Advanced Financial Accounting

Introduction to Financial Reporting Standards & Institutions

Prof. Dr. Hans Lieck

hans.lieck@hwr-berlin.de

2019/2020
Only for personal use for learning purposes at HWR; no reproduction or transmission permitted.
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Learning objective
After this session you should be able to
• specify different users and what kind of information they
need/want
• identify the major policy-setting bodies and their role in the
standard-setting process
• explain the objectives of financial reporting

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The role of an accounting information system
Activities:
Operating
Purchases Production Sales

Financing
Investing

An accounting information system collects and processes

business transaction data.

Financial statements
summarise the collected accounting data and
present it to interested parties.
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Who is interested in the financial reports/financial
statements of a company?
Users and their information needs
Stakeholder
Stakeholder Value /
Shareholder Value
Lenders
Owners Suppliers and
(present & other trade
potential investors, creditors
shareholders)

Why are they interested in the company?

Customers
Management What information do they need/want?

Competitors
Employees

Government and
Public (society)
their agencies
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What is the objective of financial reporting?
“The objective of general purpose financial
reporting is to provide financial IFRS Conceptual Framework 2018 1.2
information about the reporting entity that
is useful to
other parties
• existing and potential investors, primary users • Regulators
• lenders and • Members of the public
• other creditors • …
decision
in making decisions relating to providing usefulness
resources to the entity. To make these decisions, users assess
Those decisions involve decisions about: how efficiently and
• buying, selling or holding equity and debt effectively the entity’s
instruments, management and governing
an entity’s prospects for board have discharged their
• providing or settling loans and other future net cash inflows responsibilities to use the
forms of credit, or entity’s resources

• exercising rights to vote on, or otherwise Stewardship

influence management’s actions that
To make both these assessments, users need information
effect the use of the entity’s economic about the resources of the entity, claims against the entity
resources.” and changes in those

Predictive Value - Confirmatory Value

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European Union public reporting framework
EU Legal Instruments*)
Main Objectives Operational Objectives AD IAS TD BAD IAD
Stakeholder • Shareholder protection x x x
protection • Creditor protection x
*) Accounting Directive (AD);
• Depositor protection IAS regulation / IFRS
x (IAS);
• Policy holder protection Transparency Directive (TD);
x
Internal market Facilitate:
Bank accounts Directive (BAD);
• Cross border investments xInsurance
x Accounts
x x Directives
x
• Cross border establishment x(IAD) x x
Integrated EU Market efficiency:
capital markets • Access to capital x x x
• Capital allocation x x
• Integrated securities market x x
Source: EC CONSULTATION
Financial • Public confidence in company reporting xDOCUMENT
x x- FITNESS CHECK
stability • Trust in the resilience of specific sectors x xFOR
ON THE EU FRAMEWORK
(banking and insurance)
PUBLIC REPORTING BY
Sustainability • Enhanced corporate responsibilities / xCOMPANIESx
accountability/ good corporate governance
https://ec.europa.eu/info/con
• Empower stakeholders x x
• Foster globally sustainable activities xsultations/finance-2018-
• Foster long term investments xcompanies-public-
• Fight corruption xreporting_en#contributions
x 6
European Union
Law
• Regulations
− A "regulation" is a binding legislative act.
− It must be applied in its entirety across the EU (directly applicable in each EU Member
State).
• Directives
− A "directive" is a legislative act that sets out a goal that all EU countries must achieve.
− However, it is up to the individual countries to devise their own laws on how to reach
these goals (transformation into national law).

Source: https://europa.eu/european-union/eu-law/legal-acts_en

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Components of financial reporting
Financial Report
Management report
“Primary“ financial statements according to IFRS
/ commentary
• financial review by
statement of
• notes management that
• financial position (balance sheet) •comprising significant describes and
• profit or loss and other accounting policies and explains (i.e.):
comprehensive income (OCI) other explanatory entity‘s financial
• changes in equity information performance and
• cash flows •for listed companies: financial position;
Comparative information Segment reporting (IFRS principal
8) uncertainties and
in respect of the
risks
preceding period
Additionally requirements for listed Additional reports,
companies: Earnings per share (IAS 33) e.g. environmental,
sustainability,
corporate social
responsibility (CSR)
reports
= required by IAS 1.10 VW
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 What are consolidated financial statements?
A reporting entity is an entity that chooses, or is required, to present general purpose financial statements.
It does not have to be a legal entity and can comprise only a portion of an entity or two or more entities.

