for Accounting Professionals

IFRS Framework for the Preparation and Presentation of

Financial Statements

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 IFRS Framework for the Preparation and Presentation of Financial Statements

PREFACE
This series of workbooks has been updated by the project team of the European
Union project Implementation of the Accounting Reform in the Russian
Federation.
The workbooks cover the concepts of International Financial Reporting Standards
(‘IFRS’). They are intended to be practical self-instruction aids
that practicing accountants can use to upgrade their knowledge, understanding and
skills.
Contents
1. FRAMEWORK FOR THE PREPARATION AND
PRESENTATION OF FINANCIAL STATEMENTS .....................3
2. QUALITATIVE CHARACTERISTICS OF FINANCIAL
STATEMENTS...............................................................................5

Each workbook is designed for a maximum of three hours of study. 3. WHAT ARE FINANCIAL STATEMENTS................................7

Each workbook is a combination of: 4. EXPENSES.............................................................................12

 Information with examples
 Self Test Questions – Multiple choice and Exercises 5. ACCOUNTING MEASUREMENT .........................................15
 Answers to Self Test Questions

The members of the project team were contributed by 6. CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE16
PricewaterhouseCoopers, ACCA, FBK and Agriconsulting.

The Workbook Series consists of a range of titles listed on our website.

The copyright of the material contained in each workbook belongs to the

European Union and, according to its policy, may be used free of charge for
any non-commercial purpose.

The project team would like to express thanks to those who have contributed
their time and thoughts to the content of the workbooks.

Contact

e-mail Web
victoria.stepanova@ru.pwc.com www.accountingreform.ru
Tel. + 7 495- 967-6000 Fax. + 7 495- 967-6001

Moscow, Russia, December 2006 (updated)

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1. Framework for the Preparation and Presentation of
Financial Statements
The aim of this first workbook is, by introducing the concepts on which
International Financial Reporting Standards is based, to help the understand
the nature, format and content international recognised Financial Statements
and reports.
The International Accounting Standards Board (IASB) was formed to develop
and have agreed standards of good practice that can be applied thoughout the
world.
Financial statements are presented to users, by many undertakings around the
world. Although such financial statements may appear similar from country to
country, there are differences that have been caused by a variety of social,
economic and legal circumstances, and by different countries serving the
needs of different users when setting national requirements.
IASB is committed to narrowing these differences, by seeking to harmonise
regulations, accounting standards and procedures, relating to the preparation
and presentation of financial statements.
Scope
This framework document deals with:
(i) the objective of financial statements;
(ii) the qualitative characteristics that determine the usefulness of
information in financial statements;
(iii) the definition, recognition and measurement of the elements from
which financial statements are constructed; and
(iv) concepts of capital and capital maintenance.
The framework is concerned with financial statements, including consolidated
financial statements. These are presented at least annually, and are directed
toward the needs of a wide range of users.
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IFRS Framework for the Preparation and Presentation of Financial Statements
Some users can obtain information in addition to the financial statements.
Many users, however, have to rely on the financial statements as their major
source of financial information.
Financial statements form part of the process of financial reporting. A complete
set of financial statements normally includes
• a balance sheet,
• an income statement,
• a statement of changes in financial position and
• notes, and other statements and explanatory material, that are an
integral part of the financial statements.
The framework applies to the financial statements of all commercial, industrial
and business reporting undertakings, in the public or the private sectors.
Users and Their Needs for Information.
The main users of financial statements are
- Investors. The providers of risk capital, and their advisers, are concerned
with the risk in, and return provided by, their investments. They need to
know whether they should buy, hold or sell (and the ability of the
undertaking to pay dividends).
- Employees. Employees, and their representatives, are interested in the
stability, and profitability, of their employers. They are also interested to
assess the ability of the undertaking to provide remuneration, retirement
benefits and employment opportunities.
- Lenders. Lenders wish to know whether their loans, and interest, will be
paid, when due.
- Government though various ministeries.
There are needs that are common to all users. As investors are providers of
risk capital to the undertaking, financial statements that meet their needs will
also meet most of the needs of other users.
The management of an undertaking has the primary responsibility for the
presentation of the financial statements.
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 IFRS Framework for the Preparation and Presentation of Financial Statements

The second assumption is that of Going Concern.

The Objective of Financial Statements
The objective of financial statements is to provide information about the
financial position, performance and changes in financial position of an
undertaking, useful to a wide range of users in making decisions.
The financial statements are normally prepared on the assumption that an
undertaking is a going concern, and will continue in operation for the
foreseeable future. It is assumed that the undertaking has neither the intention,
nor the need to liquidate, or curtail materially the scale of its operations.

