Key factors driving the globalization Of financial markets Technological innovation Financial innovation Reduction of barriers to capital flows Convergence of generally accepted accounting principles Two types of Theories Positive/Descriptive theories: attempt to explain phenomena Normative/Prescriptive theories: prescribe how something should be done. Normative theories are developed through a process of deductive reasoning which begins with setting objectives.
The developer tooth theory sets whatever objectives he desires, Having set the objectives, the developer should then deduct the assumptions that underlie those objectives. Once the objectives are specified, and any underlying assumptions deducted, the developer would then deduct the principles that flowed logically from both the objectives and he assumptions, In turn, the principles then enable the inventor to deduce the definitions, activities and observable actions that should result.
The role of a framework of accounting To provide guidance to accounting standard setters when developing reporting requirements To provide a formal frame of reference for the types of transactions and events that should be accounted for, even they should be recognized, how they should be measured. TO facilitate communication between preparers, auditors and users of financial statements by providing a common set Of definitions, criteria and Other principles.
Limitations Of a framework Economic and legal constraints Social and political constraints Human resource constraints Professional judgment Development of International Financial Reporting Standards Standard-setting arrangement Domestic adoption of Furs Part 8: The SAAB Framework for the Preparation and Presentation to Financial Statements Users of General purpose Financial Statements Existing and potential investors, lenders and other creditors Approach adopted to deal with the diversity of users’ information needs To seek to provide the information set that will meet the needs of the maximum numbers of primary seers Objective of General Purpose financial statements Stewardship function of management: how efficiently and effectively management have used the resources entrusted to them Decision Usefulness objective: those wishing to assess the accountability of management are assumed to do so to assess an entity’s prospects for future net cash inflows Accountability of Management Limitations Of the decision-usefulness Objective Lack of familiarity with new types of information Decision usefulness may vary among users Capable of multiple interpretations Reporting Entity The critical feature identifying an entity as a reporting entity is the existence of users who depend on general purpose financial statements produced by that entity for resource allocation decisions, Users who can command the tailoring of financial statements to meet their specific needs would not be considered dependent users.
Assumptions of general purpose financial statements Accrual Basis Going Concern Characteristics of general purpose financial statements Understandability: financial information must be readily understood by users who have a reasonable knowledge of business and economic activities and counting and a willingness to study the information with reasonable diligence Relevance Reliability Comparability: users are able to compare the financial statements of an entity through time and compare the financial statements Of different entities 5 Aspects of Reliability Faithful representation Substance over form: the transaction should be accounted for in accordance with its economic reality rather than its legal form Neutrality: no bias Prudence: cautious Completeness Constraints on providing relevant and reliable information Balance between costs of providing information versus the benefits derived room the preparation and presentation Timeliness is another constraint because undue delays in reporting information may result in the reduced relevance of that information to users’ decision making Definition of Assets 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 Definition of Liabilities 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, Definition of Equity The residual interest in the assets of the entity after deducting all its liabilities Definition of Income Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. An increase in assets or a reduction in liabilities; and And increase in equity, other than as a result of a contribution from owners Revenue is arising in the course Of the ordinary activities Of an entity; Gains are income other than revenue. Definition of Expense
A decrease in economic benefits that may arise through outflows or depletion of assets or an increase in a liability; and A decrease in equity, other than those arising from distributions to equity participants Expenses arise in the course Of the ordinary activities of an entity; Losses are expenses that may or may not arise in the course of ordinary activities of an entity. Recognition criteria for elements of financial statements An item that meets the definition of an element should be recognized if: It’s probable that any future economic benefit associated with the item will flow to or room the entity The item has a cost or value that can be measured with reliability SIS 1 7 Accounting for leases A lease is an agreement whereby the lesser conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time. Operating Lease Finance Lease: it transfers substantially all the risks and rewards incidental to ownership of an asset.
For finance lease, the amount to be recognized for both the lease asset and lease liability is the fair value of the leased asset or, if lower, the present value of the Malls at the inception of the lease. Question 1. Pl. 39 SAAB and PASS for leases Under the approach of accounting for leases proposed by the ASSAI and FAST, the lease would recognize: An asset for its right to use the leased item for the lease term; and A liability to pay rentals SIS II Construction Contracts A contract specifically negotiated for the construction of an asset or a combination Of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use.
