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Chapter 1 The Regulatory and Conceptual Framework The Regulatory Framework

The financial statements display relevant information to internal and

external users. The information displayed will influence decisions that
stakeholders may make about the future of a particular business.

Regulations are set in place for businesses to prepare their financial

statements according to standardised principles and rules so that
users of financial statements can rely on the financial information as
fairly represented.

1 2

The Regulatory Framework The Regulatory Framework

The issuance of International Financial Reporting Standards (IFRS)

and guidance comes from the International Accounting Standards
Board (IASB), which the IFRS Foundation governs.

The governance structure of setting standards can be summarised in

the diagram from the IFRS website below.

3 4

The Regulatory Framework The Regulatory Framework

The formation of accounting standards can be represented in a three-  Governance, Strategy and Oversight
tier structure:
The development of standards by IASB and ISSB is governed and
 Independent Standard-Setting and Related Activity overseen by Trustees (IFRS Foundation Trustees). The IFRS
Advisory Council provides advice and counsel to the Trustees and
There are two independent standard-setting boards of experts: the boards

—International Accounting Standards Board (IASB), whose

role is to develop and publish accounting standards. The
Interpretations Committee works closely with IASB to support
the application of the standards.

—International Sustainability Standards Board (ISSB), whose

role is to develop a baseline of sustainability-related disclosure
standards.
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The Regulatory Framework The Regulatory Framework

 Public Accountability National bodies can do this in different ways, including:

The Trustees are accountable to a monitoring board of public  adopting IFRSs as standards for their own country
authorities (IFRS Foundation Monitoring Board).
 using IFRSs as a basis for developing their guidance
These regulatory bodies do not have the power to force
companies to comply with their requirements. It is up to national  developing their requirements but comparing them to IFRSs to
accounting standard-setting bodies or regulators to adopt the determine if their standards are sufficient.
standards, and only then will they become enforceable in a country.

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IFRS Foundation – Trustees IFRS Foundation – Trustees

The IFRS Foundation Trustees focus on the needs of emerging

The Trustee foundation is an independent body that oversees the
economies and small and medium-sized entities. This includes profit
International Accounting Standards Board (IASB) and the International
and non-profit-making organisations such as charities.
Sustainability Standards Board (ISSB).
Each Trustee member is expected to understand and is sensitive to
The Trustees are accountable to the Monitoring Board, a body of
international issues relevant to the success of an international
publicly accountable market authorities. The Trustees are not involved
organisation responsible for developing high-quality global accounting
in any technical matters relating to IFRS Standards. This responsibility
and sustainability disclosure standards for use in the world's capital
rests solely with the boards.
markets and by other users.

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Key Point International Accounting Standards Board (IASB)

The IASB is committed to developing, in the public interest, a

Key point single set of high-quality, understandable, and enforceable global
accounting standards (IFRS Standards) that require transparent
and comparable information in general-purpose financial reports.
The Board is an independent group of experts with an
appropriate mix of recent practical experience in setting The objective of general-purpose financial reports is to provide
accounting standards, preparing, auditing, or using financial information about the reporting entity that is useful to
financial reports, and accounting education. Board primary users (investors and creditors).
members are responsible for the development and
publication of IFRS Standards. The Board is also responsible for approving interpretations of IFRSs
that the IFRS Interpretations Committee develops.

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International Accounting Standards Board (IASB) International Accounting Standards Board (IASB)
Constitution Constitution

According to the IFRS Foundation Constitution:  The Board has:

 The IASB Board will typically comprise 14 members whom the — complete responsibility for all board technical matters, including
trustees appoint. The primary qualifications are professional the issue of IFRS Standards (other than IFRIC Interpretations)
competence and recent relevant experience. and Exposure Drafts

— complete discretion in developing the technical agenda for

standard setting

Publishing standards, exposure drafts and final interpretations require

a “supermajority”.

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International Sustainability Standards Board (ISSB) International Sustainability Standards Board (ISSB)

International investors with global investment portfolios are

increasingly calling for high-quality, transparent, reliable and As a result, the Trustees announced the creation of a new board
comparable reporting by companies on sustainability issues such as (ISSB) in November 2021 to meet the demand for sustainability
climate and other environmental, social and governance (ESG) standards.
matters.
ISSB’s role is to deliver comprehensive global sustainability-related
In September 2020, the IRFS Foundation Trustees published a disclosure standards that provide investors and other capital market
consultation paper to determine whether there is a need for participants with information about companies’ sustainability-related
international sustainability standards and whether the IFRS risks and opportunities.
Foundation should play a role in developing such standards.

