Development of

1 Accounting principles and

professional practice
LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Describe the growing importance of 5. Identify the objective of financial reporting.

global financial markets and its relation 6. Identify the major policy-setting bodies and
to financial reporting. their role in the standard-setting process.
2. Identify the major financial statements and 7. Explain the meaning of IFRS.
other means of financial reporting. 8. Describe the challenges facing financial
3. Explain how accounting assists in the efficient reporting.
use of scarce resources.
4. Explain the need for high-quality standards.

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 Revolution in international financial reporting

 The age of free trade and the

interdependence of national economies is
now with us.
 Many of the largest companies in the world
often do more of their business in foreign
lands than in their home country.
 Companies now access not only their home
capital markets for financing but others as
well.
 As this globalization takes place, companies
are recognizing the need to have one set of
financial reporting standards.
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 Cont’d

 For globalization to be efficient, what is

reported for a transaction in Beijing should
be reported the same way in Paris, Nework,
or London.

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 Financial reporting and accounting standards

Affected by the following, positively or

negatively
Global markets Objectives of Standard setting Financial
financial reporting organizations reporting
challenges

• F/statements • G/purpose • IOSCO • Political

and financial financial • IASB environment
reporting statements • Hierarchy of • Expectations
• Accounting & • Capital IFRS
Gap
capital providers • Significant
allocation • Entity financial
• High-quality perspective reporting issues
standards • Decision- • Ethics
usefulness
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 GLOBAL MARKETS
 World markets are becoming increasingly
intertwined. International consumers drive
Japanese cars, wear Italian shoes.
 The tremendous variety and volume of both
exported & imported goods indicates the
extensive involvement in international
trade (financial transactions across national
borders and to make investment, capital
allocation and financing decisions involving
many foreign companies).
 The move toward adoption of global
accounting standards has and will continue
1-5 to facilitate the global markets.
 GLOBAL MARKETS

Financial Statements and Financial Reporting

Financial statements are prepared using accounting.
Accounting is the universal language of business: It is
1. The identification, measurement, and communication
of financial information about

2. economic entities to

3. interested parties.

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 GLOBAL MARKETS
Accounting and Capital Allocation
Resources are limited. Efficient use of resources often
determines whether a business thrives/increases. Accountants
must measure performance accurately & fairly on a time basis,
so that the right managers & companies are able to attract
investment capital.

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 GLOBAL MARKETS

High Quality Standards

Globalization demands a single set of high-quality
international accounting standards. Some elements:
1. Single set of high-quality accounting standards established by
a single standard-setting body.
2. Consistency in application and interpretation.
3. Common disclosures.
4. Common high-quality auditing standards and practices.
5. Common approach to regulatory review and enforcement.
6. Education and training of market participants.
(Continued)

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 GLOBAL MARKETS

High Quality Standards

Globalization demands a single set of high-quality
international accounting standards. Some elements:
7. Common delivery systems (e.g., eXtensible Business
Reporting Language—XBRL).
8. Common approach to corporate governance and legal
frameworks around the world.

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 OBJECTIVE OF FINANCIAL ACCOUNTING

Objective: Provide financial information about the

reporting entity that is useful to
► present and potential equity investors,

► lenders, and

► other creditors

in making decisions about providing resources to the entity.

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 OBJECTIVE OF FINANCIAL ACCOUNTING

General-Purpose Financial Statements

► Provide financial reporting information to a wide variety
of users.
► Provide the most useful information possible at the
least cost.

Equity Investors and Creditors

► Investors and creditors are the primary user group.

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 OBJECTIVE OF FINANCIAL ACCOUNTING

Entity Perspective
► Companies viewed as separate and distinct from their
owners (shareholders). The assets of company are viewed
as assets of the company and not of a specific creditor or
shareholder.
Decision-Usefulness
► Investors are interested in assessing
1. the company’s ability to generate net cash inflows and
2. management’s ability to protect and enhance the capital
providers’ investments.