Fixed price contract A cost plus contract 2 methods: Stage of completion method: the amount of revenue recognized in each period – total expected revenue x percentage of completion – revenue recognized in prior period; the amount of expense recognized in each period = total expected costs x percentage of completion – expenses recognized in prior period journal entry: DRY Construction WIPE DRY Construction expenses Construction revenue Complete Contract Method: the construction costs are recognized as an expense in the period in which they are incurred; Revenue is recognized to the extent that it is probable that the construction costs incurred are recoverable; Profit is not recognized unless the construction contract is completed. SIS 18 Revenue Criteria for the recognition of revenue for the sale of goods PI . 48 Revenue for the sale of goods should be recognized when the significant risks and rewards of ownership are transferred to the buyer (typically, point Of sale) Revenue for rendering services should be recognized progressively as services are provided in each reporting period (stage Of completion) Revenue on construction contracts should be recognized progressively throughout production (stage of completion) Cost Based Measurements Cost/historical cost Amortized cost Current cost Definition of Cost/historical cost
The amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction or, where applicable, the amount attributed to that asset when initially recognized in accordance with the specific requirements Advantages and disadvantages of Historical cost measurement Advantages: Well understand Relevant to decision making Reliable Less costly to implement Disadvantage: Limited relevance to decision-making Undermines the comparability Of financial reports Problems with reliability Definition Of Amortized cost PI . 6 The amount at which the financial assets or financial liability is measured at initial recognition minus principal repayments, plus or minus the cumulative amortization using the effective interest method of any difference between that initial amount and the maturity amount, and minus any reduction for impairment or inconvertibility. Definition of Current Cost The current cost is the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset were acquired currently. Reproduction cost: the current cost of replacing an existing asset with an identical one
Replacement cost: the current cost of replacing an existing asset with an asset of equivalent productive capacity or service potential Value Based Measurement Fair Value sale price Fair Value less costs to sell sale price less cost of disposal Net Realizable Value Realizable (Settlement) Value Value in use Difference between Fair value less cost to sell and net realizable value Fair value less cost to sell measures the amount that could be obtained from selling the asset in its current state. Net realizable value measures the benefits that the entity expects to realism from the asset in the ordinary course of business. Risk of an asset Systematic Risk: referred to as market risk or non-diversified risk. It relates to the extent to which the variability of the return earned on an asset, or group of assets, is due to economy wide factors affecting all assets. Unsystematic Risk: the risk that is specific to a particular asset due to unique features Of that asset. Investors can drive unsystematic risk towards zero, but systematic risk cannot be eliminated. Example 1. 3 Definitions 21. 7 Minimum lease payment (ML) includes: Rental payment over the lease term Any guaranteed residual value Any bargain purchase option ML doesn’t include: Reimbursement of costs for services and taxes paid by leasers on behalf of the lease Contingent rentals (fluctuating lease payments) Short-term employee benefits The liability for short-term benefits should be measured at the undistorted amount expected to be paid on settlement to the obligation. Fifth benefit is non-accumulating, a liability and expense should not be recognized until the benefit occurs. A liability is not recognized because the employee’s service doesn’t increase the amount of the leave benefit and benefits lapse as each year ends.
If a benefit is accumulating and vesting a liability is recognized s employees render services that increase their entitlement to future compensation. Long-term employee benefits Long service Leave Superannuation Example 1. 5 Pl. 74 3 steps to measure long-term employee benefits: Estimate number Of employees Who Will become entitled to the benefits Determine the future payments for services performed up to the end of the reporting period that Will receive the benefits Determine appropriate discount rates to measure the above payments at their present value Two types of superannuation plans Defined benefit plans (Fixed Amount): the future benefits expected are the same sugarless of the performance of the plan.
The employee expects to be paid a specified benefit on the occurrence of a particular event, Defined contribution plans (Variable Amount): employees and/or employers make contributions that are then invested for the benefits of members. A members final benefit is a function to the share of contributions to the tuna and the past earnings to the plan. From the employers point of view, their primary interest in a defined contribution plan is their obligation to pay contribution to the plan. Two methods of measuring Superannuation Example 1. 6 p I . 78 Net Capitalization Approach: the balance sheet of the employer should recognize a liability when the present value of the defined benefit obligation exceeds the fair value of the plan assets; or otherwise. The superannuation expense is determined as the change in the net superannuation asset or liability.
