 20X8 financial statements were approved for issue, the entity discovered a systemic error in the calculation of its defined benefit obligation in respect of the employees pension scheme. Further investigation revealed that the calculation had been incorrectly performed since the defined benefit plan was started in 20X0. The cumulative effect of the error on the retained earnings of the entity at the beginning of 20X8 is an overstatement of CU600,000. The entity reported total equity of CU950,000 at 31 December 20X7. The error is materialit could influence the economic decisions of users made on the basis of the financial statements. Ex 7 In 20X9, before the entitys 20X8 financial statements were approved for issue, a class action lawsuit was filed against the entity. The lawsuit seeks compensation for a community experiencing health problems allegedly caused by pollution from the entitys plant. Legal counsel advised management that there is a 30 per cent chance that the action will be successful. If successful, the court is likely to award the community compensation of between CU1,000,000 and CU2,000,000. In its financial statements for the year ended 31 December 20X8, the entity neither recognised a liability for the lawsuit nor disclosed any information about it.
(3)
In this example, and in all other examples in this module, monetary amounts are denominated in currency units (CU).
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Reliability
2.7 The information provided in financial statements must be reliable. Information is reliable when it is free from material error and bias and represents faithfully that which it either purports to represent or could reasonably be expected to represent. Financial statements are not free from bias (ie not neutral) if, by the selection or presentation of information, they are intended to influence the making of a decision or judgement in order to achieve a predetermined result or outcome.
Notes
Financial reports represent economic phenomena in words and numbers. To be useful, financial information must not only represent relevant phenomena, but it must also faithfully represent the phenomena that it purports to represent. To be a perfectly faithful representation, a depiction would have three characteristics: it would be complete, neutral and free from error. Of course, perfection is seldom, if ever, achievable. The IASBs objective is to maximise those qualities as far as possible. Faithful representation does not mean accurate in all respects. Free from error means that there are no errors or omissions in the description of the phenomenon, and that the process used to produce the reported information has been selected and applied with no errors in that process. In this context, free from error does not mean perfectly accurate in all respects. For example, an estimate of an unobservable price or value cannot be determined to be accurate or inaccurate. However, a representation of that estimate can be faithful if the amount is described clearly and accurately as being an estimate, the nature and limitations of the estimating process are explained, and no errors have been made in selecting and applying an appropriate process for developing the estimate. In other words, reliability does not mean precision.
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Note
Representation on the basis of a legal form that differs from the economic substance of the underlying economic phenomenon could result in a representation that is not faithful.
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Prudence
2.9 The uncertainties that inevitably surround many events and circumstances are acknowledged by the disclosure of their nature and extent and by the exercise of prudence in the preparation of the financial statements. Prudence is the inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. However, the exercise of prudence does not allow the deliberate understatement of assets or income, or the deliberate overstatement of liabilities or expenses. In short, prudence does not permit bias.
Notes
To be a faithful representation, a depiction must be neutral (ie without bias). Prudence does not permit bias. It simply requires a degree of caution in the exercise of judgement. Consequently, management cannot deliberately reflect conservative estimates of assets, liabilities or income. An admonition to be prudent is likely to lead to a biasunderstating assets or overstating liabilities in one period frequently leads to overstating financial performance in later periodswhich is a result that cannot be described as prudent or neutral. The IASB does not attempt to encourage or predict specific actions of users. If financial information is biased in a way that encourages users to take or avoid predetermined actions, that information is not neutral.
Completeness
2.10 To be reliable, the information in financial statements must be complete within the bounds of materiality and cost. An omission can cause information to be false or misleading and thus unreliable and deficient in terms of its relevance.
Notes
A complete depiction includes all information necessary for a user to understand the phenomenon being depicted, including all necessary descriptions and explanations. For example, a complete depiction of a group of assets would include, at a minimum, a description of the nature of the assets in the group, a numerical depiction of all of the assets in the group, and a description of what the numerical depiction represents (for example, original cost, adjusted cost or fair value). For some items, a complete depiction may also entail explanations of significant facts about the quality and nature
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Comparability
2.11 Users must be able to compare the financial statements of an entity through time to identify trends in its financial position and performance. Users must also be able to compare the financial statements of different entities to evaluate their relative financial position, performance and cash flows. Hence, the measurement and display of the financial effects of like transactions and other events and conditions must be carried out in a consistent way throughout an entity and over time for that entity, and in a consistent way across entities. In addition, users must be informed of the accounting policies employed in the preparation of the financial statements, and of any changes in those policies and the effects of such changes.
Notes
Relevant and faithfully represented information is most useful if it can be readily compared with similar information reported by other entities and by the same entity in other periods. One of the most important reasons that financial reporting standards are needed is to increase the comparability of reported financial information. However, relevant and faithfully represented information is still useful even if it is not readily comparable. Comparable information, however, is not useful if it is not relevant and may mislead if it is not faithfully represented. Consequently, comparability is considered to be an enhancing qualitative characteristic rather than a fundamental qualitative characteristic. The need for comparability of financial data over time implies that the measurement and display of the financial effect of like transactions needs to be the same over time. The need for comparability of financial data between entities means that the financial effect of like transactions should be similar. Accounting standards try to ensure the comparability of the data over time and between entities. The comparability of financial data should not be confused with mere uniformity and should not be allowed to become an impediment to the introduction of improved accounting standards. It is not appropriate for an entity to continue accounting in the same manner for a transaction or other event if the policy adopted is not in keeping with the qualitative characteristics of relevance and reliability. It is also inappropriate for an entity to leave its accounting policies unchanged when more relevant and reliable alternatives exist. An important implication of the qualitative characteristic of comparability is that users must be informed of the accounting policies that have been used in the preparation of the financial statements, any changes in those policies and the effects of such changes. Including the disclosure of the accounting policies used by the entity helps to achieve comparability. Comparability is not uniformity. For information to be comparable, like things must look alike and different things must look different. Comparability of financial
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Timeliness
2.12 To be relevant, financial information must be able to influence the economic decisions of users. Timeliness involves providing the information within the decision time frame. If there is undue delay in the reporting of information it may lose its relevance. Management may need to balance the relative merits of timely reporting and the provision of reliable information. In achieving a balance between relevance and reliability, the overriding consideration is how best to satisfy the needs of users in making economic decisions.
