The Framework

1. The Framework From theory to practice

2. What is a conceptual framework? • It is a statement of generally accepted theoretical principles which form the frame of reference for a particular field of enquiry. • A conceptual framework for financial reporting will form the theoretical basis for determining, inter alia; • Which events/transactions should be accounted for ? • How they should be measured? • How they should be communicated to the user?

3. Why is a conceptual framework necessary? • It requires the resolution of fundamental issues such as: • What are the objectives of the reports? • Who are the users • What are the information needs of users • What types of report will best satisfy their needs

4. Why is a conceptual framework necessary (cont)? • Globalisation • Different definitions of elements • Different recognition criteria • Variety of social, economic and legal circumstances – different perceptions of user needs • Preference for different bases of measurement • The need for harmonisation of: • Regulations • Accounting standards • Procedures

5. How does the Framework further seek to narrow the differences? • By providing information in financial statements that is useful in making economic decisions • Examples of economic decisions: • When to buy, hold or sell an equity investment • Assess the stewardship or accountability of management • Assess the entity’s ability to pay/provide benefits to employees • Assess the security for amounts lent to the entity • Determine taxation policies • Determine distributable profits and national and dividends • Prepare and use national income statistics • Regulate the activities of entities

6. How users make economic decisions • Users make an evaluation of the entity’s ability to generate cash and cash equivalents and of the timing and certainty of the generation of this cash/cash equivalents • This evaluation enables an assessment of the entity’s: • Capacity to pay its employees and suppliers • Meet interest payments • Repay loans • Make distributions to its owners

7. Will the information provided satisfy the specific information needs of all users? • See FW par 9 for examples of the information needs of certain categories of users; • Investors • Employees • Lenders • Suppliers and other trade creditors • Customers • Governments and their agencies • The public

8. What is the general nature and purpose of the information contained in the financial statements? • The financial statements (F.S.) under discussion in the framework are general purpose financial statements, including consolidated financial statements • The F.S. are directed toward the common information needs of a wide range of users • Financial statements form part of the process of financial reporting • F.S. show the financial effects of past events ; does not necessarily provide non-financial information • F.S. show the accountability of management (stewardship) for the resources entrusted to it. • Provides information about the financial position, performance and changes in financial position • F.S. Portray the financial effects of transactions and other events by grouping them into broad classes according to their economic characteristics • Special purpose financial reports are excluded from the FW (e.g. prospectuses, tax computations)

9. What is the composition of financial statements? • A complete set of financial statements normally includes: • Balance Sheet • Income statement • Statement of changes in financial position (as a statement of cash flows or funds flow) • Notes and other explanatory material • Financial statements exclude: • Directors’ report • Chairmen’s statement • Management analysis • Etc.

10. How does the balance sheet assist in the evaluation of the entity’s ability to generate cash? • The balance sheet shows the entity’s financial position by providing information about: • The economic resources it controls – capacity in the past to modify these resources to generate cash • Its financial structure - enables prediction of future borrowing needs; and distribution of future profits ; potential to raise further finance • Its liquidity (availability of short term cash ) & solvency (availability of longer term cash ) – ability to meet financial commitments as they fall due • Its ability to adapt to changes in the environment in which it operates

11. How does the income statement assist in the evaluation of the entity’s ability to generate cash • Information about the financial performance , particularly its profitability enables an assessment to be made about the future economic resources that the entity is likely to control in the future • This may be assessed by predicting the capacity of the entity to generate cash flows from its existing resource base • Make judgements about the effectiveness with which the entity might employ additional resources

12. How does the SOCE assist in the evaluation of the entity’s source and application of cash? • Information about the changes in financial position is useful to assess its: • Investing • Financing , and • Operating activities during the reporting period • Funds can be defined as: • Financial resources • Working capital • Liquid assets • Cash

13. Using an integrative approach to assessing an entity’s capacity to generate cash • Underlying these financial statements collectively is the “accounting equation” E (Equity)=A(Assets)-L (Liabilities) • The elements (broad classes transactions and events)of the F.S. directly related to measuring the financial position (depicted in the balance sheet) • An asset is a resource controlled by the entity as a result of past vents and from which future economic benefits are expected to flow to the entity • 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 • Equity is the residual interest in the assets of the entity after deducting all its liabilities

14. Provisions, liabilities and Contingent Liabilities (IAS 37) • Provisions and other liabilities • A provision is a liability of uncertain timing or amount • A provision is recognised when: • There is a (legal or constructive) present obligation as a result of a past event • Probability of outflow of FEB to settle obligation • Reliable estimate can be made • Provisions and contingent liabilities • A contingent liability is a possible obligation … existence in confirmed by the occurrence /non-occurrence of an uncertain event not controllable by entity • Present obligation … not recognised because • Outflow of FEB through settlement of obligation not probable OR • Amount of obligation cannot be measured with sufficient reliability