Porsche SE • Annual Financial Statements:

Annual Financial statements of a separate
52,2% Financial company in accordance with local
31 Dec 2018 Statements GAAP (e.g. the German Commercial
Code (HGB) for the financial year
• Consolidated financial statements are
the financial statements of a group in
Parent company which the assets, liabilities, equity,
Volkswagen AG income, expenses and cash flows of
… the parent and its subsidiaries are
subsidiaries presented as those of a single
100% economic entity.
MAN SE 86.80% • Separate Financial Statements
99.64% Porsche Holding
Traton (unconsolidated) are those presented
Audi AG Stuttgart GmbH
by an entity in which the entity could
elect, subject to the requirements in
IAS 27, to account for its investments
in subsidiaries, joint ventures and
associates either at cost, in
accordance with IFRS 9, or using the
IAS 27.4 equity method as described in IAS 28.
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Important standard-setting organisations
and accounting standards
IFRS Foundation
International Accounting Standards Board (IASB)
International Financial Reporting Standards (IFRS)
International Accounting Standards (IAS)
- IFRIC Interpretations adopted by European Union (EU)
- SIC Interpretations ‘IAS’ regulation

convergence projects

Financial Accounting Standards Board

U.S. Securities and Exchange Commission (SEC)
US GAAP: US Generally Accepted Accounting Principles
• Accounting Standards Codification (ASC)
• Accounting Series Releases (ASR)
• Staff Accounting Bulletins (SAB)
…
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Use of IFRS around the world
Required for domestic public companies
https://www.ifrs.org/use-around-the-world/use-of-ifrs-standards-by-jurisdiction/
For detailed information see also https://www.iasplus.com/en/resources/ifrs-topics/use-of-ifrs

Note: very different status of adoption

Why are global accounting standards useful?

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The World’s Largest Public Companies
• https://www.forbes.com/global2000/list/

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 Setting International Financial Reporting Standards
Overview: IFRS Foundation Predecessor bodies:
• IASC Foundation
Monitoring Board
• International Accounting Standards
Approve and Oversee Committee (IASC)
• Standard Interpretations Committee (SIC)
Trustees
Appoint
Appoint, Oversee, Review effectiveness, Funding

Since 2001 Accounting

International Accounting IFRS Interpretation IFRS
Standards
Standards Board (IASB) Committee (IFRS IC) Advisory
Advisory
Council Forum
Approves

interprets
IFRS IFRIC https://www.ifrs.org/
IFRS
Taxo- http://archive.ifrs.org/Pages/default.aspx
nomie
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Issued Standards, Interpretations and additional material
• Issued Standards • Issued Interpretations
− Remaining (28) „old“ IAS (by − (8) remaining „old“ SIC
International Accounting Standards (published by Standard Interpretations
Committee IASC 1973 - 2000) Committee ( SIC 1997 - 2000)
− (17) „new“ IFRS (by IASB since 2001 ) − (20) „new“ IFRIC (published by IFRS
Interpretation Committee IFRSIC,
• 2 Practice Statements formerly IFRIC since 2001)
− Management Commentary
− Making Materiality Judgements
• Conceptual Framework
List of the issued IFRSs and Interpretations: https://www.ifrs.org/issued-standards/
Remarks:
• Issued Interpretations have the same authoritive
guidance as IFRSs => Therefore IFRSs/IAS, IFRIC/SIC
Interpretations collectively referred as ‘IFRSs’ => IAS 1.7
• Conceptual Framework and practice statements are not
standards