Notes
Timeliness means having information available to decision-makers in time to be capable of influencing their decisions. Generally, the older the information is, the less useful it is. However, some information may continue to be timely long after the end of a reporting period because, for example, some users may need to identify and assess trends. Timeliness is very desirable, but it is not as critical as relevance and faithful representation (ie complete, neutral and free from error). Timely information is useful only if it is relevant and faithfully represented. In contrast, relevant and faithfully represented information may still be useful (especially for confirmatory purposes) even if it is not reported in as timely a manner as would be desirable.
2.14
Financial reporting information helps capital providers make better decisions, which results in more efficient functioning of capital markets and a lower cost of capital for the economy as a whole. Individual entities also enjoy benefits, including improved access to capital markets, favourable effect on public relations, and perhaps lower costs of capital. The benefits may also include better management decisions because financial information used internally is often based at least partly on information prepared for general purpose financial reporting purposes.
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Elements
Financial statements portray the financial effects of transactions and other events by grouping them into broad classes according to their economic characteristics. These broad classes are called the elements of financial statements. The elements that are directly related to the measurement of financial position, which is shown in the statement of financial position (sometimes called the balance sheet), are assets, liabilities and equity. The elements that are directly related to the measurement of performance, which is shown in the statement of comprehensive income, are income and expenses. Income and expenses are defined with reference to changes in assets and liabilities. Consequently, assets and liabilities are the cornerstone elements.
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Financial position
2.15 The financial position of an entity is the relationship of its assets, liabilities and equity as of a specific date as presented in the statement of financial position. These are defined as follows: (a) An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. (b) 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. (c) Equity is the residual interest in the assets of the entity after deducting all its liabilities.
Notes
General purpose financial statements provide information about the financial position of a reporting entity, which is information about the entitys economic resources (assets) and the claims against the reporting entity (liabilities and equity). Financial statements also provide information about the effects of transactions and other events that change a reporting entitys economic resources and claims. Both types of information provide useful input for decisions about providing resources to an entity. Economic resources and claims Information about the nature and amounts of a reporting entitys economic resources and claims can help users to identify the reporting entitys financial strengths and weaknesses. That information can help users to assess the reporting entitys liquidity and solvency, its needs for additional financing and how successful it is likely to be in obtaining that financing. Information about priorities and payment requirements of existing claims helps users to predict how future cash flows will be distributed among those with a claim against the reporting entity. Different types of economic resources affect a users assessment of the reporting entitys prospects for future cash flows differently. Some future cash flows result directly from existing economic resources, such as accounts receivable. Other cash flows result from using several resources in combination to produce and market goods or services to customers. Although those cash flows cannot be identified with individual economic resources (or claims), users of financial reports need to know the nature and amount of the resources available for use in a reporting entitys operations. Because the specific requirements of the IFRS for SMEs override the concepts set out in Section 2, statements of financial position that conform to the IFRS for SMEs may include items that do not satisfy the definitions of an asset or a liability and are not
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Notes
The effects of applying the recognition criteria to particular assets in a particular way result in, for example, expenditures on internally generated intangible assets (eg internally generated brands) not being recognised as an asset. For example, paragraphs 18.14 and 18.15 specifically prohibit the recognition as intangible assets of brands, mastheads, publishing titles, customer lists and items similar in substance that are internally generated because internally generated intangible items of this type would rarely, and perhaps never, meet the recognition criteria. Similarly, Section 18 Intangible Assets other than Goodwill also clarifies that expenditure on research, training, advertising and start-up activities does not result in the creation of an intangible asset that can be recognised in the financial statements. Some view this interpretation of the application of the recognition criteria as being too restrictive and arbitrary. The prohibition also reflects the fact that it is sometimes difficult to determine whether there is an internally generated intangible asset distinguishable from internally generated goodwill. Similarly, the effects of applying the recognition criteria to particular liabilities in a particular way result in, for example, a present obligation for which the possibility of the outflow of resources in settlement is less likely than not (ie 50 per cent or less) not being recognised as a liability (see paragraph 21.12).
Assets
2.17 The future economic benefit of an asset is its potential to contribute, directly or indirectly, to the flow of cash and cash equivalents to the entity. Those cash flows may come from using the asset or from disposing of it.
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Notes
An entity usually employs its assets to produce goods or services capable of satisfying the wants or needs of customers. Because these goods or services can satisfy these wants or needs, customers are prepared to pay for them and hence they contribute to the cash flow of the entity. Cash itself renders a service to the entity because of its command over other resources. 2.18 Many assets, for example property, plant and equipment, have a physical form. However, physical form is not essential to the existence of an asset. Some assets are intangible.
