© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 1

CHAPTER 4

Constructing Financial
Reports: IFRS and the
Framework of Accounting

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 2
Learning Objectives
 What is management’s basic responsibility regarding a
company’s financial statements?
 What parties are generally considered to be the external
users of a company’s financial statements?
 What are the objectives, elements, and qualitative
characteristics of financial statements?
 How is accrual accounting applied in the recording of
prepayments accruals, provisions, and depreciation?

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 3
 Accounting
 Accounting provides an explanation or report in
financial terms about the transactions of an
organization to satisfy stakeholders
 Financial statements or reports (Company’s
Accounts)
 Income Statement
 Balance Sheet
 Cash Flow Statement
 International Financial Reporting Standards (IFRS)
 applicable to public entities
 Accounting Standards for Private Entities (ASPE)
 applies to private companies
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 4
Management’s Responsibility
for Fair Presentation
 Financial reports must
 present fairly the financial position, financial
performance, and cash flows of an entity
 be prepared according to generally accepted
accounting principles (GAAP)
 be audited or reviewed to ensure that this is
the case

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 5
 International Financial
Reporting Standards (IFRS)
 Global harmonization of standards
 Excluding US
 International Accounting Standards Board
(IASB) responsible for developing “a single
set of high-quality, understandable,
enforceable and globally accepted
international financial reporting standards”
 Accounting standards are principles based
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 6
 International Financial
Reporting Standards (IFRS)
 IFRS Objectives
 Promote the use and rigorous application of those standards
 Take account of the financial reporting needs of emerging
economies and small and medium-sized entities (SMEs)
 Bring about convergence of national accounting standards and
IFRSs to high-quality solutions
 IFRS and ASPE set out recognition, measurement,
presentation, and disclosure requirements dealing with
transactions and events that are important in general-
purpose financial statements (directed toward the
common information needs of a wide range of users)

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 7
 Conceptual Framework
for Financial Reporting
 Seeks to harmonize regulations, accounting standards,
and procedures relating to the preparation and
presentation of financial statements
 The Conceptual Framework deals with
 The objectives of financial reporting
 The qualitative characteristics of useful financial
information
 The definition, recognition, and measurement of the
elements from which financial statements are
constructed

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 Conceptual Framework
for Financial Reporting
 A complete set of financial statements or reports
includes
 Statement of Financial Position
 Statement of Comprehensive Income
 Statement of Changes in Shareholders’
Equity
 Statement of Cash Flows
 Notes to the financial statements

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 Objectives of Financial Statement

 To provide financial information about the

reporting entity that is helpful to the users
in making decisions about providing
resources to the entity
 decision usefulness

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 Qualitative Characteristics
of Financial Statements
Relevance
 Predictive and confirmatory value
 Affected by materiality

Faithful representation
Comparability
Verifiability
Timeliness
Understandability
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 Elements of Financial Statements

Assets
Liabilities
Equity
Income
 Revenues
 Gains

Expenses
 Losses
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 Elements of Financial Statements

Recognition
 Incorporating in the Statement of Financial Position or
Statement of Comprehensive Income items in words and
monetary measurement that meets the definition of an
element
 Element should be recognized if both of the following are
true:
1. It is probable that any future economic benefit associated with
the item will flow to or from the entity
2. The item has a cost or value that can be measured with
reliability

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 Elements of Financial Statements

Measurement
 The process of determining the monetary
amount at which elements are recognised in
the Statement of Financial Position or
Statement of Comprehensive Income
 Four bases of measurement:
1. Historical cost
2. Current cost
3. Realizable value
4. Present value
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 Reporting Profitability:
The Statement of Comprehensive Income

Profit = Income - Expenses

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Matching Principle
 Matching income with the expenses
incurred in earning that income
 Income
 Revenue (sales, fees, interest, rent, etc.)
 Gains (disposal of non-current assets, revaluations)
 Expenses
 Expenses (salaries, advertising, etc.)
 Losses (fire & flood, sale of non-current assets)

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 Reporting Profitability:
The Statement of Comprehensive Income - Extended
Operating profit = Gross profit - Expenses

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 Reporting Financial Position:
The Statement of Financial Position
Asset is classified as current asset when:
 Expected to realize the asset, or intends to sell
or consume it
 in its normal operating cycle or
 within 12 months after the reporting period
whichever is the longest
 It holds the asset primarily for the purpose of
trading
 The asset is cash or a cash equivalent
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 Reporting Financial Position:
The Statement of Financial Position
 Assets
 Current
 Money in Bank
 Accounts receivable

 Inventory

 Non current
 Tangible (Property, plant and equipment)
 Intangible (Patents, trademarks)

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 Reporting Financial Position:
The Statement of Financial Position
 Liabilities
 Current
 Accounts payables
 Loans, taxes, etc. payable within 12 months

 Non current
 Loans repayable after 12 months
 Shareholders Equity (or Capital)
 Shareholders’ investment and retained profits

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 Reporting Financial Position:
The Statement of Financial Position
1. Net assets = Total assets – total liabilities
(equal to equity)
or
2. Assets = liabilities + equity
or
3. Assets - liabilities = equity

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 Reporting Financial Position:
The Statement of Financial Position

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 Accrual Accounting
 Recognizes income when it is earned and
expenses when they are incurred
 Cash versus accruals accounting
 Matching principle
 Adjustments for
 Prepayments
 Accruals
 Provisions
 Depreciation
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Prepayments and accruals

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 Provisions
 Doubtful debts (Bad Debts)
 Inventory
 Depreciation
 The term “Amortization” is used for
intangible assets, such as patents or
copyrights)
Each of the above items is a deduction
from the its asset value in the Balance
Sheet
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 Depreciation
Depreciation is an expense that spreads the cost of the
asset over its useful life

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 Reporting cash flow:
The Statement of Cash Flows
 Movement in cash during a financial period
 From operations
 Depreciation
 Increases or decreases in working capital

 Interest receipts and payments

 Income tax paid
 Capital expenditure
 Dividends paid
 New borrowings or repayments of borrowings

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 Statement of Cash Flows

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© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4
 Cash Flow Statement
Cash flow from operations:
Operating Profit
+ depreciation (non-cash)
+/- change in working capital
- interest
- income taxes
- capital expenditure
- dividends
+/- new borrowings or repayment of borrowings
= Net increase in Cash

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 4 29
 Critical Perspective on
Accounting Standards
 Continual changes in standards
 Practical implementation issues (e.g., Pension funds and
stock options)
 Exclusion of US from IFRS
 Complexity
 Lobbying effect on standards (e.g., Enron)
 Standards can lead to more creativity
 Narrow accounting focus

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 Conclusion
 Financial Statements
 Statement of comprehensive income
 Statement of financial position
 Statement of cash flows

 IFRS and Conceptual Framework

 Accruals, prepayments, provisions
 Depreciation
 Critique of standards

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