Financial statements show the results of the stewardship of management.
Those users who wish to assess the management do so to make decisions:
whether to hold, or sell, to increase their investment, and whether to reappoint
(or replace) the management.
Assets are valued on the basis that the undertaking will continue, and no
forced sale will take place that would reduce their resale values.
If such an intention (or need) exists, the financial statements may have to be
prepared on a different basis and, if so, the basis used is disclosed.

Preparation of Financial Statements. EXAMPLE-going concern

There are two important assumptions that the users of financial statements
have.
The first assumption is that accrual accounting has been used when
recording transactions.
Banks provide loans under specific conditions, including the financial
performance of clients. A breach of these conditions may enable the bank to
liquidate the client. In these circumstances, unless the client can secure an
alternative source of finance, financial statements should not be prepared on a
going concern basis.

Financial statements are prepared on the accrual basis of accounting. The

impacts of transactions, and other events are recorded when they occur (and
not when cash is received, or paid).

EXAMPLES - of the accrual basis of accounting

In December, you sell some goods on credit. You receive cash from your client
in February. You record the sale in December, not when you receive the cash.

In December you pay office rent for January to March. The rent cost is spread
over these three months, not just expensed in full in the month that it was paid.

This is the accrual basis of accounting.

EXAMPLE - the accrual basis of accounting

In November, you buy some goods on credit. You pay cash in February. Your
December accounts will show the trade payable, alerting users to the
obligation to pay cash in the future.

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2. Qualitative Characteristics of Financial
Statements
It is important that financial information should be
1. understandable
2. relevant,
3. important – material to the user
4. reliable and
5. comparable.
1 Understandable
An essential quality of the information is that it is readily understandable by
users. Users are assumed to have a reasonable knowledge of business and
accounting, and a willingness to study the information with reasonable
diligence. Information about complex matters should not be excluded, merely
on the grounds that it may be too difficult for certain users to understand.
EXAMPLE-understandability
You are in the property development. Publishing architects’ and surveyors’
reports should be done, if this confirms specific aspects of your work. Not all of
your users will understand these reports, but they will be able to take expert
advice, if they so wish.
The same would apply to pension actuaries’ reports on pension schemes.
2 Relevance
Information has the quality of relevance when it helps users evaluate past,
present or future events, or confirms (or corrects), their past evaluations.
The same information plays a confirmatory role in respect of past predictions
about the way in which the undertaking would be structured, or the outcome of
planned operations.
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IFRS Framework for the Preparation and Presentation of Financial Statements
EXAMPLE -relevance
Reporting on segments of business activities may help users if the your firm
has diverse activities. .
The relevance of information is affected by its nature and materiality. In some
cases, the nature of information alone is sufficient to determine its relevance.
3 Important - Material
Information is material if its omission, or misstatement, could influence the
decisions of users. Materiality depends on the size of the item (or error) judged
in the circumstances of its omission (or misstatement).
EXAMPLE-materiality
Your business has previously been limited to your country. You have
expanded into another country, in another continent, with a view to further
foreign expansion. Though this may not be material to your business today,
reporting of your results and commitments in this new market will help users
understand your business.
In other cases, both the nature and materiality are important, for example, the
amounts of inventories held in each of the main categories of the business.
EXAMPLE-materiality
A competitor has filed a lawsuit against you for a large amount of money. Your
lawyers are concerned, but you believe the lawsuit to be frivolous. You should
disclose this information as a contingent liability, with expression of your views,
and those of the lawyers.
Materiality provides a threshold (or cut-off point) rather than being a primary
qualitative characteristic, which information must have, if it is to be useful.
4 Reliability
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Information has reliability when it is free from material error, and bias, and can
be depended upon to represent that which it either purports to represent, or
could reasonably be expected to represent.
EXAMPLE - reliabilty
If the validity, and amount of a claim, for damages under a legal action are
disputed, it may be inappropriate to record the full amount of the claim in the
balance sheet (although it may be appropriate to disclose the amount in the
notes, and circumstances of the claim).
If information is to represent faithfully the transactions, it is necessary that they
are presented in accordance with their substance, and economic reality, and
not merely their legal form.
EXAMPLE-substance over form
An undertaking may dispose of an asset to another party so that the
documentation purports to pass legal ownership to that party. Nevertheless,
agreements may exist that ensure that the undertaking continues to enjoy the
benefits from the asset. This may be done to raise finance, using the asset as
collateral.
In such circumstances, the reporting of a sale would not represent faithfully the
transaction.
Neutrality
The information contained in financial statements must be free from bias.
Financial statements are not neutral if, by the presentation of information, they
influence the making of a decision to achieve a predetermined result, or
outcome.
EXAMPLE-neutrality
Accounts should not reflect an over-optimistic nor an over-pessimistic view.
Provisions should reflect the current view of events and not be increased just
because “surplus” profits are available. Accounts should not be distorted to
achieve management targets, if these targets had not actually been met.
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IFRS Framework for the Preparation and Presentation of Financial Statements
To be reliable, the information in financial statements must be complete taking
account of materiality, and cost. An omission can cause information to be
false, or misleading, and thus unreliable and deficient in terms of its relevance.
EXAMPLE-completeness
Major commitments and contingent liabilities can easily omitted from financial
statements. Their omission may mislead users.
5 Comparability
Users must be able to compare the financial statements of an undertaking
through time, to identify trends in its financial position, and performance.
Users must also be able to compare the financial statements of different
undertakings in order to evaluate their relative financial position, performance
and changes in financial position.
The measurement, and display, of the financial impact of similar transactions
must be carried out in a consistent way by an undertaking, and over time, and
in a consistent way for different undertakings.
An important implication of comparability is that users be informed of the
policies employed in the financial statements, any changes in those policies,
and the impacts of such changes.
EXAMPLE-consistent policies
Using different measurement systems of inventory (FIFO and weighted-
average cost are permitted by IFRS) generates different results. Consistent
use of one method is essential to allow users to compare one period with
another. There should be no change of method, unless a Standard decrees it,
or it would help users.
If other undertakings, in the same industry, use particular accounting policies,
users will benefit if yours are consistent with theirs, to enable comparison.
Users need to be able to identify differences between the policies for like
transactions, used by the same undertaking from period to period, and by
different undertakings. Compliance with Standards, including the disclosure of
policies, helps to achieve comparability.
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 IFRS Framework for the Preparation and Presentation of Financial Statements