Notes
Physical form is not essential to the existence of an assetfor example, licences, patents, copyrights and customer lists are assets if future economic benefits are expected to flow from them to the entity and if they are controlled by the entity. Most financial assets (see the Glossary) are contractual rights.
Examplecash
Ex 10 An entity has cash. The cash is an asset of the entitythe entity determines the purpose to which the cash is put and thereby expects to generate cash inflows (ie cash renders a service to the entity because of its command over other resources).
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(4)
Trademarks are words, names, symbols or other devices used in trade to indicate the source of a product and to
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Liabilities
2.20 An essential characteristic of a liability is that the entity has a present obligation to act or perform in a particular way. The obligation may be either a legal obligation or a constructive obligation. A legal obligation is legally enforceable as a consequence of a binding contract or statutory requirement. A constructive obligation is an obligation that derives from an entitys actions when: (a) by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept particular responsibilities, and (b) as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.
Notes
An essential characteristic of a liability is that the entity has a present obligation to act or perform in a particular way. In accordance with some jurisdictions financial reporting requirements a liability called general reserves for unspecified potential or future losses is recognised based on a notion of conservatism or prudence. These are sometimes referred to as provisions. These reserves do not meet the definition of a liability in the IFRS for SMEs. Consequently, recognition as liabilities of such general reserves is prohibited. Similarly, obligations that arise from future actions of the entity, no matter how likely, are not present obligations and therefore do not meet the definition of a liability. For example, it is inappropriate to recognise a liability for expected future losses, because the entity has no present obligation to incur those losses (eg the entity could cease the operations that will generate the future losses). It is important to bear in mind, however, that the expectation of losses may be an indicator that some of the
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Examplesliabilities
Ex 21 Entity A has a contractual obligation to pay entity B CU10,000 for goods that it purchased on 30 days credit from entity B on 30 December 20X0. The debt instrument (trade payable) is a financial liability of entity Athe purchase of the goods on credit created a contractual obligation (a legal obligation) for entity A to pay (expected cash outflow) entity B. Ex 22 Waste from an entitys production process contaminated the groundwater at the entitys plant. In a lawsuit brought against the entity, members of the local community seek compensation for damages to their health as a result of the contamination. The entity acknowledges its wrongdoing and the court is deciding on the extent of the compensation to be awarded to the members of the local community. The entity has a liabilityat the end of the reporting period the entity has a legal obligation to compensate members of the local community for the damages caused (ie the obligating event). The payment for damages is expected to result in an outflow of cash from the entity. Ex 23 Waste from an entitys production process contaminated the groundwater at the entitys plant. In this example there is no court case. However, the entity is required by law to restore the contaminated environment. The entity has a liabilityat the end of the reporting period it is obliged by law to restore the damage caused to the environment (ie the obligating event). Restoring the environment is expected to result in cash outflows. Ex 24 An entity has made a written pledge to contribute a substantial sum of money toward the construction of a new performing arts centre in its community. Executives of the entity appeared in a press conference to announce the pledge. With the entitys consent, the charitable organisation that is building the arts centre has cited the entitys pledge in its materials soliciting additional pledges for construction. Under local law, pledges to charitable organisations are not legally enforceable. Although the pledge may not be legally enforceable, by participating in the press conference and by allowing its name to be used in the solicitation, the entity has indicated that it has accepted an obligation to honour its pledge and has created a valid expectation on the part of the arts centre that it will do so (ie its actions have given rise to a constructive obligation).
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Equity
2.22 Equity is the residual of recognised assets minus recognised liabilities. It may be subclassified in the statement of financial position. For example, in a corporate entity, subclassifications may include funds contributed by shareholders, retained earnings and gains or losses recognised directly in equity.
Examplesequity
Ex 28 On 31 December 20X0 an entity had equity share capital of CU100,000 in issue. In 20X1, the entity issued 50,000 equity shares at CU5 per share. At 31 December 20X1 the entitys equity included CU350,000 funds contributed by its shareholders (ie CU100,000 at 31 December 20X1 + CU250,000 contributed in 20X1). Ex 29 On 1 December 20X1 an entity distributed one of its vehicles to its owner-manager when the vehicles fair value was CU56,000 and its carrying amount was CU15,000.
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Performance
2.23 Performance is the relationship of the income and expenses of an entity during a reporting period. This IFRS permits entities to present performance in a single financial statement (a statement of comprehensive income) or in two financial statements (an income statement and a statement of comprehensive income). Total comprehensive income and profit or loss are frequently used as measures of performance or as the basis for other measures, such as return on investment or earnings per share. Income and expenses are defined as follows: (a) Income is increases in economic benefits during the reporting 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 investors. (b) Expenses are decreases in economic benefits during the reporting 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 investors.