Partial Capitalization Approach: one of the components of the superannuation expense is the expected return on plan assets, Customer loyalty programs The point of sale: DRY Cash/Receivable CRY Revenue CRY Deferred Revenue The point of Redemption: DRY Deferred Revenue Capital Maintenance Principle The profit is earned only if the capital (net assets) at the end of the period exceed the amount of capital at the beginning of the period, excluding distributions to, and contributions from owners during the period. Part C: The FAST/SAAB Conceptual Framework Project Phases of the conceptual framework project Phase A: Objectives and qualitative characteristics Phase B: Elements and recognition Phase C; . Measurement Phase D: Reporting entity ; Presentation and disclosure Phase E. Phase purpose and status Phase G: Application to not-for-profit entities Phase 1;1_ Remaining issues MODULE 2 PRESENTATION go HANNIBAL STATEMENTS
PART A: PRESENTATION OF FINANCIAL STATEMENTS SIS I Presentation Of Financial Statements Complete Set of Financial Statements A statement Of financial position A statement of comprehensive income A statement Of changes in equity A statement of cash flow Notes which include accounting policies and explanatory notes A statement of financial positions as at the beginning of the earliest comparative period when any of the following occurs: An accounting policy is applied retrospectively Items in the financial statements are retrospectively restated Items in the financial statements are reclassified Review by management of the entity’s performance (additional, not necessary) Details about environmental issues (additional, not necessary) A value-added statement (additional, not necessary) Considerations tort the presentation of financial statements Fair presentation and compliance with Firms (need to be disclosed) Going Concern (don’t need to be disclosed unless where this is not the case) Accrual basis Materiality and aggregation: information is material if its non-disclosure could influence the decisions of financial statement users. Moreover, the materiality of an item is determined by reference to both the size and nature of the item.
Offsetting (not allowed, except where a particular standard requires, or permits, offsetting) Comparative information Consistency: the presentation and classification of items should be consistent every year Circumstance where departing from FIRS is permitted (very rare) The entity needs to disclose detailed information about the departure as follows, A statement that management believes that the departure provides financial Statements that present fairly Details Of the departure Reasons why the FIRS treatment is considered misleading The financial impact Of the departure on the entities profit, financial position and ash flows Selection of accounting policies SIS 8 Determine the applicability of Firms, take into account any implementation guidance associated with a relevant FIRS where it is mandatory. An accounting policy for a particular transaction, event or condition must comply with any relevant accounting standards and AFRICA Interpretations. If there is no specific FIRS requirements, management should use judgment and develop police that ensures financial statements provide information that is: Relevant Neutral Prudent Complete in all material respects Disclosure of accounting policies
SIS I requires that the notes to the financial statements include information concerning: The measurement basis used in preparing the financial statements Details of all accounting policies necessary to understand the financial statements Circumstances in which an accounting policy can be changed Required by an APRS Vulnerably change by the entity and the change will result in the provision of more relevant or reliable information about the financial position, financial performance or cash flows of the entity Accounting treatment on changing accounting policies Required by FIRS – the entity must apply the transitional provisions in the FIRS. Voluntary change/no transitional provisions in FIRS – the accounting policy change must be made retrospectively. First, the opening balance of each component of equity affected by the change must be adjusted for the earliest prior period included in the financial statements. Second, any comparative amounts included in the financial statements must be restated as if the new policy had always been applied by the entity. Disclosure requirements on changing accounting policies Required by FIRS: The title to the FIRS’ and description of transitional provisions if applicable The nature of the change
The amount of adjustment for each financial statement item The adjustments relating to prior periods Voluntary Change: The nature of the change The reason why the change provides reliable and more relevant information The amount of adjustment for each financial statement item Accounting treatment on changes in accounting estimates and errors Requires income and expense adjustments as a result of the revision to be recognized in either the current reporting period, or the current and future reporting periods, depending on which periods the change of estimate affects Specifies that, where elevate, adjustments to assets, liabilities and equity items should be made in the accounting period of the change of estimate Specifies disclosure of the nature and amount Of the revision in accounting estimate where the change affects the current reporting period and to the extent it is practicable, disclosure of the effect on future reporting periods Disclosure on changes in accounting estimates and errors The nature of the error The amount of correction for each financial statement item affected The amount of correction to restate opening balance Where retrospective restatement is impracticable, details of why this is the case ND a description to how the error has been corrected SIS 10 Events after the reporting period Events occurring after the reporting period are those events, that occur between the end of the reporting period and the date when the financial statements are authorized for issue.