As users wish to compare the financial position, performance and changes in

3. What are Financial Statements
financial position over time, it is important that the financial statements show
corresponding information for the preceding periods. There are three financial statements:

Constraints on Provision of Information 1. measurement of financial position;

2. the measurement of performance;
Certain limits have to be places on the quality of information. The include 3. the measurements of the changes in financial position.
Timeliness
Management may need to balance the relative merits of timely reporting, and
the provision of reliable information. To provide information on a timely basis, it 1 Financial Position - Balance Sheet
may often be necessary to report before all aspects of a transaction are
known, thus impairing reliability. The elements directly related to the measurement of financial position are
assets, liabilities and equity. These are defined as follows:
Conversely, if reporting is delayed until all aspects are known, the information (i) An asset is a resource, controlled by the undertaking, as a result of
may be reliable, but of little use to those who have had to make decisions in past events, and from which benefits will flow to the undertaking.
the interim. In achieving a balance between relevance and reliability, the
overriding consideration is how best to satisfy the needs of users. (ii) A liability is a present obligation, arising from past events, the
settlement of which will be payment.
Balance Between Benefit and Cost (iii) Equity is the residual interest in the assets, after deducting all
liabilities.
The benefits derived from information should not exceed the cost of providing
it. The evaluation of benefits and costs is a judgmental process. The costs do
EXAMPLE-equity – residual interest
not necessarily fall on those users who enjoy the benefits.
You have $100 million of assets and $85 million of liabilities.
Your equity = $15 million.
True and Fair View/Fair Presentation
Assets
Financial statements are frequently described as showing a ‘true and fair view’
The benefit embodied in an asset is its contribution (directly, or indirectly) to
of the financial position, performance, and changes in financial position of an
the flow of cash to the undertaking.
undertaking.
The benefit may to produce goods. It may also take the form of convertibility
The application of the principal qualitative characteristics, and of appropriate
into cash (or a capability to reduce the costs of production).
standards, normally results in financial statements that convey a ‘true and fair
view’ of such information.
Assets produce goods (or services) capable of satisfying the wants (or needs)
of clients; clients are prepared to pay for them, and contribute to the cash flow
of the undertaking.

