Financial Accounting

• CF for financial reporting consists of a coherent set of fundamental principles which underpin financil accounting and so provide a sound theoretical basis for the development of accounting standards
• CF does not override accounting standards
• CF indentifies certain concepts which, in the view of the IASB, underlie the preperation and presentation of financial statements
• The IASB CF replaces the framework for the preparation and presentation of financial statements issued in 1989

• CF for financial reporting consists of a coherent set of fundamental principles which underpin financil accounting and so provide a sound theoretical basis for the development of accounting standards
• CF does not override accounting standards
• CF indentifies certain concepts which, in the view of the IASB, underlie the preperation and presentation of financial statements
• The IASB CF replaces the framework for the preparation and presentation of financial statements issued in 1989

• to assist in the development of future international standards and in the review of existing standards
• to provide a basis for reducing the number of alternative accounting treatments permitted by international standards
• to assist national standard-setters in developing national standards
• to assist preparers of financial statements in applying international standards
• to assist auditors in forming an opinion on whether financial statements conform with international standards
• to assist users of financial statements in interpreting information in financail statements in accordance with international standards
• to povide people who are interested in the work of IASB with infomation about its approach to the formulation of international standards

The conceptual Framework deals with the following matters:

• The objective of general purpose financial reporting
• the qualitative characteristics of useful information
• the going concern assumption
• the elements of financial statements
• recognition of the elements of financial statements
• measurement of the elements of financial statements
• concepts of capital and capital maintenance

• "to provide financial information about the reporting entity that is useful to existing and potential investers, lenders and other creditors in making decisions about providing resources to the entity"- referred to a 'primary users'
• primary users need information that will help them to assess the prospects for future cash inflows to an entity. such information will include:
  • information about the entitys recources 
  • claims against the entity
  • efficiency
  • effectiveness
  • how managemnet uses the entitys resources
• primiary users can not expect the entity to provide the information directly to them, so they rely on the general financial eports for much of the information they need
• designed to show to show the value of the reporting entity but may help primary users estimate the entity's value
• Need to be prepared in accordance with standards and meet the needs of the maximum number of primary users 
• other parties might find GPFR useful including, employees, customers, governments and the public

The CF indentifies 6 qualitative characteristics:

• Relevance- relevant to users' decision-making needs
• faithful representation- complete, neutral and free from error

These are the 2 fundamental characteristics, the remaining 4 are 'enhancing'

• comparability- enables users to comapre with simillar enity's and be consistant 
• vertifiability- can be direct or indirect
• timeliness- made available to users in time to influence their economic decisions
• understandability- should be undertandable for users with "reasonable knowledge"

• An entity will continue in operation for the forseeable future 
• The entity has no intension or need to close down or materially reduce the scale of it operations

Assets

Liabilities

Equity

Income

Expenses

"the process of incorporating in the balance sheet or income satements an item that meets the defenition of an element and satisfies the criteria for recognition"

The conceptual framework states that an item which satisfies the defenition of an element shoud be recognised in the financial statements, so long as:

• that future economic benefit from that item will flow to or from the entity and its value can be measured with reliablity

Determining the monetary amount of the value to be show on the statements

• historical cost- assets are recorded at the amount paid
• current cost- shown at the current market value
• realisable value- shown at the amount the entity would obtain if they sold the asset in an orderly disposal
• present value- present dicounted value of future net cash inflows that the asset would be expected to generate in the normal business

• profit is equal the increase in capital

2 ways of comparing and entity's capital at the start and end of the accounting period:

• Financial capital maintenance
  • profit is earned only if the value of the net assets at the end of the period is greater than the value of net assets at the begining.
• Physical capital maintenance
  • profit is earned only if the physical operating capability of the entity at the end of a period is greater than its physical operating capability at the start, after adjusting for any amounts contributed by or distributed to owners during the period.

IAS16

• PPE must be recognised as an asset, as long as it is satisfied under the criteria
• Items of PPE should be measured in the financial statements initially and later
• the way in which depreciation charges should be caluculated and accounted for

IAS16 defines PPE as "tagible assets that:

• are held for use in the production and supply of goods or services, for rental to others or for administrative purposes and are expected to be used during more than one period

The amount shown in the financial statements

"the amount at which an asset is recognised after deducting any acumulated depreciation and accumulated impairment losses"- can also be reffered to the assets written down value.

IAS 16 states that an item of PPE should be recognised as an asset if and only if:

• It is probable that future economics benefits associated with the item will flow to the entity concerned and
• the cost of the item can be measured reliably

Further points:

• an "item" generally consists of individual peice of property, plant and equipment. However, it may sometimes be appropriate to group relatively insignificant items together (e.g small tools) and apply the recognition criteria to the group.
• Spare parts should be regonised as PPE if they meet the criteria. however small parts may be treated as inventory and accounted for as an expense when they are used in the repair of PPE
• Items of PPE accuired for safety or environmental reasons do not directly generate future economic benefits. However, they do qulify for recognition as assets because they enable the entity to derive future economic benefits from its other PPE.