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IFRS Advisory Council (IFRSAC) IFRS Advisory Council (IFRSAC)

The Advisory Council comprises 30 or more members appointed by the

trustees (for a renewable term of three years).
The IFRS Advisory Council advises the IFRS Foundation Trustees and
the standards-setting boards (IASB and ISSB). Its members include  The council provides a forum for participation by other interested
investors, academics, auditors and members of local standard-setting parties (e.g. the Organisation for Economic Change and Development
bodies. (OECD), the United States Financial Accounting Standards Board
(FASB) and the European Commission).
The board consults the IFRSAC on their agenda, priorities, and issues
related to the application and implementation of IFRSs.  Its primary responsibility is to advise the standards-setting board on
agenda issues, work priorities and the views of IFRS Advisory
Council members on the development of standards projects.

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IFRS Interpretations Committee (IFRS IC) IFRS Interpretations Committee (IFRS IC)

The committee’s responsibilities include:

The IFRS IC reviews and provides guidance on issues arising when  interpreting the application of IFRS Standards
IFRSs have been implemented. These include the different ways of
accounting for different types of transactions, doubt about correct  Provide timely guidance on financial reporting issues not explicitly
accounting treatments or unclear disclosure requirements. The IFRS IC addressed in IFRS Standards.
also provides guidance on issues not addressed in IFRSs.
It publishes draft interpretations for public comment and considers
The IFRS Interpretations Committee (IFRS IC) is the interpretative comments before finalising them. It reports to the Board and obtains
body of the IASB. The trustees appoint 14 voting members and a non- the Board’s approval for final interpretations.
voting chairperson.

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Activity 1 Activity 1 Answer

Match the accounting body to the correct example of work 1. IFRSF - Advising national authorities on the process for adopting
carried out. IFRSs
Accounting body Activity 2. IASB - Issuing a draft of a new IFRS
IFRS Foundation Providing a forum for a wide range of
(IFRSF) users to discuss IFRSs 3. IFRS IC - Advising on how a current IFRS should be applied

International 4. IFRS AC - Providing a forum for a wide range of users to discuss

Advising national authorities on the
Accounting Standards
process for adopting IFRSs IFRSs
Board (IASB)

IFRS Interpretations
Issuing a draft of a new IFRS
Committee (IFRS IC)

IFRS Advisory Council Advising on how a current IFRS should

(IFRS AC) be applied
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International Financial Reporting Standards (IFRSs) International Financial Reporting Standards (IFRSs)
Global Accounting Standards Objectives

The International Accounting Standards Board (IASB) develops and IASB’s Mission Statement sets out its objectives: “To develop IFRS
publishes International Financial Reporting Standards (IFRS). Each Standards that bring transparency, accountability and efficiency to
standard is created to cover a specific aspect of accounting. financial markets around the world. Our work serves the public interest
by fostering trust, growth and long-term financial stability”.
 The term IFRS includes all standards and interpretations issued
under the previous constitution (IASC) that the Board has approved.

 International Accounting Standards (IASs) and Interpretations

issued by the Standards Interpretations Committee (SIC) that have
been so approved continue to be applicable until they are withdrawn.

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International Financial Reporting Standards (IFRSs) International Financial Reporting Standards (IFRSs)
Objectives Objectives

The goals of the IFRS Standards are to: The goals of the IFRS Standards are to:

 bring transparency by enhancing the international comparability  strengthen accountability by reducing the information gap between
and quality of financial information so investors can make informed the providers of capital (investors) and those to whom they have
economic decisions. entrusted their money (management).

If the investors are not involved in the day-to-day business, they will
not have access to the same information that managers have.
Managers may exploit the differences in information for their benefit.
IFRS Standards provide information that is needed to hold
management to account.

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International Financial Reporting Standards (IFRSs) Developing IFRS Standards

Objectives Due Process

The goals of the IFRS Standards are to: IFRS Standards are developed through a due process which ensures
that standard setting is transparent and considers a wide range of
 contribute to economic efficiency by helping investors identify views from interested parties such as:
opportunities and risks worldwide, improving capital allocation. (A
single, trusted accounting language lowers the cost of capital and - accountants, financial analysts and other users of financial
reduces international reporting costs for businesses.) statements

- the business community

- stock exchanges

- regulatory and legal authorities

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Developing IFRS Standards Developing IFRS Standards

Due Process Project Development

- academics Due process for projects typically, but not necessarily, involves the
following steps:
- other interested individuals and organisations throughout the world.

The Board consults the Advisory Council on significant projects, agenda

 Setting the Agenda
decisions and work priorities and discusses technical matters in
When deciding what standards to develop, the IASB focuses on the
meetings open to public observation.
relevance of the information to investors. It also looks at the
availability of existing guidance and whether publishing an IFRS will
lead to adopting a common approach.