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 STANDARD-SETTING ORGANIZATIONS

Main international standard-setting organization:

► International Accounting Standards Board (IASB)
● Issues International Financial Reporting Standards
(IFRS).
● Standards used on most foreign exchanges.
● IFRS used in over 166 countries.
● Organizations that have a role in international standard-
setting are the International Organization of Securities
Commissions (IOSCO) and the IASB.

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 STANDARD-SETTING ORGANIZATIONS

International Organization of Securities

Commissions (IOSCO)
► Does not set accounting standards.

► Dedicated to ensuring that global

markets can operate in an efficient
and effective basis.
http://www.iosco.org/
► Supports the use of IFRS as the
single set of international
standards in cross-border offerings
and listings.

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 International Accounting Standards Board

Due Process
The IASB due process has the following elements:
1. Independent standard-setting board;
2. Thorough and systematic process for developing
standards;
3. Engagement with investors, regulators, business leaders,
and the global accountancy profession at every stage of
the process; and
4. Collaborative efforts with the worldwide standard-setting
community.
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 International Accounting Standards Board

ILLUSTRATION 1-5
International
Standard-Setting
Structure

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LO 6
 International Accounting Standards Board

Types of Pronouncements/declarations
Issued by the IASB
► International Financial Reporting Standards.

► Conceptual Framework for Financial Reporting.

► International Financial Reporting Standards Interpretations.

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 STANDARD-SETTING ORGANIZATIONS

Hierarchy of IFRS
Companies first look to:
1. International Financial Reporting Standards;
2. International accounting standard; and
3. Interpretations originated by the international financial
reporting interpretations committee (IFRIC) or the former
standing interpretations committee (SIC).

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 FINANCIAL REPORTING CHALLENGES
ILLUSTRATION 1-6

IFRS in a Political Environment User Groups that Influence

the Formulation of
Accounting Standards

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 FINANCIAL REPORTING CHALLENGES

The Expectations Gap

What the public thinks accountants should do vs. what
accountants think they can do.

Significant Financial Reporting Issues

► Non-financial measurements (customer satisfaction
indexes, reject rates on goods purchased)
► Forward-looking information (only focused on
historical and current issues)
► Soft assets-focused on hard assets
► Timeliness-no real time or daily financial statements
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 FINANCIAL REPORTING CHALLENGES

Ethics in the Environment of Financial

Accounting
► Companies that concentrate on “maximizing the bottom
line,” “facing the challenges of competition,” and
“stressing short-term results” place accountants in an
environment of conflict and pressure.
► IFRS do not always provide an answer.

► Technical competence is not enough when encountering

ethical decisions.

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 CONCEPTUAL FRAMEWORK

Issued by IASB
Conceptual Framework establishes the concepts that
underlie financial reporting.
Need for a Conceptual Framework
► Rule-making should build on and relate to an established
body of concepts.
► Enables IASB to issue more useful and consistent
pronouncements over time.

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 CONCEPTUAL FRAMEWORK

Overview of the Conceptual Framework

Three levels:
 First Level = Objectives of Financial Reporting
 Second Level = Qualitative Characteristics and
Elements of Financial Statements
 Third Level = Recognition, Measurement, and
Disclosure Concepts.

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 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition
Third level
3. Monetary unit 3. Expense recognition
The "how"—
4. Periodicity 4. Full disclosure implementation
5. Accrual

QUALITATIVE
CHARACTERISTICS ELEMENTS
1. Fundamental 1. Assets
qualities 2. Liabilities Second level
2. Enhancing 3. Equity Bridge between
qualities 4. Income
levels 1 and 3
5. Expenses
ILLUSTRATION 2-7
Conceptual Framework
for Financial Reporting OBJECTIVE
Provide information
about the reporting
entity that is useful
to present and potential First level
equity investors, The "why"—purpose
lenders, and other of accounting
creditors in their
capacity as capital
providers.
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 FIRST LEVEL: BASIC OBJECTIVE

OBJECTIVE
“To provide financial information about the reporting entity
that is useful to present and potential equity investors,
lenders, and other creditors in making decisions about
providing resources to the entity.