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IFRS for SMEs
• is a small Standard (approximately 250
pages) that is tailored for small companies
• IFRS for SMEs Standard is stand-alone
• based on the principles in full IFRS Standards
− simplifications from full IFRS Standards:
− some topics in full IFRS Standards are
omitted because they are not
relevant to typical SMEs;
− some accounting policy options in full
IFRS Standards are not allowed
because a more simplified method is
available to SMEs;
− many of the recognition and
measurement principles that are in
full IFRS Standards have been
simplified;
− substantially fewer disclosures are
required
• Not been adopted by the EU
https://www.ifrs.org/use-around-the-
world/use-of-ifrs-standards-by-jurisdiction/
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 Standard setting process (“due process”)
IFRS Foundation Due Process Handbook
https://www.ifrs.org/groups/due-process-oversight-committee/pages/due-process-handbook/

Setting the
agenda Discussion Exposure Published Post-
and paper*) draft*) IFRS implementation
planning review
the project

*) Published for public comments,

Comment letters are provided e.g. by preparer, Accounting Standards Committee
of Germany (ASCG), auditors, academics, ESMA
(https://www.esma.europa.eu/convergence/ias-regulation ), EFRAG http://efrag.org, other
user groups

Actual work plan IASB: https://www.ifrs.org/projects/work-plan/

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Financing IFRS Foundation 2017 Source: IFRS Foundation Annual Report 2017

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IFRS endorsement process in the EU
5 steps The IASB adopts a new standard, an
amendment to an existing standard or an
interpretation of a standard

The European Financial Reporting Advisory

Group (EFRAG) provides its advice to the
European Commission on endorsement

If the European Commission decides to

endorse, it prepares a draft regulation and
submit it to the Accounting Regulatory
Committee (ARC)
If the ARC's opinion is positive, the European
Commission submits the draft regulation to
Adoption and publication the European Parliament and the European
• Regulation (EC) No Council for a 3-month scrutiny period
1126/2008 codifies IFRS
as adopted by the EU
If there are no objections from the European
• Adopted IAS/IFRS and
Parliament or the European Council, the
consolidated versions
European Commission adopts the endorsing
• EFRAG status report regulation
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https://ec.europa.eu/info/business-economy-euro/company-reporting-and-auditing/company-reporting_en
Use of IFRS in the European Union
IAS Regulation (EC) No 1606/2002: Application of IFRSs as adopted by the EU
Article 4 Consolidated accounts of publicly Financial “Listed „Non-Listed
traded companies Statements companies” companies“
For each financial year starting on or after 1
January 2005, companies governed by the law of Consolidated Mandatory Member
a Member State shall prepare their consolidated state option
accounts in conformity with the IAS adopted in Annual Member Member
accordance with the procedure laid down in
Article 6(2) if, at their balance sheet date, their (Separate) state option state option
securities are admitted to trading on a regulated
market of any Member State within the meaning Meaning of „listed companies“:
of Article 1(13) of Council Directive 93/22/EEC of
10 May 1993 on investment services in the Traded securities On regulated
securities field (1). (equity and debt ) market*

Article 5 Options in respect of annual accounts Securities are In any Member

and of non publicly-traded companies
Member States may permit or require:
(a) the companies referred to in Article 4 to
prepare their annual accounts,
(b) companies other than those referred to in
Article 4 to prepare their consolidated
accounts and/or their annual accounts,
in conformity with the IAS adopted in accordance
with the procedure laid down in Article 6(2).
admitted to trading at State
the balance sheet
day**
*Regulated market = basically, market organized and
supervised by a state authority ; list of regulated
markets in the EU: https://eur-lex.europa.eu/legal-
content/EN/TXT/?uri=CELEX:52009XC0711(01)
** In some countries (e.g. Germany) already by filing
https://eur-lex.europa.eu/legal-
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content/EN/TXT/?uri=CELEX:32002R1606
EU public reporting framework
Publication of individual and consolidated financial statements in accordance with
national GAAP (Generally Accepted Accounting Principles) by any limited liability
company established in the EU
• The aim of the ‘accounting’ directive 2013/34/EU is to harmonise national
requirements about:
− presentation and content of annual or consolidated financial statements
» a certain number of notes to the financial statements.
− presentation and content of management reports
− large and medium-sized companies also have to publish management reports (thresholds )
− audit of financial statements
− publication of financial statements
− Publication of non-financial information
−…