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Developing IFRS Standards Developing IFRS Standards

Project Development Project Development

 Planning the Project  Developing and Publishing a Discussion Paper

The IASB draws up a project plan. The board may develop the A discussion paper is developed and published for public comment
standard itself or with another standard setter, for example, the US (also called a discussion document). The discussion paper gives an
standard-setting body, Financial Accounting Standards Board. overview of the issues, such as a summary of possible approaches
and the initial views of the authors.
National accounting requirements and practices are studied, and the
board exchanges views about the issues with national standard A discussion paper must be approved by a majority of the Board’s
setters. The board consults with the Advisory Council about adding members.
the topic to the Board's agenda, and an advisory group (working
group) is formed to advise the Board on the project.

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Developing IFRS Standards Developing IFRS Standards

Project Development Project Development

 Developing and Publishing an Exposure Draft An exposure draft must be approved by a supermajority of the
Board:
After considering comments and dissenting opinions (alternative
views) received, an exposure draft is developed. The draft is then — Nine of the 14 members or
published again for public comment. The IASB may publish a second
exposure draft if comments identify significant issues. — Eight if there are 13 or fewer members

33 34

Developing IFRS Standards Developing IFRS Standards

Project Development Project Development

 Developing and Publishing an IFRS  Procedures after an IFRS is issued

After the IASB has considered all the comments received and is After publication, the IASB may discuss with interested parties any
satisfied that it has addressed all the points raised during the unforeseen issues that have happened because of the IFRS being
consultation process, it drafts the final version of the IFRS. IASB applied. In time, the IASB may formally review the standard if, for
then has the final draft externally reviewed and obtains approval example, the financial reporting and legal environment have
from its members that it should be published. changed.

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Developing IFRS Standards Scope and Application

IFRS Standards apply to published financial statements of any
commercial, industrial or business reporting entity (whether public or
Useful Information private sector).

IFRSs used to be called International Accounting Standards  They apply to separate and consolidated financial statements (where
(IASs), and several IASs are still in force because there has not applicable).
been a need to update them.
 Any limitation on the applicability of specific standards is made clear
In many countries, there is a collection of commonly followed in an IFRS.
accounting rules, legal requirements and standards for financial
reporting referred to as the local GAAP (generally accepted  A standard applies from a date specified in the standard and is not
retroactive (unless stated otherwise).
accounting practice).

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Scope and Application Advantages and Disadvantages of IFRS Standards

 Exclusions where IFRS Standards are not required to be applied: The advantages of using IFRS in preparing financial statements of a
business include:
—Non-business aspects of public sector entities.
—Private sector not-for-profit (NFP) entities.  Comparisons between businesses in different countries also using
IFRSs will be easier.

 Foreign investors may trust financial statements prepared in

compliance with IFRSs, meaning that companies find it easier to
raise money from abroad.

 Companies operating in several countries can use IFRSs as a shared

basis for preparing their financial statements.

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Advantages and Disadvantages of IFRS Standards Advantages and Disadvantages of IFRS Standards
The advantages of using IFRS in preparing financial statements of a The disadvantages of using IFRS in preparing financial statements of
business include: a business include:

 National authorities can adopt IFRSs as ready-made requirements  There will be costs involved in adopting IFRSs for the first time.
without developing their guidance.
 IFRSs may not be as rigorous as national guidance in some areas.
 Other organisations that operate internationally, for example,
accountancy firms, will find it easier to deal with a common set of  Adopting IFRSs may be challenging in some countries because some
standards. of its requirements may conflict with local law.

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Corporate Governance Corporate Governance

Global Definitions Global Definitions

The Organisation for Economic Cooperation and Development (OECD) The Australian Securities Exchange defines corporate governance as:
defines corporate governance as:
"The system by which companies are directed and managed. It
"The system by which business corporations are directed and influences how the objectives of the company are set and achieved,
controlled. The corporate governance structure specifies the how risk is monitored and assessed, and how performance is optimised.
distribution of rights and responsibilities among different participants in Good corporate governance structures encourage companies to create
the corporation and spells out the rules and procedures for making value (through entrepreneurism, innovation, development and
decisions on corporate affairs. It also provides the structure through exploration) and provide accountability and control systems
which the company objectives are set, and the means of attaining commensurate with the risks involved."
those objectives and monitoring performance."

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Corporate Governance Corporate Governance

Concept of Corporate Governance Concept of Corporate Governance

Corporate governance is a set of rules intended to create transparency Corporate governance mechanisms are needed to ensure that
and protect the interests of shareholders and stakeholders. It sets to companies not only take account of the views of powerful shareholders
prescribe the roles and responsibilities of directors as the stewards of with more considerable shareholdings but also act in the interests of
the company, which helps align the directors' interests with that of the shareholders owning a smaller proportion of shares.
shareholders.
The concept of corporate governance revolves around these three
The way corporate governance operates will vary significantly between aspects:
companies. In some companies, the owner will own all the shares or a
great majority of them, and corporate governance procedures will be
simple. In other companies, no single party holds a majority of shares,
but some financial institutions may have significant shareholdings.