 Provided by issuing general-purpose financial statements.

 Assumption is that users need reasonable knowledge of business
and financial accounting matters to understand the information.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Qualitative Characteristics of Accounting

Information
IASB identified the Qualitative Characteristics of
accounting information that distinguish better (more useful)
information from inferior (less useful) information for
decision-making purposes.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

ILLUSTRATION 2-2
Hierarchy of Accounting
Qualities

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 Relevance
Relevance

ILLUSTRATION 2-7
Conceptual Framework
for Financial Reporting

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Relevance

To be relevant, accounting information must be capable of making

a difference in a decision.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Relevance

Financial information has predictive value if it has value as an input

to predictive processes used by investors to form their own
expectations about the future.

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 For example, if potential investors are interested in
purchasing ordinary shares in Nippon Co., they may
analyze its
• Current resources and claims to those resources,
• Its dividend payments, and
• Its past income performance to predict the amount,
timing, and uncertainty of Nippon’s future cash
flows.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Relevance

Relevant information also helps users confirm or correct prior

expectations.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Relevance

Information is material if omitting it or misstating it could influence

decisions that users make on the basis of the reported financial
information.

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 Faithful
Faithful Representation
Representation

ILLUSTRATION 2-7
Conceptual Framework
for Financial Reporting

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Faithful Representation

Faithful representation means that the numbers and descriptions

match what really existed or happened.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Faithful Representation

Completeness means that all the information that is necessary for

faithful representation is provided.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Faithful Representation

Neutrality means that a company cannot select information to favor

one set of interested parties over another.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Faithful Representation

An information item that is free from error will be a more accurate

(faithful) representation of a financial item.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS
Enhancing Qualities
These characteristics distinguish more useful information
from less useful information.

Information that is measured and reported in a similar manner for

different companies is considered comparable.
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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Enhancing Qualities

Verifiability occurs when independent measurers, using the same

methods, obtain similar results.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Enhancing Qualities

Timeliness means having information available to decision-makers

before it loses its capacity to influence decisions.

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SECOND LEVEL: FUNDAMENTAL CONCEPTS

Enhancing Qualities

Understandability is the quality of information that lets reasonably

informed users see its significance.
Understandability is enhanced when information is classified,
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characterized, and presented clearly and concisely.
 Basic
Basic Elements
Elements

ILLUSTRATION 2-7
Conceptual Framework
for Financial Reporting

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 SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements

Asset A resource controlled by the entity as a

result of past events and from which
future economic benefits are expected to
Liability flow to the entity.

Equity

Income

Expenses

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 SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements

Asset
A present obligation of the entity arising
from past events, the settlement of which
Liability
is expected to result in an outflow from the
entity of resources embodying economic
Equity benefits.

Income

Expenses

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 SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements

Asset

Liability

Equity The residual interest in the assets of the

entity after deducting all its liabilities.

Income

Expenses

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 SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements

Asset

Liability

Equity Increases in economic benefits during the

accounting period in the form of inflows or
enhancements of assets or decreases of
Income
liabilities that result in increases in equity,
other than those relating to contributions
Expenses from equity participants.

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 SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements

Asset

Liability

Equity Decreases in economic benefits during the

accounting period in the form of outflows
Income or depletions of assets or incurrences of
liabilities that result in decreases in equity,
other than those relating to distributions to
Expenses
equity participants.
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 SECOND LEVEL: BASIC ELEMENTS
Exercise 2-4: Identify the qualitative characteristic(s) to be used
given the information provided. Characteristics
(a) Qualitative characteristic being Relevance
displayed when companies in the Faithful representation
same industry are using the same Predictive value
accounting principles.
Confirmatory value
(b) Quality of information that confirms Neutrality
users’ earlier expectations.
Materiality
(c) Imperative for providing comparisons Timeliness
of a company from period to period.
Verifiability
(d) Ignores the economic consequences Understandability
of a standard or rule.
Comparability
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 SECOND LEVEL: BASIC ELEMENTS
Exercise 2-4: Identify the qualitative characteristic(s) to be used
given the information provided. Characteristics
(e) Requires a high degree of consensus Relevance
among individuals on a given Faithful representation
measurement. Predictive value
(f) Predictive value is an ingredient of this Confirmatory value
fundamental quality of information. Neutrality
(g) Four qualitative characteristics that Materiality
enhance both relevance and faithful Timeliness
representation.
Verifiability
(h) An item is not reported because its Understandability
effect on income would not change a
Comparability
decision.
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 SECOND LEVEL: BASIC ELEMENTS
Exercise 2-4: Identify the qualitative characteristic(s) to be used
given the information provided. Characteristics
(i) Neutrality is a key ingredient of this Relevance
fundamental quality of accounting Faithful representation
information. Predictive value
(j) Two fundamental qualities that make Confirmatory value
accounting information useful for Neutrality
decision-making purposes.
Materiality
(k) Issuance of interim reports is an Timeliness
example of what enhancing
Verifiability
ingredient?
Understandability
Comparability
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THIRD LEVEL: RECOGNITION, MEASUREMENT,
AND DISCLOSURE CONCEPTS

These concepts explain how companies should recognize,

measure, and report financial elements and events.

Recognition, Measurement, and Disclosure Concepts

ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition
3. Monetary unit 3. Expense recognition
4. Periodicity 4. Full disclosure
5. Accrual

ILLUSTRATION 2-7
Conceptual Framework for
Financial Reporting

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 THIRD LEVEL: ASSUMPTIONS

Basic Assumptions
Economic Entity – company keeps its activity separate from its
owners and other business unit.

Going Concern - company to last long enough to fulfill

objectives and commitments.

Monetary Unit - money is the common denominator.

Periodicity - company can divide its economic activities into

time periods.

Accrual Basis of Accounting – transactions are recorded in the

periods in which the events occur.
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 THIRD LEVEL: ASSUMPTIONS

BE2-8: Identify which basic assumption of accounting is best

described in each item below.
(a) The economic activities of FedEx Corporation
(USA) are divided into 12-month periods for the Periodicity
purpose of issuing annual reports.
(b) Total S.A. (FRA) does not adjust amounts in its Monetary
financial statements for the effects of inflation. Unit
(c) Barclays (GBR) reports current and non-current
classifications in its statement of financial Going Concern
position.
(d) The economic activities of Tokai Rubber
Industries (JPN) and its subsidiaries are Economic
merged for accounting and reporting purposes. Entity

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 THIRD LEVEL: BASIC PRINCIPLES

Measurement Principles
 Historical Cost is generally thought to be a faithful
representation of the amount paid for a given item.

 Fair value is defined as “the price that would be received to

sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement
date.”

 IASB has given companies the option to use fair value as the
basis for measurement of financial assets and financial
liabilities.

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 THIRD LEVEL: BASIC PRINCIPLES

Revenue Recognition
When a company agrees to perform a service or sell a product to
a customer, it has a performance obligation.

Requires that companies recognize revenue in the accounting

period in which the performance obligation is satisfied.

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 THIRD
LEVEL:
BASIC
PRINCIPLES
Illustration: Assume
the Airbus (DEU) signs
a contract to sell
airplanes to British
Airways (GRB) for
€100 million. To
determine when to
recognize revenue,
Airbus uses the five
steps for revenue
recognition shown at
right.
ILLUSTRATION 2-5
The Five Steps of
1-57 Revenue Recognition
 THIRD LEVEL: BASIC PRINCIPLES

Expense Recognition - Outflows or “using up” of assets

or incurring of liabilities during a period as a result of delivering
or producing goods and/or rendering services. ILLUSTRATION 2-6
Expense Recognition

“Let the expense follow the revenues.”