Two types of events can be identified: Adjusting events: those that provide further evidence of conditions that existed at the end of the reporting period Non-Adjusting events: those that are indicated of conditions that arose subsequent to the end of the reporting period Recognition and measurement of events after the reporting period For adjusting events, adjust income, expenses, assets, liabilities and disclosure Where necessary gore non- adjusting events, if material, include in the notes to the financial statements: The nature Of the event Its estimated financial effect PART B: STATEMENT OF COMPREHENSIVE INCOME Presentation of comprehensive income SIS 1 requires an entity to present either: A single statement of comprehensive income; or Two statements – an income statement and a statement of comprehensive income Disclosure for the statement of comprehensive income The following items should be disclosed separately in the statement of comprehensive income: Revenue
Finance costs Share of the profit or loss of associates and joint ventures accounted for using the equity method Tax expense A single amount comprising the total of :the post-tax profit or loss of discontinued operations: the post-tax gain or loss recognized on the measurement to fair values less costs to sell or on the disposal of the assets or disposal groups constituting the discontinued operation Profit or loss Each component of other comprehensive income classified by nature Share of the other comprehensive income of associates and joint ventures accounted for using the equity method Total comprehensive income SIS 1 adopts an “all-inclusive” view of comprehensive income and provides for separate disclosure of a number of material items. Material items include finance costs, tax expense and profit or loss. Reclassification adjustments Items previously included in Other comprehensive income can be reclassified to the profit or loss upon particular events PART C: STATEMENT OF CHANGES IN EQUITY Disclosures of changes in equity A statement Of changes in equity discloses: The changes to each equity item arising from comprehensive income. Ramifications with owners, and retrospective adjustments in accordance with SIS Reconciliation between the opening and closing amounts of each component of equity for the period PART D: STATEMENT OF UNCIAL POSITION Current asset Current asset as an asset which satisfies any of the following criteria: It’s expected to be realized in, or is intended for sale or consumption in, the entity’s normal operating cycle It’s held primarily for trading purposes It’s expected to be realized within 12 months after the reporting period It’s cash or a cash equivalents, provided there is no restriction on its use by the entity until 12 months after the reporting period Current liability Similar to current asset UP. 0 Disclosure in the statement of financial position The following items need to be disclosed separately in the statement of financial position: Cash and cash equivalents Inventories Provisions Issued capital and reserves PART E: SIS 7 STATEMENT B CASH PLOWS Information relevant to the operating, financing and investing activities of a reporting entity are to be separately disclosed. Case study, calculation UP. 23 MODULE 3 SIS 37 PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS PART A: PROVISIONS Definition of Provision Provisions are a subset of liabilities.
Provisions are liabilities where there is inherent uncertainty regarding the amount and timing of the future sacrifice of economic benefits, Therefore, it follows that provisions should be recognized when, and only when, the definition of a liability is met. A key aspect of this definition is the requirement that uncertainty exists. Further, where the degree to uncertainty is insignificant, the amount is not a provision: rather, it’s treated as a liability. Where the degree of uncertainty in relation to the timing or amount of the liability is unable to be measured with sufficient reliability, the amount is classified as a contingent liability. Difference between an accrual and a provision Accruals are liabilities to pay for goods or services that have been received or supplied but hue not been paid, invoiced or formally agreed with the supplier, including amounts due to employees.
The uncertainty of accruals is generally much less than for provisions, Scope of SIS 37 SIS 37 applies to all provisions other than: Executor contract -? contracts under which neither party has performed any of its obligations nor both parties have partially performed their obligations to an equal extent Financial instruments Construction contracts Income taxes Leases Employee benefits Insurance contracts within the scope of FIRST Recognition of provision An entity has a present obligation (legal or constructive) as a result o a past event It’s probable that an outflow of resources embodying economic benefits will be required to settle the obligation A reliable estimate can be made of the amount of the obligation Measurement to provisions SIS 37 requires that the amount recognized as a provision shall be the best estimate to the expenditure required to settle the present obligation at the end of the reporting period.
The best estimate is the amount that an entity would continually pay to settle the obligation at that date or transfer it to a third party at that time. It is determined using the judgment of the management of the entity, supplemented by experience of similar transactions and, in some cased, reports from independent experts. If the effect of the time value of money is material, the amount of a provision shall be the present value of the expenditures expected to be required to settle the obligation.