15. Contingent assets • A possible asset that arises from past events and whose existence will only be confirmed by the occurrence/non-occurrence of one or more uncertain events

16. What is a resource? • Not specifically defined in the Framework • The dictionary meaning (Oxford) – • A supply of something that an organisation can use, especially to increase their wealth • Something that can be used to help achieve an entity’s aims

17. What is a past event iro assets? • FW: 58 (Process) • Purchasing • Producing • Donations, Grants, Inheritance • Discovery (mineral deposits, innovations) It is NOT • An INTENTION to do the above • Risks and rewards incidental to ownership has passed from one party to another (IAS17:8)

18. What is a past event iro liabilities? • Par 63 • The acquisition of goods giving rise trade payables • The use of services giving rise to trade receivables • The receipt of a bank loan • Future rebates based on annual purchases by customers

19. What is control? • Resulting from legal rights • Access to economic benefits are restricted (secret formula or process) “An entity controls an asset if the entity has the power -to obtain the future economic benefits flowing from the underlying resource and - and to restrict the access of others to those benefits” (IAS38Intangibles:13)

20. Future economic benefits -Inflow • Definition: FW: 53 - Must have the potential to contribute to the flow of cash/cash equiv • Process FW:55 (How obtained) • Production as part of operating activities • Convertibility into cash/cash equiv (exchanged for other assets; settlement of liability or distributed to shareholders) • Capability to reduce cash outflows

21. Future economic benefits -Outflow • Settlement of a present obligation: • Payment of cash • Transfer of other assets • Provision of services • Replacement of that obligation with another obligation • Conversion of the obligation to equity

22. Using an integrative approach to assessing an entity’s capacity to generate cash (cont) • Increases /decreases in E (equity) resulting from its operational performance are portrayed in the income statements through the ‘elements’ of income and expenses. • Income is the increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than contributions from equity participants • Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity • Profit is used as a measure of performance (e.g. gross margin, profit before tax ) or as a basis for other measures (e.g. ROI or EPS)

23. The nature of ‘Income’ • Includes revenue and gains • Revenue includes sales, fees, dividends, royalties and rent • Gains include : • Realised gains (e.g. arising on the sale of non-current ) assets) • Unrealised gains (e.g. on revaluation of marketable securities; increases in the carrying amount of L.T. assets

24. The nature of ‘expenses’ • Includes expenses that arise in the course of ordinary activities of the entity as well losses • Losses include : • Losses resulting from disasters such as fire and flood • Losses on disposal of non-current assets • Unrealised losses (e.g. increases in the rate of foreign currency iro borrowings

25. ‘Recognising’ the elements • FW 82: Recognition is the process of incorporating in the balance sheet or income statement an item that meets the definition of an element on condition that: • It is probable that the associated future economic benefits will flow to or from the entity • The item can be reliably measured at a cost or value • See par 89-98 for the recognition of assets, liabilities, income and expenses

26. ‘Measuring’ the elements • Measurement is the process of determining the monetary amounts at which the elements of the financial statements are to be recognised and carried in the balance sheet and income statement • Measurement bases (par 100): • Historical cost • Current cost • Realisable (settlement) value • Present value

27. Reliability of Measurement • In many cases cost or value must be estimated • IAS 37 see ‘Best estimate’

28. Underlying assumptions • The accrual basis - when transactions occur not merely when cash is received • Accrual basis tell the users of past transactions involving payment and receipt of cash and • Of obligations to pay cash in the future • Of resources that represent cash to be received in the future • Going concern – the entity will continue in operation for the foreseeable future . • No intention or need exists to liquidate or curtail materially its scale of operations

29. Qualitative characteristics • Understandability – readily understandable to users who have reasonable knowledge business and economic activities and accounting • Relevance – relevant to the decision-making needs of users to evaluate past, present or future events or confirming or correcting past evaluations • Reliability – Free from material error and bias. Faithfully represent the transactions and events; Substance –over- form – substance and economic reality; Neutrality – no bias; Prudence – the inclusion of a degree of caution by ensuring that assets or income are not overstated and liabilities or expenses are not understated. Completeness - no omissions • Comparability – enables comparison through time and with different entities. The impact of changes in accounting policies to be accounted for to ensure comparability

30. Fair presentation • Where there is a clash of qualitative characteristics the overriding aim is to fairly present the financial position and performance of an entity • Professional judgement is to be used to achieve an appropriate balance amongst the characteristics

31. Now look at the real Financial Statements • Pick ‘n Pay Ltd • Naspers Ltd • Transnet Ltd