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Corporate Governance Corporate Governance

Concept of Corporate Governance Concept of Corporate Governance

 Risk Management  Quality of Information

A company’s management must manage the level of risk the business The company’s management should ensure that proper accounting
faces and refrain from making decisions that will create and information systems are in place to produce reliable financial
uncontrollable risk. The management should also disclose to its statements. Information provided should be relevant, timely,
stakeholders the existence and standing of faced risk in the financial accurate and represent a true and fair view of the company's position.
statements. Companies should maintain sound internal control
systems to manage their risk levels. For example, a company investing in accounting software to
streamline its trading activities ensures that information is accurate
For example, a company having repeatedly breached lending and produced on time. The company employs proper corporate
covenants would be on the verge of having its borrowing facilities governance as the quality of information is secured.
withdrawn. This constitutes poor risk management as such actions
would affect its ability to trade.
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Corporate Governance Corporate Governance and Financial Statements

Concept of Corporate Governance The UK Corporate Governance Code (which applies to all listed
companies but is also considered best practice for unlisted companies
 Stewardship and non-corporate entities) states that:

A company’s management should be open and transparent and  The board of directors must:
present critical decisions on the business's performance. They
should also explain the overall strategy and their intentions for the
— present a balanced and understandable assessment of the
company's position by issuing a set of financial statements
future so that investors can decide whether these align with their
expectations.
— maintain a sound system of internal control concerning risk
management
For example, a company portrays stewardship by providing financial
information on how it has performed over the year and the strength
of its asset base.

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Corporate Governance and Financial Statements Corporate Governance

 An audit committee (consisting of at least three independent non- Duties and Responsibilities of Directors
executive directors) must:
The directors of a company have a fiduciary duty to act in good faith
—monitor the integrity of the financial statements on behalf of the company. A business’s directors are responsible for
preparing the financial statements, ensuring appropriate accounting
—review the internal controls and risk management systems
systems are in place and keeping proper records.
—monitor the internal and external auditors.
Concerning financial statements, a company's board of directors is
collectively responsible for their:

 preparation every financial year to show a “true and fair view.”

 presentation to and approval by the shareholders.

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Corporate Governance Corporate Governance

Duties and Responsibilities of Directors Duties and Responsibilities of Directors

To satisfy this responsibility, the directors should: To satisfy this responsibility, the directors should:

 Only approve the financial statements if they are satisfied that the  Explain the company’s business model and its strategy for delivering
financial statements give a true and fair view of the assets, liabilities, the objectives of the company in the financial statements
financial position and profit or loss
 Ensure that the financial statements are prepared per the form and
 State in the financial statements that the responsibility of preparing content as prescribed by law and GAAP (e.g. IFRS)
them lies with the directors
 Ensure that adequate accounting records are kept from which the
 Consider the appropriateness of their use of going concern principles financial statements are prepared.
and convey the message in the financial documents

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Corporate Governance Corporate Governance

Duties and Responsibilities of Directors Duties and Responsibilities of Directors

The accounting records must be adequate to: The accounting records must be adequate to:

—show and explain the company's transactions — show day-to-day entries of all sums of money received and paid
(and the matters in respect of which the receipts and payments
—disclose the company's financial position with reasonable take place)
accuracy
— record the company's assets and liabilities
—prepare accounts which comply with the appropriate legal
requirements  Ensure that the financial statements are filed according to law. (For
example, in the UK, public companies must file the financial
statements with Companies House within six months after the
reporting date.)

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Corporate Governance Corporate Governance

Duties and Responsibilities of Directors Duties and Responsibilities of Directors

Other responsibilities of the directors of an organisation include:  Cooperate with Auditors - Directors should cooperate with the
company's auditors and not collude, mislead or deceive them. They
 Prevention of Fraud – They have a duty to prevent and detect fraud. must provide the auditors with the information and explanations
This goes beyond the financial statements, although misstatements they need to conduct their audit.
may be made for fraudulent reasons.
In reviewing the financial statements, the external auditor should
clearly state its independent position and ensure no conflict of
interest is evident.

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Key Point Audit Committee Responsibilities

Key point
An audit committee is a branch of a business’s board of directors
The fiduciary duties of directors concerning the financial that takes charge of a company’s financial reporting responsibilities
statements are explicitly stated in the company law of and ensures internal controls are kept in place.
most jurisdictions.

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Audit Committee Responsibilities Audit Committee Responsibilities

The responsibilities of the audit committee in a business include:

 Ensuring that the interests of shareholders are adequately protected  Monitoring and reviewing the effectiveness of the internal audit
concerning financial reporting and internal control. function.

 Monitoring the integrity of the financial statements and  Reviewing and monitoring the external auditor’s independence and
announcements relating to the company’s financial performance, objectivity and the effectiveness of the audit process.
including review of the significant financial reporting judgments
made.