• Routine servicing, repair and maintenance costs inccured after initial recognition of an item of PPE as an asset are not capital expenditure, these costs are accounted for as an expense.
• However, to replace major parts of some items of PPE at regular intervals (e.g interior fittings of an aircraft)should be treated as capital expenditure and recognised as an addition to the carrying amount of the asset concerned. The same concept applies to major inspections

IAS16 requires that an items of PPE should be masured at cost. The cost of an item of PPE comprises:

• the purchase priceof the item, including import duties and non-refundable purchase taxes, less trade discounts or rebates
• costs that are dirctly attributable to bringing the iem to the location and condition necessary for it to be operated as intended, inlcuding:
  • labour costs arising directly from the condtuction ot acuisition of the item
  • site preparation costs
  • initial delivery and handling costs
  • installation, assembly and testing costs
  • proffessional fees
• the estimated costs of dismantling and removing the item and restoring the site on which the item is located, as long as the obligation to meet these costs is inccured at the time of acquisition

In general admin and other OH expenses ar enot part of the cost

IAS 16 allows 2 ways of measuring PPE

• Cost model - carried at cost less any accumulated depreciation and less any impairment losses
• Revaluation model - carried at a revalued amount. The revalued amount of an item consists of its fair value at the date of revaluation, less any subseqent accumulated depreciation and less any subsequent  accumulated impairment losses.This model can not be applied unliess the item of PPE can be measured reliably and applied to that group of items of a simliar nature simultaneously.

If the carrying amount of an item of PPE has increased as a result of a revaluation, the increase must normally be credited to a revaluation reserve abd shown as 'other comprehensivee income' in the income statement. This stops the income being shown as profit when it comes to dividend payments.

If it has decreased as a result of a revaluation must be accounted for as an expense. The decrease must be debited to the revaluation reserve as a negetive figure in other comprehensive income. 

any revaluation gain which is included in the revaluation reserve may be trasferred to retained earnings, this has now been recognised and recorded in the changes in equity statement and does not effect the income statement which shows that it exluded from profit and loss in a subsequent period

IAS 16 defines depreciation as "the systematic allocation of the depreciable amount of an asset over its useful life". The purpose of depreciation is to allocate an expense between accounting periods.

Depreciation charges reduce profits but have no direct effect on entity's cash resources and do not ensure that cash is 'savedup' to buy replacement assets.

• depreciation is 'the cost of a asset, or other amount substituted for cost, less its residual value'.
• the residual value of an asset is 'the estimated amount that an entity would curently abtain from disposal of the asset, after debducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life'.
• Useful life is 'the period over which an asset is expected to be available for use by an entity... or the numer of production or similar units expected to be obtained from the asset by an entity'.

IAS 38 defines intanglible assets as "an identifiable, on-monetary asset without physical substance".

An item can not be an intanglible asset unless it is an asset in the first place. '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'.

The criteria to satisfy:

• future economic benefits - there must be an expectation of future economic benefits, such as revenue from the sale of goods or services, or cost savings.
• Control - stem from legally enforceable rights. However, in the absence of such rights it is difficult to prove that an asset exist. e.g. training staff to generate future economic benefits but the entity has no conrtol over staff who could decide to move toa dfferent employer.
• without physical substance - distingushed from PPE. e.g. software, patents and copyrights, franchises etc
• non-monetary - intanglible assets must be non-monetary, not cash, bank deposits or trade recievables
• Identifiable - when it arises from cpntractual or other legal rights or when it is serparable (can be sold seperatly from the company

defined as: "the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use".

Examples:

• The design, construction and testing of pre-production prototypes and models
• the design of tools, jigs, moulds and dies involving new technology
• the design, construction and operation of a pilot plant
• the design, construction and testing of a chosen alternative for new or improved materials, products, processes etc.

Because this is more advanced than the research phase it may be possible to identify it as an intangible asset, it will produce future economic benefit.

IAS 38 states in order to be recognised it must comply with the following:

• the technical feasibility of completing the asset so that it will be ready for use or sale
• the entity's intention to complete the asset and use or sell it 
• the entity's ability to use or sell the asset
• the fact that the asset will probably generate future economic benefits
• the availablity of adequate technical, financil and other resources to complete the development work and use or sell the asset
• the entity's ability to measure reliably the expenditure attributable to the asset during its development

If any of these can not be demonstrated the development expenditure must be written off as an expense when it is incurred.

- expenditure on internally generated brands, mastheads, publishing titles, cusomer lists and similar items must always be written off.

the cost of an internallt generated asset is the sum of the directly attributable costs incurred in relation to the asset as from the date when it first meets the recognition criteria for the development phase. some examples of directly attributable costs include:

• costs of materials and serices used or consumed in generating the asset
• labour costs arising from the generation of the asset
• fees to register legal rights
• amortisation of patents and licenses used to generate the asset.

Selling, administrative and other general overhead costs are usually excluded, as are staff training costs.