Sources
• https://ec.europa.eu/info/business-economy-euro/company-reporting-and-auditing/company-reporting/financial-reporting_en#non-
ifrs-financial-statements
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EU public reporting framework Amendments to the
“Accounting directive” by
Publication of non-financial information Directive 2014/95/EU
• regular reports on the social and • Information to be disclosed
environmental impacts of their activities − policies large companies implement in relation to
• Companies that must comply − environmental protection
− Large public-interest companies with more − social responsibility and treatment of
than 500 employees employees
− listed companies − respect for human rights
− banks − anti-corruption and bribery
− insurance companies − diversity on company boards
(in terms of age, gender, educational and
− other companies designated by national
professional background)
authorities as public-interest entities
• How to report
− The information should be part of the
Documents and related links: management report, or published in a separate
o Commission guidelines on non-financial reporting report.
o Consultation on the non-binding guidelines on the
methodology for reporting non-financial information − Non-binding guidance
(closed on 15 April 2016) − the UN Global Compact
o Frequently asked questions on Directive 2014/95/EU
o Directive 2014/95/EU: Impact assessment − the OECD guidelines for multinational enterprises
accompanying the original proposal from the − ISO 26000
Commission
o Corporate social responsibility
− EU Commission – Commission Communication
C/2017/4234 21
EU public reporting framework
Publication of country-by-country reports

• on payments to governments
− by any large company that is active in extraction or logging by virtue of Chapter 10 of
Accounting Directive 2013/34/EU and Article 6 of Transparency Directive 2004/109/EC.
− This fosters transparency on payments to governments, including third country
governments, made in relation to these activities.

• where large multinational companies make their profits and where they pay tax
− The Commission has proposed a new directive therefore

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What is the Conceptual Frameworks role in financial
reporting?
• What is the objective of financial reporting?
Addresses • Who are the primary users?
fundamental • What makes financial information useful?
issues • What are assets, liabilities, equity, income and expenses?
• When should they be recognised?
• How should they be measured?
• How should they presented and disclosed?
• …

• Board to develop standards

Assists • Prepares to develop consistent accounting policies
• Others to understand and interpret standards

• Not a Standard and does not override Standards

• Conceptual Framework: 1989 IASC adopted 2001 by IASB, revised 2010 and March 2018

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What makes financial information useful?
Qualitative characteristics (QC) of useful financial information
Funda-
Relevance Faithful representation
mental QC
Information must faithfully represent the substance of what it purports to represent
• Information is
relevant if it is complete neutral free from error
capable of making a
difference to the Additional aspects of faithful representation:
decisions made by
users • Supports neutrality
• => if it has a Prudence • Exercise of caution under conditions of uncertainty
predictive value, • Does not allow for overstatement or understatement of
confirmatory value or assets, liabilities, income or expenses
both. • Arises when monetary amounts cannot be observed directly
• => is affected by its and need to be estimated
materiality
Measurement
• Does not prevent information from being useful
uncertainty • If very high, may affect whether a sufficiently faithful
representation can be achieved

• Economic substance of the underlying economic phenomenon

Substance is normally the same as the legal form
over form • If not, need to represent the substance to provide faithful
representation

Enhancing
Comparability Verifiability Timeliness Understandability
QC

Cost constraint (benefits exceeding the cost ) 24

What are assets, liabilities and equity?
Elements of financial position - Definition
Conceptual Framework 2018
“An asset is a present economic
Asset resource controlled by the entity as a
result of past events.”
F 4.3 seq.
An economic resource is a right
that has the potential to produce
economic benefits.
2010
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.
F 4.4

“A Liability is a present obligation of

Liability the entity to transfer an economic
resource as a result of past events.” F 4.26
An obligation is
• a duty or responsibility that the
entity has no practical ability to
avoid
• …
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. F 4.4

