2.

0 SOURCES OF FINANCIAL REPORTING AUTHORITY

This explains the sources of the rules governing financial reporting. In Kenya, there
are two major sources of reporting authority:

- Conceptual framework and the IFRS

- Company’s act (Cap. 486)
2.1 IASB’s CONCEPTUAL FRAMEWORK

2.1.1. Definition.

A conceptual framework is like a constitution. It is a coherent system of interrelated

objectives and fundamentals that can lead to consistent standards and that prescribe
the nature, functions and limits of financial accounting and financial statements.

The International accounting standards Board (IASB) has developed a framework for
the preparation and presentation of the financial statements.

The framework sets out the concepts that underlie the preparation and presentation
of financial statements for external users.

The framework assists the IASB in among other things;

i. Development of International Financial Reporting standards (IFRS) and

International Accounting Standards (IAS).
ii. Interpretation of the IFRS.

The interpretation of the IFRS is done by a special committee called the international
financial reporting interpretations committee (IFRIC) which comprises twelve
members and a non-voting chairman, all appointed by the Trustees. The role of the
IFRIC is to prepare interpretations of IFRSs for approval by the IASB and provide
timely guidance on financial reporting issues not specifically addressed in IFRSs.

In addition, the framework may assist;

- National standards setting bodies in the development of national standards
- Auditors in forming an opinion on whether financial statements conform with
IFRS.
- Preparers of financial statements in applying IFRS and in dealing with topics
that are yet to form the subject of a standard or an interpretation.
- Users of financial statements in interpretation of the information contained in
the financial statements, prepared in conformity with the IFRS.

2.1. 2. The scope of the framework includes;

i. The objectives of financial statements

ii. Qualitative characteristics that determine the usefulness of information
contained in the financial statements.
iii. Definition, recognition and measurement of the elements from which the
financial statements are constructed.
These are explained below.
• Qualitative characteristics of the financial statements’ information
1. Primary qualities
a. Relevance.
To be useful in decision making, information must be relevant to those
making the decisions. Relevant information has the following characteristics;
- Predictive value; helps in evaluating the potential effects of the past, present
or future transactions and events on the future cashflows.
- Timeliness; information should be available to the decision makers as and
when required, before it loses its value or capacity to influence decisions.
b. Reliability.
Reliable information exhibits the following characteristics;
- Verifiable; different knowledgeable and independent observers should reach
a general consensus on the information.
- Representational faithfulness; the information should be a faithful
representation of the real world economic conditions that it seeks to
represent.
- Neutrality; is the absence of bias.
- Completeness; that is including all relevant and necessary information that
would influence the user’s decision making.
2. Secondary qualities
a. Comparability. This is the quality of information that enables users to identify
similarities and differences between two sets of financial statements. In other
words, enhances the comparison of financial statements between companies
or different accounting periods.
b. Consistency. Refers to the use of the same accounting policies and procedures
from period to period within an entity. For example, adopting the same
method of depreciation year in year out.
c. Understandability. This is the quality of information that enables the users to
understand its meaning. understandability is enhanced when information is
classified and presented clearly.
• Recognition and measurement of the financial statement’s elements.
a) Fundamental assumptions
These are the basis upon which accounting explanations can proceed. There
are four main fundamental accounting assumptions;
i. Separate entity
A company is regarded as an entity separate from its owners. It is regarded
by law as an artificial person, with the rights to acquire, own dispose property
and enter into contracts in its own name. The assets, liabilities and any other
obligations of the company are separate from the owners’ and are reported as
such in the financial statements.
ii. Going concern
A company is assumed to continue with its operations for an indefinite period
of time.i.e. Its operations are not coming to an end in the near future.
The entity is assumed to be a going concern.
This enables the classification of the company’s assets and liabilities into long-
term and short-term in the statement of financial position.
iii. Time period or periodicity assumption
Because a company is assumed to continue its operations indefinitely, the
indefinite time period is divided into specific periods of time, after which the
financial performance, position and cashflows are measured and reported.
Most companies prepare their financial statements after a period of one
accounting year, which is not necessarily the calendar year.
iv. Unit of measure
All measurements of transactions or economic events and activities are in
terms of money.

b). Accounting concepts or principles.