Notes
Information about a reporting entitys financial performance helps users to understand the return that the entity has produced on its economic resources. Information about the return that the entity has produced provides an indication of how well management has discharged its responsibilities to make efficient and effective use of the reporting entitys resources. Information about the variability and components of that return is also important, especially in assessing the uncertainty of future cash flows. Information about a reporting entitys past financial performance and how its management discharged its responsibilities is usually helpful in predicting the entitys future returns on its economic resources. Income and expenses are defined with reference to the cornerstone elements of assets and liabilities, thereby providing robustness to the concept of accrual accounting that underlies the IFRS for SMEs. Financial performance (ie comprehensive income) is
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Notes
Information about a reporting entitys financial performance during a period, reflected by changes in its economic resources and claims other than by obtaining additional resources directly from investors and creditors, is useful in assessing the entitys past and future ability to generate net cash inflows. That information indicates the extent to which the reporting entity has increased its available economic resources, and thus its capacity for generating net cash inflows through its operations, rather than by obtaining additional resources directly from investors and creditors. Information about a reporting entitys financial performance during a period may also indicate the extent to which events such as changes in market prices or interest rates have increased or decreased the entitys economic resources and claims, thereby affecting the entitys ability to generate net cash inflows.
Income
2.25 The definition of income encompasses both revenue and gains. (a) Revenue is income that arises in the course of the ordinary activities of an entity and is referred to by a variety of names including sales, fees, interest, dividends, royalties and rent. (b) Gains are other items that meet the definition of income but are not revenue. When gains are recognised in the statement of comprehensive income, they are usually displayed separately because knowledge of them is useful for making economic decisions.
Examplesrevenue or gain?
Ex 34 On 31 December 20X5 an entity sold inventory for CU1,500 when the carrying amount of the inventory was CU1,000. On 31 December 20X5 the entity recognises CU1,500 income (revenue from the sale of goods) and CU1,000 expense (costs of goods sold). (See also paragraph 13.20.)
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Expenses
2.26 The definition of expenses encompasses losses as well as those expenses that arise in the course of the ordinary activities of the entity. (a) Expenses that arise in the course of the ordinary activities of the entity include, for example, cost of sales, wages and depreciation. They usually take the form of an outflow or depletion of assets such as cash and cash equivalents, inventory, or property, plant and equipment. (b) Losses are other items that meet the definition of expenses and may arise in the course of the ordinary activities of the entity. When losses are recognised in the statement of comprehensive income, they are usually presented separately because knowledge of them is useful for making economic decisions.
Examplesexpense or loss?
Ex 37 On 31 December 20X5 an entity sold inventory for CU900 when the carrying amount of the inventory was CU1,000. On 31 December 20X5 the entity recognises CU900 income (revenue from the sale of goods) and CU1,000 expense (costs of goods sold) (see also paragraph 13.20). Ex 38 On 31 December 20X5 an entity sold a machine used by the entity in the manufacture of goods for CU900 when the carrying amount of the machine was CU1,000.
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2.28
The failure to recognise an item that satisfies those criteria is not rectified by disclosure of the accounting policies used or by notes or explanatory material.
Notes
Section 2 does not specify whether the recognition threshold is not satisfied only when there is no probability of a cash flow occurring, or whether a higher level (eg greater than 50 per cent) is necessary to trigger recognition. Consequently, the recognition criteria determined at the requirement level are not consistent across the IFRS for SMEs. Some requirements give effect to this concept by requiring recognition of an item that meets the definition of an element only if it is more likely than not that the future economic benefit associated with the item will flow to or from the entity (eg in determining whether a liability is recognised for a particular present obligation). In such cases, the outcome is binaryif the probability of the outflow is greater than 50 per cent a liability is recognised (conversely, if the probability of the outflow is 50 per cent or less, the obligation is not recognised as a liability, ie it is excluded from the entitys statement of financial position).
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Reliability of measurement
2.30 The second criterion for the recognition of an item is that it possesses a cost or value that can be measured with reliability. In many cases, the cost or value of an item is known. In other cases it must be estimated. The use of reasonable estimates is an essential part of the preparation of financial statements and does not undermine their reliability. When a reasonable estimate cannot be made, the item is not recognised in the financial statements.
2.31
An item that fails to meet the recognition criteria may qualify for recognition at a later date as a result of subsequent circumstances or events.
2.32
An item that fails to meet the criteria for recognition may nonetheless warrant disclosure in the notes or explanatory material or in supplementary schedules. This is appropriate when knowledge of the item is relevant to the evaluation of the financial position, performance and changes in financial position of an entity by the users of financial statements.
Notes
In Section 21 the recognition criterion probable is specified to mean more likely than not (ie the recognition threshold for recognising a liability (provision) for a present obligation is satisfied only when the probability of the outflow is greater than 50 per cent. Consequently, in Section 21, if the probability of the outflow is 50 per cent or less, the present obligation is not recognised as a liability (ie the contingent liability is excluded from the entitys statement of financial position). However, unless the possibility of the outflow of resources is remote, the contingent liability is disclosed in the notes (see paragraph 21.12).
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The expected value of the cash flow is (40 per cent CU100) + (30 per cent CU200) + 30 per cent CU500) = CU250. The expected value technique is one of the building blocks to compute a current value of an asset or liability when that amount is not directly observable. The IFRS for SMEs requires entities to measure particular assets and liabilities at expected value, or specifies a measurement objective (such as fair value) that can be satisfied using expected value techniques. Examples include: measuring a contingent liability in accordance with Section 19 Business Combinations and Goodwill; measuring a provision involving a large population of items in accordance with Section 21 Provisions and Contingencies; and measuring value in use in accordance with Section 27 Impairment of Assets.