Equity = Assets—Liabilities “Equity is the residual interest in the assets of the entity after
deducting all its liabilities.” F 2018 4.63; F 2010 4.4
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Framework - Definitions

Income Expenses
Revenues Expenses
Income arising in the course of the ordinary Expenses arising in the course of the
activities ordinary activities

Gains Losses
Income not arising from the course of Expenses not arising from the course of
ordinary activities (e.g., due to re- ordinary activities (e.g., due to impairment
measurement of assets/liabilities) of assets/liabilities)

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When should the elements be recognised?
Recognition criteria
• “Only items that meet the definition of an asset, a liability or equity are recognised
in the statement of financial position.
• Similarly, only items that meet the definition of income or expenses are recognised
in the statement(s) of financial performance.
• However, not all items that meet the definition of one of those elements are
recognised.” (F 2018 5.6)
Framework 2018 2010
An asset or liability is recognised only if such Recognition Asset
recognition of that asset or liability and of any • when it is probable that future economic
resulting income, expenses or changes in equity benefits will flow to the enterprise
provides users of financial statements with (probability), and
information that is useful, ie with: • when cost or value of the asset can be
a) relevant information about the asset or measured reliably (reliability)
liability and about any resulting income, Recognition Liability
expenses or changes in equity (see • when it is probable that there will be an
paragraphs 5.12-5.17); and outflow of resources to settle a present
b) a faithful representation of the asset or obligation (probability)
liability and of any resulting income, • when the outflow can be measured reliably
expenses or changes in equity (see (reliability)
paragraphs 5.18-5.25) (F 2018 5.7) F 2010 4.38 seq. 27
When should assets and liabilities be derecognised?

“Derecognition is the removal of all or part of a recognised asset or liability from an

entity's statement of financial position. Derecognition normally occurs when that item no
lonqer meets the definition of an asset or of a liability:
a) for an asset, derecognition normally occurs when the entity loses control of all or part
of the recognised asset; and
b) for a liability, derecognition normally occurs where the entity no longer has a present
obligation for all or part of the recognised liability." (F 2018 5.26)

“Accounting requirements for derecognition aim to faithfully represent both:

a) any assets and liabilities retained after the transaction or other event that led
to the derecognition (including any asset or liability acquired, incurred or
created as part of the transaction or other event); and
b) the change in the entity's assets and liabilities as a result of that transaction
or other event.“ (F 2018 5.27)”
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Two Measurement bases
What is the most useful measurement basis?

What makes information useful?

Selection criteria: Current value
Historical cost
include
• Relevance include
• characteristics of the
amortised cost fair value
asset or liability
=> IFRS 13
• contribution to future
=> IAS 16, IAS 38 cash flows value in use
• Faithful representation => IAS 36
• measurement
inconsistency
fulfilment value
• measurement
uncertainty
• Enhancing qualitative
characteristics current cost
• Cost constraint

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Two Measurement bases
Historical cost
include
amortised cost
“The historical cost of an
asset when it is acquired or
created is the value of the
costs incurred in acquiring
or creating the asset,
comprising the
consideration paid to
acquire or create the asset
plus transaction costs. The
historical cost of a liability
when it is incurred or taken
on is the value of the
consideration received to
incur or take on the liability
minus transaction costs.” (F
2018 6.18)
Measurement is the process of quantifying
assets, liabilities, income and expenses.
Current value
fair value
is 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
value in use
present value of the cash flows, or other economic benefits, that
an entity expects to derive from the use of an asset and from its
ultimate disposal
fulfilment value
is the present value of the cash, or other economic resources, that
an entity expects to be obliged to transfer as it fulfils a liability
current cost
• of an asset is the cost of an equivalent asset at the
measurement date, comprising the consideration that would
be paid at the measurement date plus the transaction costs
that would be incurred at that date.
• of a liability is the consideration that would be received for an
equivalent liability at the measurement date minus the
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transaction costs that would be incurred at that date.