Week 1 - Introduction

APC311International Financial Reporting

Lecture 1: Introduction:

The regulatory and conceptual framework of IFR

Why do standards need to be mandatory?

To define the way in which accounting numbers are presented in financial statements

To eliminate (or reduce) subjectivity in presenting financial information

To increase public’s confidence in the accounting profession and in the financial reporting system

How might we regulate financial reporting?

1. Market– Each company chooses its own rules pressured by the capital

markets2. Associationism

– Rules are developed by organisations formed to represent the interests of its members

3. Corporatism– Rules are developed by organisations that are licensed by the

state and incorporated into a state sponsored system of regulation

4. State– Statutory rules with an enforcement mechanism

The IASB Framework

• First: Objectives of financial statements:

To provide information about financial position, performance and changes in financial position

To a wide range of users – priority user is the investors group

For the purpose of rationalising economic decision making

The IASB FrameworkUnderlying assumptions: Accruals (or matching) Revenues are to be recognised when they are earned, i.e. when goods

are sold not when cash is collected Expenses are to be recorded when they are incurred not when they are

paid Going concern (justifies the Historical Cost principle)

The IASB Framework

• Second: Qualitative characteristics of quality information

Understandability Relevance (including materiality) Reliability (including faithful representation;

neutrality; prudence; completeness) Comparability

The IASB Framework

• Third: Element definition: Asset: a resource controlled by an enterprise as

a result of past events and from which future economic benefits are expected to flow to the enterprise

Liability: a present obligation of the enterprise arising from past events the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits

The IASB Framework

Equity: the residual interest in the assets of the enterprise after deducting all its liabilities

Income: increases in equity (other than transactions with owners)

Expenses: decreases in equity (other than transactions with owners)

The IASB Framework

The recognition of elements when: It is probable that any future economic

benefit associated with the item will flow to or from the enterprise, and

The item has a cost or value that can be reliably measured

The IASB Framework

The measurement of elements:• Choices include:

Historical costCurrent or replacement cost (entrance

value)Net realisable value (NRV) (exit value)Present value (PV) (economic value)

Why a regulatory framework?

Financial statements Direction Guidance Quality Users’ requirements

Quality True and fair view/fair presentation

Global standards?

The EU regulation imposes endorsed IFRSs on the consolidated statements of all companies listed in the UK from 1st January 2005 onwards.

Currently the US Financial Accounting Standards Board (FASB) and the IASB are working together on a ‘convergence project’

2009 aim to eliminate the SEC requirement for foreign private issuers that seek registration in NYSE to reconcile IFRS-based financial statements to US GAAP

IFRS and IAS SummariesFramework - Technical Summary *

IFRSs:• IFRS 1 First-time Adoption of IFRSs• IFRS 2 Share-based Payment • IFRS 3 Business Combinations * • IFRS 4 Insurance Contracts • IFRS 5 Non-current Assets Held for Sale and Discontinued Operations • IFRS 6 Exploration for and evaluation of Mineral Resources • IFRS 7 Financial Instruments: Disclosures *• IFRS 8 Operating Segments• IFRS 9 Financial Instruments• IFRS 10 Consolidated Financial Statements• IFRS 11 Joint arrangements• IFRS 12 Disclosure of interests in other entities• IFRS 13 Fair value measurement

APPENDIX

IFRS and IAS Summaries• IASs:• IAS 1 Presentation of Financial Statements *• IAS 2 Inventories • IAS 7 Cash Flow Statements *• IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors • IAS 10 Events After the Balance Sheet Date • IAS 11 Construction Contracts • IAS 12 Income Taxes    • IAS 16 Property, Plant and Equipment * • IAS 17 Leases *• IAS 18 Revenue • IAS 19 Employee Benefits • IAS 20 Accounting for Government Grants and Disclosure of Government

Assistance • IAS 21 The Effects of Changes in Foreign Exchange Rates • IAS 23 Borrowing Costs *

IFRS and IAS Summaries• IAS 24 Related Party Disclosures • IAS 26 Accounting and Reporting by Retirement Benefit Plans • IAS 27 Consolidated and Separate Financial Statements • IAS 28 Investments in Associates • IAS 29 Financial Reporting in Hyperinflationary Economies • IAS 31 Interests in Joint Ventures • IAS 32 Financial Instruments: Presentation *• IAS 33 Earnings per Share *• IAS 34 Interim Financial Reporting • IAS 36 Impairment of Assets *• IAS 37 Provisions, Contingent Liabilities and Contingent Assets *• IAS 38 Intangible Assets *• IAS 39 Financial Instruments: Recognition and Measurement *• IAS 40 Investment Property • IAS 41 Agriculture

The trial balanceA trial balance is a list of account balances arranged according to whether they are debit or credit balances.