There are usually risks and uncertainties about the amounts, timings and probabilities assigned to the expected cash flows. Those risks and uncertainties can be captured either in estimates of cash flows or in the interest rates. However, the same uncertainties must not be captured in both (ie do not double count risks). 2.34 Two common measurement bases are historical cost and fair value: (a) For assets, historical cost is the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire the asset at the time of its acquisition. For liabilities, historical cost is the amount of proceeds of cash or cash equivalents received or the fair value of non-cash assets received in exchange for the obligation at the time the obligation is incurred, or in some circumstances (for example, income tax) the amounts of cash or cash equivalents expected to be paid to settle the liability in the normal course of business. Amortised historical cost is the historical cost of an asset or liability plus or minus that portion of its historical cost previously recognised as expense or income. (b) Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arms length transaction.
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Notes
Alternatives are available for all aspects of financial reporting, including recognition, derecognition, measurement, classification, presentation and disclosure. When developing financial reporting standards, the IASB chooses the alternative that goes furthest towards achieving the objective of financial reporting. Providers of financial information also choose among the alternatives if there are no applicable requirements available (as set out in paragraph 2.35), or if application of a particular standard requires judgements (for examples see the significant estimates and other judgements section of each module of this training material) or options (for examples see paragraphs 3.173.19, 7.7, 9.26, 14.4, 15.9 and 35.10), to achieve the objective of financial reporting. The qualitative characteristics of useful financial information identify the characteristics of information that are likely to be most useful to the existing and potential investors, lenders and other creditors for making decisions about the reporting entity on the basis of information in its financial report. Consequently, subject to the cost-benefit constraint, maximising the qualitative characteristics of financial information guides the judgements needed to apply the objective of financial reporting.
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Examplesdeveloping an accounting policy when the IFRS for SMEs does not specify particular accounting
Ex 39 On 1 January 20X7, as part of a scheme to provide support for projects to help rural communities, a non-government development agency announced a plan whereby during 20X720X9 entities can apply for a grant of CU50,000 to set up farming operations in a specified rural area Entities must complete an application form, submit their proposal and provide specified documents, which the development agency will consider before issuing the grant. The IFRS for SMEs does not explicitly specify how to account for a grant from a non-government development agency. Because the IFRS for SMEs does not specify how to account for a grant from a non-government development agency management must develop the entitys accounting policy in accordance with paragraphs 10.4 and 10.5 that results in information that is relevant and reliable. Relevant financial information is capable of making a difference in the decisions made by users. Information about the nature and amount (fair value) of the grant from a non-government development agency and any unfulfilled conditions and other contingencies attached to the grant would be relevant to the decisions made by users of the entitys financial statements (eg existing and potential investors, lenders and other creditors). The fair value of the grant received is known (ie CU50,000 received). That information is reliable (eg faithful representation, neutral and free from material error).
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Accrual basis
2.36 An entity shall prepare its financial statements, except for cash flow information, using the accrual basis of accounting. On the accrual basis, items are recognised as assets, liabilities, equity, income or expenses when they satisfy the definitions and recognition criteria for those items.
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Examplesrecognition of assets?
Ex 41 An entity has developed a formula that it uses to manufacture a unique glue. The glue is the leading adhesive product in the market because of its distinctive mix of chemicals. The special formula is known only by the entitys two owner-managers and hence no competitors have been able to discover and replicate the formula. The formula is not protected by a patent, or by other means. Many competitors have approached the entity to try to purchase the formula.
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2.38
An entity shall not recognise a contingent asset as an asset. However, when the flow of future economic benefits to the entity is virtually certain, then the related asset is not a contingent asset, and its recognition is appropriate.
Examplescontingent assets?
Ex 44 An entity is taking legal action against its competitor for patent infringement relating to a patent that had been granted to the entity on one of its products. The outcome of the case is uncertain. However, it is probable that the court will order the competitor to pay damages to the entity. The entity must disclose the contingent asset as set out in paragraph 21.16 because an inflow of economic benefits is probable, but not virtually certain. Ex 45 The facts are the same as in example 44. However, in this example, it is virtually certain that the court will order the competitor to pay damages to the entity.
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Liabilities
2.39 An entity shall recognise a liability in the statement of financial position when: (a) the entity has an obligation at the end of the reporting period as a result of a past event, (b) it is probable that the entity will be required to transfer resources embodying economic benefits in settlement, and (c) the settlement amount can be measured reliably.
2.40
A contingent liability is either a possible but uncertain obligation or a present obligation that is not recognised because it fails to meet one or both of the conditions (b) and (c) in paragraph 2.39. An entity shall not recognise a contingent liability as a liability, except for contingent liabilities of an acquiree in a business combination (see Section 19 Business Combinations and Goodwill).
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Income
2.41 The recognition of income results directly from the recognition and measurement of assets and liabilities. An entity shall recognise income in the statement of comprehensive income (or in the income statement, if presented) 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.
Exampleincome recognition
Ex 49 On 1 January 20X1 an entity acquired a property for CU1,000. It rents the property to independent third parties under operating leases in return for rental payments. In 20X1 CU90 lease rentals accrued to the lessee (the tenant paid the CU90 rent to the entity on 1 January 20X2). The entity measures investment property, after initial recognition, at fair value. At 31 December 20X1 the fair value of its investment property was CU1,100. The entity recognises income in the year ended 31 December 20X1 as follows: CU90 rental income (ie the increase in the asset (rent receivable)CU90 at 31 December less nil at 1 January 20X1); and CU100 increase in the fair value of its asset (investment property)CU1,100 at 31 December less CU1,000 at 1 January.
Expenses
2.42 The recognition of expenses results directly from the recognition and measurement of assets and liabilities. An entity shall recognise expenses in the statement of comprehensive income (or in the income statement, if presented) 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.