IAS 38 provides a number of examples of expenditure on intanglible rescources the must be recognised as an expense when the expenditure in incurred. These examples include:

• start-up costs
• training expenditure
• expenditure on advertising and promotional activities
• expenditure on relocating or reorganising part or all of an entity

IAS 38 allows entities to choose between the "cost model" and the "revaluation model" for measurement.

• The cost model - intangible assets are carrie dat cost less any accumulated amortisation and accumulated impairment losses.
• The revaluation model - carried at a revalued amount, the assets fair value at the date of revaluation, less any amortisation and less any impairment losses.

Intangible assets with finate useful life are amortised, those with infinate useful life are not.

You need to be able to determine useful life, factors include:

• expected usage
• public info on estimate of simillar assets
• technological, commercial or other types od obsolescence
• stability of the industry that the asset is being used in
• expected actions by competitors
• level of maintenace required
• period of control
• legal limits on the amount of time the asset can be used

depreciable amount = cost less residual value

goodwill arises from an entity's good reputation and strong customer relationships.

it is impossible to detemine reliably the cost or value of internally geerated goodwill

goodwill is a vunrable asset and may be easily destroyed or damaged

because of this !AS 38 does not allow internally generated goodwill to be recognised as an asset

The objective of this standard is to ensure that the assets are not  caried in the financial statements at more than their recoverable amount.

IAS 36 defines an impairment loss as 'the amount by which the carrying amount of an asset or a cash-generating unit exceeds its recoverable amount'. you only need to find the recoverable amount if you think that the asset might be impaired examples of indications:

• external sources of information- e.g other assets declining in other firms
• Internal sources of information- e.g physical damage

If these indications are persistant then you need to test the asset for impairment and determine the recoverable amount, there could be other indications though.

- goodwill

- assets which have an infedinate useful life that are not yet availbale for use

IAS 36 states that the recoverable amount of an asset as ' the higher of its fair value less costs of disposal and its value in use'.

fair value = the price that would be received to sell an asset or paid to transfer the liablity 

coats of disposal = costs directly attributed to the disposal of an asset, excluding finance costs and income tax expense

value in use = the present value of the future cash flows expected to be delivered from an asset or cash-generating unit

a lease is ' an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time".

There are 2 types of leases, which are accounting for differently:

• Finance lease - a lease that trasfers substanitially all the risks and rewards incidental to owenership of an asset. Title may or may not eventually be tranferred
• operating lease - a lease other than a finance lease

indications of a finance lease include-

• the lease transfers owenership of the asset to the lessee at the end of the lease term
• the lessee has to option to buy the asset
• the lease term is the majority of the assets useful life
• minimum payments are more or equal too, the fair value of the asset
• the asset is besoke to the business

• The lessee

This is simple because the lessee has not taken any risks or rewards from the asset. 

the lease payments should be accounted for as an expense, on a straight line basis

not shown on the financial statements, except the expense of the lease

• the lessor

Has retained the risks and rewards so the leased intem is shown as an asset on their financial statements and depreciated as usual. 

the lease payments are recognised as income, on a striaght line basis over the lease term

any costs inccured by the lessor shouls be added to the carrying amount of the asset and then written off over the lease term

the lessee has acquired the risks and rewards of owenership and therefor the asset should be shown on the financial statements as an asset with a corrosponding liablilty to the lessor.

At commencement the asset and liability to the lessor should be recognised as the lower of the following:

• Fair value of the leased item
• The present value of the minimum lease payments

Any costs inccured should be added to the asset.

The liability should be split between non-current liablities and current liabilities

Depreciation should be in accorance to the companies usual depreciation policy, if the lease term is the assets useful life it should be depreciated on this. 

the cost should be apportioned by the finance charge and the (an expense, interest) and the amount that reduces the liability.

The total finance charge is equa to the difference between:

• the total of the minimum lease payments
• the liablity to the lessor which was established at the commencment of the lease.

IAS 17 requires that the finance charge should be allocted between accounting periods during the lease term. there are 2 methods:

• The actuaial method- can not be used unless the interest rate is known
• The sum of digits method 
• The level spread method - allocated the finance charge between accounting periods

The sum of digits method:

• digit 1 is the last period, 2 is second last .... 
• The digits are totalled to give the sum of digits. If the loan is for 12 periods the sum of digits would be 78.
• The finance charge for each period is then equal to the total finance charge divided by the sum of digits and multiplied by each digit assigned to that peirod.

IAS 20 defines Government grants as " assistance by government in the form of transfers of resources to an entity in return for past or future complience with certain conditions relating to the operating activites of the entity". There are 2 types:

• Grants related to assets - These are government grants made on one condition, that the entity should purchase, construct or aquire long term assets such as PPE. The purpose of the grant is to help the entity pay for the asset or assets concerned.
• Grants related to income- These are grants other than related to assets. Purpose is to help the entity pay some of its operating expenses

Should not be recognised in the finacial statements until there is evidence that the conditions have been met and the grant has been recieved. ONce this has been done the grant should be recognised in profit or loss on a systamic basis over the periods the grant has been used. This means it should be recognised as income.