The basic structure of a trial balance is below

Dr Cr £ £

Name of account

Sales X Expenses X Assets X Liabilities X Capital X Drawings X

X X

DR (£) CR (£)Sales 96,450Stock at 01/06/ 2005 23,500Purchases 73,180Wages and Salaries 12,555Rent and rates 6,050Telephone 352Insurance 820Sundry expenses 318Buildings at cost 25,000Fixtures at cost 3,500Creditors 12,295Debtors 14,320Bank 3,500Cash 150Drawings 8,500Loan from C Green 10,000Motor vehicles at cost 12,000Capital 65,000

183,745 183,745

Review of financial statements

The following is the trial balance of G Brown as at 31 May 2006.

Construct the appropriate financial statements for the year ended 31 May 2006, i.e. prepare Profit & Loss Account and Balance Sheet.

(Stock at 31 May 2006 was valued at £25,350)

Profit & loss account for the year ended 31 May 2006 £ £

Sales 96,450 Less: Cost of goods soldOpening stock 23,500 Purchases 73,180

96,680 Less: Closing stock 25,350 Cost of goods sold (71,330)

Gross profit 25,120

Less: ExpensesWages and salaries 12,555 Rent and rates 6,050 Telephone 352 Insurance 820 Sundry expenses 318

(20,095)Net profit 5,025

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Balance sheet for the year ended 31 May 2006 £ £

Non-Current assets Buildings 25,000 Fixtures 3,500 Motor vehicles 12,000

40,500 Current assets Stock 25,350

Debtors 14,320 Bank 3,500 Cash 150

43,320 Less current liabilities Creditors (12,295)Current assets less Current Liabilities 31,025

71,525 Long term liabilities Loan C Green (10,000)Net Assets 61,525

Financed by:Capital 65,000 Add: Profit for the period 5,025 Less: Drawings (8,500)

61,525 19

2. Accruals and prepaymentsAn accrual (accrued expense) is a current liability representing an amount which relates to the period under review but not yet paid at the end of that period.

A prepayment is a current asset representing an amount paid in the period under review but which relates to the following period, i.e. an expense for the following period paid in advance.

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Example

Mr J Smith paid £200 for the telephone bill for the year ending 31 Dec 2011 but prepaid £50 for 2012. He also paid £500 rent for the same period. However, he should have paid £700 for the whole year (a) Profit & loss account for the year ending 31 Dec 2011 ExpensesTelephone (£200 paid - £50 prepayment) £150Rent (£500 paid + £200 accrual) £700 (b) Balance sheet extract as at 31 Dec 2011 Current assetsPrepayments £50 (how much he paid extra up to the year ending 31

Dec 2011)Current liabilitiesAccruals £200 (how much he still owes up to the year ending 31

Dec 2011)

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3. DepreciationDepreciation is the reduction in the value of an asset over time. The following are the two methods of depreciation:

1. Reducing balance method = Percentage of net-book value

E.g., if depreciation is charged at the rate of 20% per annum:

(a)Profit & loss account as at 31 Dec 2007 and 31 Dec 2008

Expenses 2007 2008Depreciation 200 160

(b) Balance sheet as at 31 Dec 2007 and 31 Dec 2008

2007 2008Asset Cost 1,000 800 Depreciation @ 20% (200) (160)Net Book Value 800 640

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e.g. Bought an asset on 1st Jan 2007 for £1,000. Expected useful life 4 years and residual value expected to be £400:

1,000 - 400 = £150 p/a 4

(a)Profit & loss accounts as at 31 Dec 2007 and 31 Dec 2008

Expenses 2007 2008Depreciation 150 150

(b) Balance sheet as at 31 Dec 2007 and 31 Dec 2008

Non-current assets 2007 2008

Asset Cost 1,000 1,000 Less depreciation (150) (300)Net book value 850 700

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2. Straight Line method = Cost - Residual Value Useful Life