Exampleexpense recognition
Ex 50 An entity recognised a liability (provision for a lawsuit) at CU40,000 in its statement of financial position at 31 December 20X1. At 31 December 20X2, the entity remeasured the liability at CU90,000. CU3,000 of the increase in the provision is attributable to the unwinding of the discount (ie the increase in the CU40,000 because it is one year closer to settlement) and the remainder of the
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2.44
Profit or loss is the arithmetical difference between income and expenses other than those items of income and expense that this IFRS classifies as items of other comprehensive income. It is not a separate element of financial statements, and a separate recognition principle is not needed for it.
2.45
This IFRS does not allow the recognition of items in the statement of financial position that do not meet the definition of assets or of liabilities regardless of whether they result from applying the notion commonly referred to as the matching concept for measuring profit or loss.
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Non-financial assets
2.49 Most non-financial assets that an entity initially recognised at historical cost are subsequently measured on other measurement bases. For example: (a) An entity measures property, plant and equipment at the lower of depreciated cost and recoverable amount. (b) An entity measures inventories at the lower of cost and selling price less costs to complete and sell. (c) An entity recognises an impairment loss relating to non-financial assets that are in use or held for sale. Measurement of assets at those lower amounts is intended to ensure that an asset is not measured at an amount greater than the entity expects to recover from the sale or use of that asset.
2.50
For the following types of non-financial assets, this IFRS permits or requires measurement at fair value: (a) investments in associates and joint ventures that an entity measures at fair value (see paragraphs 14.10 and 15.15 respectively). (b) investment property that an entity measures at fair value (see paragraph 16.7). (c) agricultural assets (biological assets and agricultural produce at the point of harvest) that an entity measures at fair value less estimated costs to sell (see paragraph 34.2).
Offsetting
2.52 An entity shall not offset assets and liabilities, or income and expenses, unless required or permitted by this IFRS. (a) Measuring assets net of valuation allowancesfor example, allowances for inventory obsolescence and allowances for uncollectible receivablesis not offsetting. (b) If an entitys normal operating activities do not include buying and selling non-current assets, including investments and operating assets, then the entity reports gains and losses on disposal of such assets by deducting from the proceeds on disposal the carrying amount of the asset and related selling expenses.
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Materiality assessments
Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions of users made on the basis of the financial statements. Materiality is entity-specificinformation is material if omitting it or misstating it could influence decisions that users make on the basis of financial information about a specific reporting entity. The definition of material implies that an entity need not provide a specific disclosure required by this standard if the information is not material and that an entitys accounting policies need not be applied when the effect of applying them is immaterial. Materiality assessments are made in the context of users that have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence. Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination of both, could be the determining factors.
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In their Manual of Accounting IFRS 2011 PricewaterhouseCoopers lists the following items as often qualifying as material, regardless of their individual size: Related party transactions A transaction or adjustment that changes a profit to a loss, and vice versa. A transaction or adjustment that takes an entity from having net current assets to net current liabilities, and vice versa. A transaction or adjustment that affects an entitys ability to meet analysts consensus expectations. A transaction or adjustment that masks a change in earnings or other trends. A transaction or adjustment that concerns a segment or other portion of the entitys business that has been identified as playing a significant role in the entitys operations or profitability. A transaction or adjustment that affects an entitys compliance with loan covenants or other contractual requirements. A transaction or adjustment that has the effect of increasing managements compensation, for example by satisfying requirements for the award of a bonus. Changes in laws and regulations. Non-compliance with laws and regulations. Fines against the entity. Legal cases. Deterioration in relationships with individual or groups of key suppliers, customers or employees. Dependency on a particular supplier, customer or employee. Applying the materiality concept may require significant judgement.
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Accounting policies
When the IFRS for SMEs does not specifically address a transaction, or other event or condition, management must use its judgement in developing an accounting policy for that transaction, or other event or condition, in accordance with paragraphs 10.4 and 10.5 of the IFRS for SMEs. In making the judgement described in paragraph 10.4, management may consider the requirements and guidance in full IFRSs dealing with similar and related issues, but is not required to do so. Example 1 An entity that has operations in multiple jurisdictions chooses to provide financial information by operating segment even though those segment disclosures are not required to comply with the IFRS for SMEs. Management uses its judgement in developing and applying the entitys accounting policy for disclosing segment information. Judgements would include identifying segments, measuring segment information in a manner that results in information that is relevant to the economic decision-making needs of users and is reliable (eg a faithful representation that is free from bias and complete in all material respects). In making those judgements management may consider the requirements of IFRS 8 Operating Segments, but is not required to do so. Example 2 An entity has factored some of its accounts receivable with a bank. In purchasing the receivables, the bank has assumed all credit risk up to 15 per cent of the amount of the receivables. The selling entitys experience is that credit losses in its receivables have historically been less than 10 per cent. In deciding whether to account for the factoring as a sale of receivables or a collateralised borrowing, the selling entity must use its judgement to determine whether it has transferred to the bank all of the significant risks and rewards relating to the receivables (see paragraph 11.33(b)). In making the judgement, management may consider the requirements and guidance in full IFRSs, but is not required to do so.