These are broad rules adopted by the accounting profession as a guide in the
preparation and presentation of financial statements.
There are four major accounting concepts;
i. Historical cost
All assets are recorded in the financial statements at the purchase cost. This
purchase cost is known as historical cost.
The historical cost is then adjusted for accumulated depreciation (loss in value
of a non-current asset over its useful life.). The figure arrived at is known as
the book value.
i.e. historical cost – accumulated depreciation = book value
ii. Revenue recognition
Revenue is recognized in the financial statements ( except statement of
cashflows) when it is earned and realized, whether it has been received or not,
so long as the time for doing so has expired or an event denoting receipt of
cash has occurred.
Expenses are recognised in the financial statements when incurred, whether
money has been paid or not, so long as time for doing so has expired or an
activity denoting payment of cash has occurred. For example, accrued
expenses such as rent, electricity.
iii. Matching concept
Revenue earned in a given period is matched against all the expenses
incurred in earning that revenue.
For example, expenses incurred in earning revenue of the year 2010 for
company X will be matched against revenue earned, whether the expenses
were paid in the year 2010 or not.
iv. Full disclosures
All relevant and material information not disclosed by the financial
statements should be disclosed by way of notes to the financial statements.
c). Constraints
i. materiality
Any information is regarded as being material if its inclusion or non-inclusion
will affect or influence the decision making process of the users.
Only material information should be included in the financial statements. For
example, the cost of a waste basket, though an asset, is negligible and is
therefore expensed in the income statement rather than being taken to the
statement of financial position.
ii. Industry’s practice
 A company tends to follow the industry’s practice with respect to the
treatment of specific items or events in the financial statements. For example,
brokerage firms may use market value for purposes of valuing all marketable
securities.
iv. Conservatism/ Prudence constraint.
The preparers of financial statements should be conservative in the
recognition of revenue and expenses. One should provide for probable
expenses, such as bad debts and depreciation, and only record realised
profits.
This ensures that expenses are not understated while revenue is not
overstated.
Iv.Cost- benefit constraint;
The benefits of preparing financial statements should exceed the costs
incurred in preparing them.

2.1.3 International accounting standards committee (IASC)

The IASC was formed in 1973 in London and was empowered to establish
International accounting standards (IAS).
It was reorganised into the IASB (International Accounting Standards Board)
in early 2001.
The IASC developed 41 IAS, many of which have been revised, merged with
others or superseded by others.
The IASB began a second series of standards known as the International
Financial Reporting standards (IFRS).
The IFRS focus on general principles derived from the conceptual framework,
reflecting the recognition, measurement and reporting requirements for
transactions.
Many countries have adopted the IAS and IFRs instead of setting their own
accounting standards.
2.1.4 Benefits of adopting global accounting standards to companies.
1. Easier access to foreign capital markets as countries use a common global
financial reporting language.
2. Increased credibility of domestic capital markets to foreign capital
providers since they conform to the IAS requirements
3. Lower cost of capital to companies since they can raise capital cheaply
from foreign markets.
4. Enhances comparability of financial data across the countries’ boundaries.
5. Greater understand ability- a common financial language.
6. Greater transparency as companies follow the globally accepted
standards.
2.1.5 Recent trends in IFRS.
The following observations have been made about trends in IFRS.
1. Recent IFRS reflect greater use of fair (current) value in measuring
transactions and a movement away from the traditional historical cost
basis of measurement. Current values are more relevant for economic
decision making than historical costs.
 2. More assets are being reported at the current value in the statement of
financial position rather than at the historical cost.
3. The recent IFRS are substantially expanding financial statements
disclosure, especially about judgments and assumptions. Companies must
disclose the judgments and assumptions they make in preparation of
financial statements.
4. Recent IFRS are moving off- balance sheet items on to the balance sheet.
For example, guarantees to other individuals or parties.
5. Traditionally, income has been recognized based on the realization
principle. In the recent IFRS however, Performance reporting has become
key. The income statement is required to separately report the realized
component of income and those components of income that result from
changes in the fair value of assets and liabilities even before they are
disposed off. For example shares of another company. If the price
increases with sh 2m, this gain is reported in the income statement even if
not realised.
6. The recent IFRs are eliminating the choice for two or more acceptable
methods of accounting for the same transactions
7. An important goal of IASB is to converge IFRS and the US GAAP on the
best quality standards.
2.2 The Company’s Act Chapter 486.
The company’s act (cap.486) also sets out some reporting standards. For example;
1. Section 147- keeping of books of accounts
2. Section 148- income statement and statement of financial position
3. Section 149- general provisions as to the contents and forms of accounts to
maintain
4. Section 151- form of group accounts
5. Section 152- content of group accounts
6. Sixth schedule to the act. It explains in details what the accounts should
contain.
2.3 Other sources of reporting authority.
The Nairobi Stock Exchange (NSE) and the Capital Markets Authority (CMA) are
agencies set up by law, and they have powers to prescribe supplementary
reporting requirements for companies trading their shares and bonds publicly.