 Reviewing the company’s internal control, internal financial controls

and risk management systems.

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Activity 2 Activity 2 Answer

State whether the following statements about governance 1. False. The auditors do not act for the directors. The auditors act for
guidance are true or false. and report to the shareholders when they audit the financial
statements.
1. The auditors act as the directors’ agents when they audit the financial
statements. 2. True. This requirement features in most governance codes.

2. Under corporate governance best practice, both directors and auditors 3. False. The directors should state that the financial statements have
should state their responsibilities in the financial statements. been prepared on a going-concern basis.

3. The auditors should state that the financial statements have been 4. False. This is the requirement of some governance guidance, such
prepared on a going-concern basis. as the UK Corporate Governance Code, but it is not part of IFRSs.

4. To comply with the requirements of IFRSs, the directors should

explain their strategy for delivering the company’s objectives.

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Ethics and Governance Ethics and Governance

ACCA’s Code of Ethics and Conduct

The ACCA Code of Ethics and Conduct is binding on all ACCA members,
students, and partners in an ACCA practice. The ethical concepts that
apply to the preparation of accounting information are:
As well as being based on legal requirements, corporate
governance is founded on a series of ethical concepts.  Integrity
The Cadbury report on governance stressed that the integrity of
reports depends on the integrity of those who prepare the reports.
Integrity is about being straightforward. It means reporting financial
information honestly, not misleading the users of financial
statements, and producing a balanced picture of the company’s
affairs.

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Ethics and Governance Ethics and Governance

ACCA’s Code of Ethics and Conduct ACCA’s Code of Ethics and Conduct

 Objectivity  Professional Behaviour

In preparing financial statements, accountants should be unbiased Professional behaviour includes compliance with the laws and
when they make judgements about what should be included in them. standards related to financial statements. It also has a broader
They should not be influenced by their self-interest or pressures meaning: avoiding behaving in a way that could generally damage
from others towards distorting the financial statements. the accounting profession’s reputation.

 Professional Competence and Due Care

Accountants preparing or reviewing financial statements must have
sufficient knowledge to do so properly. They also need to carry out
their work carefully, avoiding errors.

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Ethics and Governance Scenario Walkthrough 1

ACCA’s Code of Ethics and Conduct Let’s discuss a famous business scandal where the accounting
practices that the company used were a significant issue.
 Confidentiality Background

Confidentiality means respecting the confidential nature of Enron was a massive energy sector company based in America and
information acquired through professional relationships. Confidential operating globally. It bought and sold energy and controlled operating
information should not be disclosed unless there is specific facilities. It stated that it aimed to transform the energy sector.
permission or a legal or professional duty. Instead, Enron collapsed in 2001 and is now best remembered as one
of the biggest company scandals in history. It also destroyed the
major accountancy firm, Arthur Andersen, which was Enron’s external
auditor.

Enron’s collapse resulted in the development of the Sarbanes–Oxley

Act, an essential set of laws on corporate governance applicable to
companies which report in the United States.
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Scenario Walkthrough 1 Scenario Walkthrough 1

What happened What happened

A significant element in the Enron scandal was its accounting policies. A significant element in the Enron scandal was its accounting policies.
Enron also had other accounting problems that internal accounting Enron also had other accounting problems that internal accounting
documents revealed. These included: documents revealed. These included:

 Enron used connected businesses to hold assets and liabilities  Enron immediately included income in the financial statements on
(particularly debt). Under the accounting rules operating in the US, contracts due to last for many years. It also timed transactions so
Enron did not need to show these businesses in its main financial that they were accounted for at the end of a period to boost
statements. earnings.

 Enron used its shares and not cash to fund businesses, which  Enron also hid what was happening through various trading
caused problems when the share price of Enron began to fall. activities, including using financial instruments known as
derivatives. Derivatives are a type of financial instrument that
derives its value from the underlying asset.

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Scenario Walkthrough 1 Scenario Walkthrough 1

Issues of Corporate Governance and Ethics Rules-based framework not sufficient?

There was a lack of transparency between the company’s What happened at Enron showed the weakness of relying on
management and shareholders. Enron’s financial statements showed accounting standards based on specific rules rather than guiding
an incomplete picture of the company’s affairs. principles. What Enron did may not have breached the rules, but it
seriously misled investors and the stock market. Good ethical
There was a lack of integrity as business arrangements were made to practices need to be adopted by the people running the company,
deceive investors and others about the actual happenings at Enron. who are the directors.
Directors were more concerned with protecting their position than
what was best for the company, showing a lack of objectivity in Enron encouraged employees to buy its shares. As a result, many
decision-making. employees suffered substantial financial losses. However, several
senior managers sold their shares when the company was about to
collapse.