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Question 1
The objective of general purpose financial statements prepared in accordance with the IFRS for SMEs is: (a) to support the reporting entitys annual tax return (b) to provide the government of the jurisdiction in which the reporting entity operates with financial information for use in government statistics or government planning or both (c) to provide management of the reporting entity with financial information about the reporting entity (d) to provide information about the financial position, performance and cash flows of the entity that is useful for economic decision-making by a broad range of users who are not in a position to demand reports tailored to meet their particular information needs (eg investors and creditors)
Question 2
Which qualitative characteristics are fundamental to general purpose financial information? (a) relevance and reliability (b) relevance and comparability (c) reliability and comparability (d) prudence and comparability
Question 3
The qualitative characteristic prudence implies that in preparing financial statements management should (a) have a bias toward understating assets and income and overstating liabilities and expenses (b) have a bias toward overstating assets and income and understating liabilities and expenses (c) be neutral (ie no bias) and cautious in the exercise of judgements needed in making estimates (d) if permitted to do so, use full IFRSs rather than the IFRS for SMEs
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Question 5
Which of the descriptions below best describes the qualitative characteristic reliability? (a) Information is reliable when it is measured precisely (ie little or no uncertainty in measurement) (b) Information is reliable when it is measured at historical costs (c) Information is reliable when it is measured at fair value (d) Information is reliable when it is free from material error and bias and represents faithfully that which it either purports to represent or could reasonably be expected to represent
Question 6
Which of the following is not an element for which there is a concept in Section 2? (a) Asset (b) Liability (c) Income (d) Expense (e) Other comprehensive income
Question 7
Expenses are recognised in comprehensive income (ie profit or loss or other comprehensive income) (a) using the matching bases (ie on the basis of a direct association between the costs incurred and the earning of specific items of income) (b) using an accrual basis of accounting (c) at the discretion of management (d) at the discretion of the owners of the entity
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Question 8
The accrual basis of accounting that underlies financial information prepared in accordance with the IFRS for SMEs: (a) specifies that expenses are recognised as an expense in the period in which the income they generate is recognised (a matching concept) (b) specifies that an entity must be conservative in its accounting (ie understate assets and income and overstate liabilities and expenses) (c) specifies that an element (asset, liability, equity, income and expense) is recognised when it satisfies the definition and recognition criteria for an element (d) specifies that management discretion determines the timing of the recognition of income and expenses
Question 9
Which of the following satisfies the definition of a liability? (a) The income generating capacity of a snow ski resort is greatly influenced by the amount of snowfall. Snowfall is erratic. To reduce the volatility in its reported profit, a snow ski resort would like to recognise a liability (and corresponding expense) in years of high snowfall (a provision for warm weather) and release that provision to income in years of low snowfall. (b) An entity self insures its assets against loss or damage, ie it opens a separate bank account (in the companys name) into which it transfers each month an amount equal to the market rate for damage/loss insurance cover. When the entity suffers damage or loss its uses the money in the separate bank account to restore or replace the damaged or lost item. To reduce volatility in its reported profit, the entity would like to recognise a liability (and corresponding expense) in the period in which it transfers cash into the separate bank account (a provision for self insurance) and decrease that provision when cash is paid out of the separate bank account to replace or restore a damaged or lost item. (c) An entity is being sued for allegedly breaching the patent of one of its competitors. The entitys legal counsel believes that it to be more likely than not that the entity will lose the case. (d) All of the above (ie (a) to (c)) (e) None of the above
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Question 10
One of the criteria that must be satisfied for a liability to be recognised in an entitys financial statements is that it must be probable that future economic benefits will flow from the entity. Which of the following statements is true? (a) Probable always means the cash outflow is more likely than not (ie a greater than 50 per cent chance that the outflow of economic benefits will occur) (b) Probable always means there is a greater than zero per cent probability that the cash outflow will occur (c) The meaning of probable is not specified in Section 2. Its meaning is specified in other sections of the IFRS for SMEs. For example, when measuring an item at fair value (eg derivatives, see section 12) probable means a greater than zero per cent probability. However, when measuring a provision in accordance with Section 21 Provisions and Contingencies, probable means more likely than not
Question 11
An entity made an unusually high profit for the year ended 31 December 20X7 because it negotiated a significantly lower cost price for its main raw material at a time when the selling price of its products was rising sharply. Management does not want to make public the unusually high profit because they believe that knowledge of the entitys profitability would result in their customers seeking to negotiate lower selling prices when purchasing goods from the entity. Consequently, management would like to decrease profit for the year by recognising a provision for unforeseen possible expenses. (a) Because creation of the provision is prudent, it is acceptable accounting (b) Because creation of the provision is common practice in the jurisdiction in which the entity operates, it is acceptable accounting (c) Provided the reason for creating the provision is explained in the notes, it is acceptable accounting (d) Because they do not satisfy the definition of a liability, the entity cannot create a provision for unforeseen possible expenses
Question 12
Recognition criteria determine when to recognise an item. Measurement is determining the monetary amounts at which to measure an item. Uncertainties about the extent of future cash flows: (a) Only affect the decision about whether to recognise the item (b) Only affect the estimation of the amount at which to measure the item (c) Could affect decisions about both whether to recognise an item and the measurement of that item
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Question 13
How many measurement bases does the IFRS for SMEs specify for the measurement of assets? (a) Onehistorical cost (b) Onefair value (c) Twohistorical cost and fair value (d) Manyincluding historical cost, fair value, value in use, estimated selling price less costs to complete and sell, and the equity method
Question 14
Rather than distributing its excess cash to its shareholders an entity acquired a rare painting. The painting is held for capital appreciation rather than for: (a) use in the production or supply of goods or services or for administrative purposes; or (b) sale in the ordinary course of business.. The IFRS for SMEs does not explicitly specify how to account for investments in paintings. How should the entity account for its investment in the painting? (a) Because the IFRS for SMEs does not explicitly specify how to account for an investment in a painting, on initial recognition the entity would recognise the expenditure on the painting as an expense in profit or loss. (b) Because the carrying amount of the painting will be recovered through capital appreciation (or possibly rental to others), the relevant information that users of the entitys financial statements would want about the painting is its current market value. Consequently, by analogy to the accounting specified for investment property (see Section 16 Investment Property) the entity should initially measure the painting at cost and thereafter at fair value, with changes in fair value being recognised in profit or loss. (c) Same as (b). However, if the fair value of the painting cannot be measured reliably without undue cost or effort on an ongoing basis then, by analogy to Section 17 Property, Plant and Equipment (which includes investment property whose fair value cannot be determined reliably without undue cost or effort on an ongoing basis) the entity would account for the painting using the cost-depreciation-impairment model. (d) Because the IFRS for SMEs does not explicitly specify how to account for an investment in a painting the entity must, in accordance with paragraph 2.46, measure the painting asset at its historical cost and subsequently, in accordance with paragraph 2.49, measure it at cost less impairment.