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 THIRD LEVEL: BASIC PRINCIPLES

Full Disclosure
Providing information that is of sufficient importance to
influence the judgment and decisions of an informed user.
Provided through:
 Financial Statements
 Notes to the Financial Statements
 Supplementary information

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 THIRD LEVEL: BASIC PRINCIPLES

BE2-9: Identify which basic principle of accounting is best

described in each item below.
(a) Parmalat (ITA) reports revenue in its income Revenue
statement when it delivered goods instead of when Recognition
the cash is collected.
(b) Google (USA) recognizes depreciation expense for Expense
a machine over the 2-year period during which that
Recognition
machine helps the company earn revenue.
(c) KC Corp. (USA) reports information about pending
Full
lawsuits in the notes to its financial statements.
Disclosure
(d) Fuji Film (JPN) reports land on its statement of
financial position at the amount paid to acquire it,
even though the estimated fair market value is Measurement
greater.
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 THIRD LEVEL: COST CONSTRAINT

Cost Constraint
Companies must weigh/Consider the costs of providing the
information against the benefits that can be derived from using
it.
 Rule-making bodies and governmental agencies use cost-
benefit analysis before making final their informational
requirements.
 In order to justify requiring a particular measurement or
disclosure, the benefits perceived to be derived from it
must exceed the costs perceived to be associated with
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 Summary of
the Structure

ILLUSTRATION 2-7
Conceptual Framework
for Financial Reporting

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 1.5 Financial reporting requirements in Ethiopia
 Ethiopia passed a financial reporting law in 2014 which
requires the use of IFRS by commercial businesses
operating in Ethiopia.
Proclamation No. 847/2014
Regulation No. 332/2014
 Accounting and Auditing Board of Ethiopia (AABE) is
established by Regulation No. 332/2014
 It is an autonomous government organ accountable
to MOFEC.
 It is headed by the Director General
 It has 12-member Board of Directors
 Monitor & control IFRS implementation in
Ethiopia
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 Structure, strategic plan, and roadmap of AABE

The proclamation (No. 847/2014) requires:

 Commercial organizations to follow
 International Financial Reporting Standards (IFRS), or
 International Financial Reporting Standards for Small
and Medium Enterprises (IFRS for SME)
 Charities and societies to follow International Public Sector
Accounting Standards (IPSAS)
 Public auditors to follow International Standards for
Auditing.
 Public interest entity (PIE) should use the full IFRS

1-64
 AABE duties (among others)

 Issue standards and directives relating to financial

reporting and auditing and ensure their compliance.
 Receive and register financial statements of reporting
entities
 Review and monitor the accuracy and fairness of FS to
enforce compliance with the reporting standards
 Register and license public auditors
 Oversee professional accountancy bodies
 Establish, publish and review a code of professional
conduct and ethics for certified public accountants and
certified auditors
 Conduct or arrange for the conduct of professional
examination for the purpose of registering certified
public accountants
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 roadmap of AABE Reporting
SME

Reporting Date:
Other PIEs 2011
Reporting Date:
Significant PIEs
Transition Date: SMEs
2010/11
• IFRS
Transition Date: by ot
Other PIEs • IFRS/Quarterly • A
2009/10
reporting by other pro
Transition Date: PIEs • Stak
Significant PIEs • IFRS/Quarterly • Audit procedures comm
2008/09 • Stakeholders
reporting by sig. • Com
PIEs communications moni
• Audit procedures • Compliance
2007/08 • Transition Oth
• Stakeholders monitoring for sig.
adjustments communications PIEs
IFRS Competency

• Prepare IFRS • Other PIE’s • SMEs prepare

• Awareness
• Assessment opening SFP prepare opening opening SFP and
• Amendment of laws, • Dry Runs for SFP & comparative figs
comparative figs • Stakeholders
regulation and “significant PIEs”
directives • Prepare • Dry Runs for communications
• Training other PIEs • Dry Runs for SMEs
• Planning/impact comparative • SME’s commence
analysis figures transition
• Transition
adjustments/ opening planning
BS for sig. PIEs
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Realization and standardization of statutory reporting
1-67
67