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Scenario Walkthrough 1 Scenario Walkthrough 1

Rules-based framework not sufficient? Independence in Financial Reporting

All staff have a responsibility to act ethically, whatever their role. Independence is emphasised because a company’s affairs and
Enron set stringent performance targets, and employees who failed to management must be effectively scrutinised. Some directors, known
meet them were sacked. This encouraged staff to focus on reporting as non-executive directors, are not involved with the company full-
that they met targets even if they had not met them. time but monitor the behaviour of the executive directors who run the
company daily.

The non-executive directors at Enron were condemned for being

ineffective and not challenging how the executive directors ran the
company. Some non-executive directors had personal interests, which
conflicted with their role of holding the executive directors to account.

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Scenario Walkthrough 1 Exam Guidance

Independence in Financial Reporting

`Enron’s auditor, Arthur Andersen, was responsible for reporting

problems with the financial statements. Instead, they went along with
the accounting treatments that Enron used as they did not want to Exam Advice
risk losing a large amount of fee income from Enron.
Whilst ethics and specific events, such as the Enron
scandal, are not examinable, students must follow
ACCA’s Code of Ethics and Conduct throughout their
professional work.

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The Conceptual Framework Conceptual Framework Definition and Purpose

If the financial statements are to be useful to interested readers, the

information contained in the financial statements should be reliable
and of high quality. The conceptual framework is a statement of generally accepted
assumptions and principles that provides a frame of reference
This means the information must have specific characteristics and be for developing new practices and evaluating existing ones.
prepared using certain assumptions. The conceptual framework guides
these characteristics and assumptions.

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Conceptual Framework Definition and Purpose Qualitative Characteristics of Financial Information

The purpose of the Conceptual Framework for Financial Reporting The Conceptual Framework for Financial Reporting identifies two
(Conceptual Framework) is to assist: fundamental qualitative characteristics and four enhancing qualitative
characteristics relating to useful financial information.
 the IASB (Board) in developing IFRS standards
The fundamental qualitative characteristics of useful financial
 the preparers of financial statements in developing consistent information are:
accounting policies
 Relevance
 all parties to understand and interpret the standards.  Faithful Representation
The Conceptual Framework is not a standard. Therefore, nothing in the
Conceptual Framework can override a specific IFRS.

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Qualitative Characteristics of Financial Information Qualitative Characteristics of Financial Information

The Conceptual Framework also provides four enhancing qualitative Relevance
characteristics of useful financial information are:

 Comparability For financial information to be relevant, one or both things must apply:

 Verifiability  The information needs to help the user form a view about what will
happen to the business in the future
 Timeliness
 the information confirms what has happened in the past.
 Understandability

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Qualitative Characteristics of Financial Information Qualitative Characteristics of Financial Information

Relevance Relevance

Relevant information can be affected by its: Relevant information can be affected by its:

 Nature  Materiality
Some items may be relevant to users simply because of their nature. Information is material if its omission or misstatement could
For example, if a director has borrowed money from the company, influence primary users’ decisions based on the financial information
the transaction must always be disclosed, even if the amount is small. about the specific reporting entity.

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Qualitative Characteristics of Financial Information Qualitative Characteristics of Financial Information

Faithful Representation Faithful Representation

Faithful representation means the financial statements describe Faithful representation also means presenting the substance (the
financial events and conditions fairly in words and numbers. The commercial effect) of an economic phenomenon rather than its legal
information given should be: form.

 Complete (within bounds of materiality and cost) – Information

reported should be complete as an omission can cause financial
statements to be false or misleading and, therefore, unreliable.

 Neutral (free from bias)

 Free from error (no errors or omissions)

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Exam Guidance Ethics and Governance

Comparability

Useful Advice
Comparability means users should be able to make comparisons
between information:
Suppose the validity and amount of a claim for damages
under a legal action were disputed. In that case, it may  about the same business in different periods
be inappropriate to recognise the total amount of the
claim in the statement of financial position as a liability.  between different businesses in the same period
To faithfully represent the situation, it may be appropriate
to disclose the amount and circumstances of the claim.

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Ethics and Governance Ethics and Governance

Comparability Comparability

Comparability requires consistent measurement and classification, Accounting policies – the specific principles, bases, conventions, rules
and presentation of the financial effects of similar transactions and and practices adopted by an entity in preparing and presenting
events. financial statements.

Comparability does not always mean using the same methods to Another implication of comparability is that financial statements must
prepare information. Comparability implies that users must be show corresponding information for preceding periods. In the
informed (in the notes to the financial statements) of the principal financial statements of a business, another column of figures is present
accounting policies used, any changes to them and the effects of such to show the financial information of the preceding year.
changes.