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Answers
Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8 Q9 Q10 Q11 Q12 Q13 Q14 (d) see paragraph 2.2 (a) see paragraph 10.4 and the notes below paragraph 10.4 (c) see paragraph 2.9 (c) see paragraph 2.6 (d) see paragraph 2.7 (e) see paragraphs 2.152.26 (b) see paragraph 2.36 (c) see paragraph 2.36 (c) see paragraph 2.15 and 2.20 (c) see paragraphs 2.27, 2.29 and 2.39 (d) see paragraph 2.20 (c) see paragraphs 2.272.34 (d) see paragraph 2.34 (c) see paragraph 2.35
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Case study 1
Entities A and B are identical in every respect. They started trading on 1 January 20X1 and have entered into identical transactions with the same counterparties, are subject to the same events and operate in the same economic environment. In conformity with the IFRS for SMEs, entity A recognised CU50 profit in 20X1 and CU50 profit in 20X2. Entity B, in error, recognised only CU40 profit in 20X1. If it had not made that error it would have recognised profit of CU50 in 20X1 and CU50 profit in 20X2. In accordance with Section 10 an entity must retrospectively restate its financial information to correct a prior period error and prospective apply revised accounting estimates. Required: Explain, with reference to the objective of financial reporting and the qualitative characteristics of financial information why the IFRS for SMEs, requires retrospective restatement for the correction of prior period errors and prospective application for the accounting estimates.
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The qualitative characteristics flow from the objective of general purpose financial statements. They identify the characteristics of information that are likely to be most useful to the existing and potential investors, lenders and other creditors for making decisions about the reporting entity on the basis of information in its financial report. Consequently, subject to the cost-benefit constraint, maximising the qualitative characteristics of financial information guides the judgements needed to apply the objective of financial reporting. The most critical qualitative characteristics are relevance and reliability (faithful representation). Other qualitative characteristics (eg comparability) are less critical but still highly desirable. When developing financial reporting standards, subject to the effects of the cost constraint, the IASB chooses the alternative that goes furthest towards achieving the objective of financial reporting. Consequently, the IFRS for SMEs requires retrospective restatement to correct prior period errors. Retrospective restatement results in relevant information (CU50 faithfully represents the profit earned by entity B in each of 20X1 and 20X2 in accordance with the IFRS for SMEs. It is also neutral and free from error). The resulting information about entity Bs financial performance and its financial position would be comparable with other entities that use the same reporting framework, (eg entity A) and would allow users to compare entity Bs performance over time (ie to compare 20X2 with 20X1). Without retrospective restatement, entity Bs profit for 20X2 would appear to be 50 per cent higher than its profit for 20X1. This would not faithfully represent its financial performance over time and might lead potential investors to conclude wrongly that entity B is a high-growth company and entity As growth is only stable over the two-year period. In conclusion, retrospective restatement of prior period errors is required because it provides a more faithful representation of an entitys financial position and its financial performance, and maximises the other qualitative characteristics of the reporting entitys financial information. Thus it provides users with information that is consistent with the objective of financial reporting.
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Case study 3
SME A purchased a collection of personal belongings of a famous actress. The entity holds the collection for capital appreciation rather than for: (a) use in the production or supply of goods or services or for administrative purposes; or (b) sale in the ordinary course of business.
Required:
Describe how, in accordance with the IFRS for SMEs, SME A would account for its collection.
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Because the IFRS for SMEs does not explicitly specify how to account for the collection, SME A must, in accordance with paragraph 2.35, develop an accounting policy that provides relevant and reliable information. Applying the accrual basis of accounting, the collection would be recognised on the date on which it is first controlled by SME A. From that date it is probable that the future economic benefits to be derived from the collection will flow to the entity. At that date the cost of the asset (ie collection) can be measured reliably (ie its purchase price). In developing its accounting policy for the measurement of the collection after initial recognition, SME A would analogise to the accounting treatments required by the IFRS for SMEs for similar assets. Consequently, SME A could, by analogy to the requirements in Section 16, account for the collection at fair value, with changes in fair value recognised in profit or loss in the period in which the change occurs. Applying the requirements of Section 16 should provide relevant information that can be determined reliably.
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