Revise Lecture 2

1. Revise Lecture 2

2. Revise Lecture - 2 • The regulatory system • 2. A conceptual framework

3. Revise lecture - 2 • Why a regulatory framework is necessary? A regulatory framework is required to ensure that relevant and reliable financial reporting is achieved to meet the needs of shareholders and other users.

4. Revise Lecture - 2 • Principles-based and Rules-based framework

5. Revise Lecture - 2 Harmonisation of accounting standards There are a number of reasons why the harmonisation of accounting standards would be beneficial. Businesses operate on a global scale and investors make investment decisions on a worldwide basis. There is thus a need for financial information to be presented on a consistent basis

6. A Concept and Regulatory Framework Development of an IFRS The procedure for the development of an IFRS is as follows; • The IASB identifies a subject and appoints an advisory committee to advise on the issues • The IASB publishes an exposure draft for public comment, being a draft version of the intended standard

7. A Concept and Regulatory Framework Development of an IFRS • Following the consideration of comments received on the draft, the IASB publishes the final text of the IFRS • At any stage the IASB may issue a discussion paper to encourage comment • The publication of an IFRS, exposure draft requires the votes of at least eight of the 15 IASB members

8. A Concept and Regulatory Framework Status of IFRS’s • Neither the IFRS foundation, the IASB nor the accountancy profession has the power to enforce compliance with IFRSs. • Nevertheless, some countries adopt IFRSs as their local standards and others ensure that there is minimum difference between their standards and IFRSs. • In recent years, the status of the IASB and its standards has increased, so IFRSs carry considerable persuasive force worldwide.

9. Generally Accepted Accounting Practice (GAAP)

10. A Concept and Regulatory Framework Generally Accepted Accounting Practice (GAAP) • You may come across the expression generally accepted accounting practice (GAAP). • This means the set of accounting practices applied in combination of legislation, accounting standards, stock exchange requirements and in area where detailed rules do not exist, other acceptable accounting practices.

11. A Concept and Regulatory Framework • Thus one may speak of ‘UK GAAP’ or ‘US GAAP’ . In an international context ‘GAAP’ means accounting practice as defined in IASs, with each country adding its own local requirements and practices.

12. A Concept and Regulatory Framework A conceptual framework - Introduction There are two main approaches to accounting: • A conceptual framework approach (a Principles based) such as that used by the IASB. • A rules-based approach such as that used in the US.

13. A Concept and Regulatory Framework What is a conceptual framework? • A conceptual framework is a framework which prescribes the nature, function and limits of financial accounting and financial statements • A coherent system of interrelated objectives and fundamental principles

14. A Concept and Regulatory Framework Why have a conceptual framework? There are a variety of arguments for having a conceptual framework • It enables accounting standards and GAPP to be developed in accordance with agreed principles • It avoids ‘fire-fighting’ whereby accounting standards are developed in a piecemeal way in response to specific problems or abuses

15. A Concept and Regulatory Framework • Lack of a conceptual framework may mean that certain critical issues are not addressed, e.g. until recently there was no definition of basic terms such as ‘asset’ or ‘liability’ in any accounting standard • Accounting standards based on principles are thought to be harder to circumvent • A conceptual framework strengthens the credibility of financial reporting and the accounting profession

16. A Concept and Regulatory Framework Objective of financial reporting The objective of financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.

17. A Concept and Regulatory Framework When do financial statements show fair presentation? FS will generally show a fair presentation when: • They conform with accounting standards • They conform with the any relevant legal requirements • They have applied the qualitative characteristics from the Framework

18. A Concept and Regulatory Framework Objectives of financial statements The objective of FS is to provide information about: • The financial position of an entity (provided mainly in the SFP) • The financial performance (provided mainly in the IS) • Changes in the financial position of an entity (provided in the statement of changes in equity and statement of cash flows)

19. A Concept and Regulatory Framework User groups FS is useful to a wide range of users in making economic decisions • Equity investors (existing & potential) • Existing lenders and potential lenders • Employees • Stock market analysts and advisers • Business contacts including customers • Suppliers and competitors • The government, including tax authorities • The general public

20. A Concept and Regulatory Framework Qualitative characteristics of FS • The qualitative characteristics of FS are set of attributes which together make the information in the FS useful to users. Main qualitative characteristics are; • Relevant: • To the needs of users to assist in evaluating performance

21. A Concept and Regulatory Framework Qualitative characteristics of FS 2. Reliable: • Can be relied upon • Free from material error • Neutral • Complete • Prudent

22. A Concept and Regulatory Framework Qualitative characteristics of FS 3. Comparable • With other businesses • With the previous periods results

23. A Concept and Regulatory Framework Qualitative characteristics of FS 4. Understandable • Must be presented so it is understandable to users

24. A Concept and Regulatory Framework Historical cost • Under historical cost accounting, assets are recorded at the amount of cash or cash equivalents paid, or the fair value of the consideration given for them • Liabilities are recorded at the amount of proceeds received in exchange for the obligation. This method of accounting has advantages, but it also has serious disadvantages.

25. A Concept and Regulatory Framework Advantages of historical cost accounting • Records are based on objectively verifiable amounts (actual cost of assets, etc. • It is simple and cheap. • The profit concept is well understood. • Within limits, historical cost figures provide a basis for comparison with the results of other companies for the same period or similar periods, with the results of the same company for previous periods and with budgets.

26. A Concept and Regulatory Framework Disadvantages of historical cost accounting 1. It overstates profits when prices are rising through inflation. Several factors contribute to this. • For example, if assets are retained at their original cost, depreciation is based on that cost. As inflation pushes prices up, the true value to the enterprise of the use of the asset becomes progressively more than the depreciation charge.

27. A Concept and Regulatory Framework • This disadvantage can be overcome by revaluing non-current assets. IAS 16 the requires depreciation to be based on the revalued amount.