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Ethics and Governance Ethics and Governance

Verifiability Timeliness

Verifiability means giving financial statements users confirmation that Understandability means showing information clearly and concisely.
their financial information is faithfully represented. Some items in the financial statements are complicated. However, if
they are omitted, the statements will be incomplete. Understandability
Verifiability means that knowledgeable, independent observers can also assumes that the users of the financial statements have some
reach a consensus that a particular representation has the fundamental accounting knowledge.
quality of faithfulness.

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Ethics and Governance Ethics and Governance

Understandability Understandability

Understandability means showing information clearly and concisely.  Users are assumed to have a reasonable knowledge of business and
Some items in the financial statements are complicated. However, if economic activities and accounting and a willingness to study
they are omitted, the statements will be incomplete. Understandability information with reasonable diligence.
also assumes that the users of the financial statements have some
accounting knowledge.  Information about complex matters should not be excluded because
it may be too difficult for certain users to understand.
Financial information should be made understandable through clear
and concise classification and presentation.

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Activity 3 Activity 3
Match the characteristics of good accounting information to the Action Characteristic
list of actions that preparers or users of financial information Shareholders have been asked if there is anything in
would take to ensure it displays those characteristics. the annual financial statements that confuses them, Relevance
and they have said everything is clear.
The auditors have completed their audit work and
Faithful
have found that the accounting records support the
Representation
financial statements.
Management checks information before publication to
Comparable
ensure it is all correct and does not miss anything.
Financial advisers use financial information to see
how the company is doing compared to other Verifiable
companies and to advise their clients.
Investors use financial information to judge a
company’s prospects and decide whether to continue Timeliness
to invest in the company.
The accounts department prepares financial
information covering an accounting period within two Understandable
weeks of the end of the period.

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Activity 3 Answer Activity 3 Answer

Understandable – Shareholders have been asked if there is anything in Relevance – Investors use financial information to judge a company's
the annual financial statements that confuses them, and they have prospects and decide whether to continue to invest in the company.
said everything is clear.
Timeliness – The accounts department prepares financial information
Verifiable – The auditors have completed their audit work and have covering an accounting period within two weeks of the end of the
found that the accounting records support the financial statements. period.

Faithful Representation – Management checks information before

publication to ensure it is all correct and does not miss out on anything.

Comparable – Financial advisers use financial information to see how

the company is doing compared to other companies and to advise their
clients.

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Accounting Principles Accounting Principles

Materiality

The item’s nature and size are evaluated when determining whether
the information is material. If the item’s non-disclosure could influence
Accounting principles are the fundamental concepts the economic decisions of users based on the financial statements, it is
accountants use to prepare financial statements. Standard- material.
setting boards consider these principles when developing new
frameworks and financial standards. Each material item should be presented separately in the financial
statements. At the same time, immaterial amounts of a similar nature
or function should be aggregated and need not be presented separately.

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Accounting Principles Accounting Principles

Offsetting Consistency

An entity shall not offset assets and liabilities or income and expenses Consistency is needed to achieve comparability. It means treating and
unless required or permitted by an IFRS. consistently presenting similar items in the financial statements over
different periods unless there are appropriate reasons to make a
An organisation should report assets, liabilities, income and expenses change.
separately. Offsetting between these elements in the financial
statements is not allowed unless the offsetting reflects the substance
of the transaction.

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Accounting Principles Accounting Principles

Consistency Prudence

Reasons for change in the treatment of similar items could be due to Prudence is the exercise of caution when making judgements under
the following: conditions of uncertainty. In preparing a business’s financial
statements, assets and income should not be overstated, while
 a significant change in its operations or liabilities and expenses should not be understated.

 if another classification provides a more suitable presentation of its The main problem with exercising prudence is that it may result in the
transaction. understatement of assets (and income) and the overstatement of
liabilities (and expenses).
 Required by a new IFRS standard
However, this is not allowed as this would conflict with the qualitative
Changes in accounting policies need to be disclosed in the notes of characteristic of faithful representation. Such misstatements would also
financial statements. lead to misstatements in future periods.

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Accounting Principles Accounting Principles

Duality (dual aspect) Historical Cost and Current Value

Also known as the dual effect or dual aspect, the double entry The historical cost concept states that all transactions are
concept explains that every transaction has at least two impacts initially recorded at historical cost, which is the cost at the time of
on a business, a debit and credit entry. the transaction. The historical cost system of accounting is
particularly relevant to Assets.

Current value measures provide monetary information about

assets, liabilities and related income and expenses, using
information updated to reflect conditions at the measurement date.

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Accounting Principles Accounting Principles

Historical Cost and Current Value Substance over Form

Some bases of current value include: Substance over form is part of faithful representation. It means
that the treatment of items in a company’s financial statements
 Fair value (price on an active market, or present value of future should be determined by their commercial reality and not by how
cashflows) they could be treated for legal purposes.

 Value-in-use (value derived from use of the asset) The concept is particularly relevant to assess:

 Current cost (value of an equivalent asset on measurement  whether the definition of an element is met
date)
 management’s assertions that elements of financial statements
are complete, valid and accurate.

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Accounting Principles Accounting Principles

Substance over Form Substance over Form

In most circumstances, substance and legal form are the same. If  A sale of goods or services to a customer is made in exchange
they are not, information about the legal form alone would not for purchasing a similar value of goods or services from the
faithfully represent the economic substance. For example: customer.

 A legal sale of an item of equipment may, in substance, be a Whether the substance of a transaction should prevail over its
lease. legal form is a complex deliberation and depends on each
transaction's circumstances.
 Sales to a customer may be paid for using the proceeds of a
loan to the customer. When the transactions are considered
together, the sale may be without substance.

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Basis of Financial Statements Preparation Basis of Financial Statements Preparation

The financial statements are prepared by the management (directors)  Accruals basis – The financial statements cover all transactions
of a company with these three basic assumptions: and events in the stated accounting period.

 The business is a going concern. Transactions and events are recognised in a company’s accounting
records when they happen and are not based on cash settlement.
Going concern assumes that an entity will continue operating for the
foreseeable future (the next 12 months). During that time, the The transactions or events will be included in the financial
company directors do not intend or will not be forced to liquidate the statements for the period they apply to. This may result in year-end
business or cease trading. accruals that are included within current liabilities in the financial
statements.
Going concern underlies the basis of the preparation of all published
financial statements. It is so fundamental that users are entitled to The accruals basis links to the matching concept that expenses are
assume that this basis has been applied unless an alternative basis is recognised in the same accounting period as the revenues they
stated (in the notes to the financial statements). relate to.

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Basis of Financial Statements Preparation Activity 4

 Business Entity – The contents of the financial statement relate to For each statement below, comment if it is true or false.
the business.
1. The materiality concept states that omitting or misstating information
The business is a separate entity from its owners/shareholders. The may influence the decisions of users of financial statements.
financial statements should only include transactions that relate to
the business and not transactions that relate to the shareholders' 2. The accruals basis states that transactions should be accounted for
personal interests. when they are settled by cash.
The business entity concept is an accounting concept, not a legal 3. Sarah is a sole trader. She has recently bought a car, which she does
concept. Therefore, it applies to sole traders and partnerships even not use when on business. She has paid for the car through her
though the business and the owners are not legally distinct. business's bank account and included the car as an asset in the
business's financial statements. This is a violation of the business
entity concept.

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Activity 4 Activity 4 Answer

For each statement below, comment if it is true or false. 1. True. This is a description of the materiality concept.

4. The going concern concept implies that the business will continue 2. False. The accruals basis states that transactions should be accounted
operation for the longer term, at least the next five years. for in the period they arise. For example, a sale is recorded when it
occurs, not when the cash settlement is made.
5. Substance over form means that an accountant will account for a
transaction according to its legal substance. 3. True. The car is not used for business purposes and should not be
included as an asset in the business's financial statements.
6. Consistency means that the same items must always be treated in
the same way in the financial statements over different periods. 4. False. The going concern concept implies that the business will
continue operation for the foreseeable future. This is generally taken
7. The application of prudence means expenses should consistently be to mean the next 12 months.
recognised if there is any likelihood of them occurring, but
accountants should be more cautious about recognising income.

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Activity 4 Answer Summary

5. False. Substance over form refers to commercial substance, not legal  The IFRS Foundation and the IASB (“the Board”) are independent bodies.
form.  The Board has sole responsibility and authority to issue IFRS Standards and
IFRICs.
6. False. Consistency does not always apply because there are
legitimate reasons for changing presentation, for example, to comply  The IFRS Advisory Council advises the IASB.
with an IFRS that has changed.  The IFRS IC provides guidance on reporting issues not addressed by IFRS
Standards and publishes draft interpretations.
7. False. The exercise of prudence does not require more persuasive  Due process on projects includes consideration of the Board’s IFRS Framework
evidence for income than for expenses. The intention is that both (see Chapter 18), consultation, discussion, public comment, consideration of
income and expenses should be neither understated nor overstated. costs and benefits and at least one exposure draft before a new IFRS is
published.
 Exposure drafts and standards must be approved by at least nine of the Board’s
14 members.

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Summary Summary

 IFRS Standards apply to published financial statements of all business/profit-  There are FOUR enhancing characteristics:
oriented entities.
— Comparability
 IFRS Standards do not apply to immaterial items. — Verifiability
 Harmonisation can lead to improvements by considering alternative approaches,
but the inherent compromise required may lead to lower standards.
— Timeliness
 Understandability
 The Conceptual Framework is not a standard.
 There is just ONE underlying assumption:
— Going concern
 There are TWO fundamental characteristics:
— Relevance
— Faithful representation

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