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Many assets, for example, property, plant and equipment, have a physical
form. Physical form is not essential to the existence of an asset; hence
patents and copyrights are assets, if benefits will flow from them, and if they
are controlled by the undertaking
In determining the existence of an asset, the right of ownership is not
essential.
EXAMPLE – property held on a lease
Property held on a lease is an asset, if the undertaking controls the benefits
that will flow from the property.
An item may satisfy the definition of an asset, even when there is no legal
control.
EXAMPLE-asset with no legal control.
Know-how obtained from a development activity may meet the definition of an
asset when, by keeping that know-how secret, an undertaking controls the
benefits that will flow from it.
The assets of an undertaking result from past transactions. Undertakings
normally obtain assets by purchasing or producing them, but other
transactions may generate assets; property received by an undertaking from
government, as part of a program to encourage growth in an area, and the
discovery of mineral deposits.
EXAMPLE-government grant
To generate employment in a depressed area, government may provide a
range of grants. One option is to provide disused property to investors, either
free, or at a low price.
Transactions expected to occur in the future do not in themselves give rise to
assets; an intention to purchase inventory does not, of itself, meet the
definition of an asset.
EXAMPLE-inventory on order
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IFRS Framework for the Preparation and Presentation of Financial Statements
You have placed an order for inventory, which has yet to be delivered. This is
not (yet) an asset, as you do not (yet) control it.
There is a close association between incurring expenditure and generating
assets, but the two do not necessarily coincide. Hence, when an undertaking
incurs expenditure, this may provide evidence that benefits were sought, but is
not conclusive proof that an item satisfying the definition of an asset has been
obtained.
Similarly the absence of a related expenditure does not preclude an item from
satisfying the definition of an asset, and thus becoming a candidate for
recognition in the balance sheet; items that have been donated to the
undertaking may satisfy the definition of an asset.
EXAMPLE- absence of a related expenditure
To generate employment in a depressed area, government may provide a
disused property to investors without payment. This donation provides the
undertaking with an asset, even if related payments (to develop a business on
the site) have yet to be made.
Liabilities
An essential characteristic of a liability is that the undertaking has a present
obligation (to pay money). Obligations may be enforceable as a consequence
of a binding contract, or statutory requirement. This is normally the case with
amounts payable for goods (and services) received.
Obligations also arise from normal business practice, custom and a desire to
maintain good business relations, or act in an equitable manner.
EXAMPLE – Voluntary obligation
If an undertaking decides (as a matter of policy) to rectify faults in its products,
even after the warranty period has expired, the amounts expended, in respect
of goods already sold, are liabilities.
A distinction needs to be drawn between a present obligation and a future
commitment. A decision to acquire assets in the future does not, of itself, give
rise to a present obligation.
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An obligation normally arises only when the asset is delivered, or the
undertaking enters into an irrevocable agreement to acquire the asset. The
irrevocable nature of an agreement means that the undertaking must pay.
The settlement of a present obligation usually involves paying the other party.
Settlement of a present obligation may occur in a number of ways, for
example, by:
(i) payment of cash;
(ii) transfer of other assets (including barter);
(iii) provision of services;
(iv) replacement of that obligation with another obligation; or
(v) conversion of the obligation to equity.
An obligation may also be extinguished by other means, such as a creditor
waiving, or forfeiting its rights.
Liabilities result from past transactions.
EXAMPLES - liabilities
The acquisition of goods (and the use of services) gives rise to trade payables
(unless paid for in advance, or on delivery) and the receipt of a bank loan
results in an obligation to repay the loan.
An undertaking may also record future rebates, based on annual purchases
by clients, as liabilities; the sale of the goods in the past gives rise to the
liability.
Some liabilities can be measured only by using estimation. Some undertakings
describe these liabilities as provisions. In some countries, such provisions are
not regarded as liabilities, as the concept of a liability is defined narrowly so as
to exclude estimates. IFRS definition of a liability follows a broader approach.
When a provision involves a present obligation, and satisfies the rest of the
definition, it is a liability, even if the amount has to be estimated.
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IFRS Framework for the Preparation and Presentation of Financial Statements
EXAMPLE- estimated provision
You have been sued. You have lost the case. Your total costs are not finalised
When the accounts are approved. You have estimated your provision for the
costs of the liability.
Examples include provisions for payments to be made under existing
warranties, and provisions to cover pension obligations.
Equity
Although equity is defined as a residual, it may be sub-classified in the balance
sheet. In a corporate undertaking,
- funds contributed by shareholders,
- retained earnings,
- reserves representing appropriations of retained earnings, and
- reserves representing capital maintenance adjustments
may be shown separately.
Such classifications can be relevant to the users of financial statements,
when they indicate legal, or other restrictions, on the ability to distribute its
equity. Parties with ownership interests have differing rights to the receipt of
dividends, or the repayment of capital.
The creation of reserves is sometimes required by statute, to give the
undertaking, and its creditors, more protection from the impacts of losses.
Other reserves may be established, if national tax law grants exemptions from
(or reductions in) taxation liabilities, when transfers to such reserves are made.
The existence and size of these legal and tax reserves is information that is
relevant to users. Transfers to such reserves are appropriations of retained
earnings, rather than expenses.
EXAMPLE- ‘legal’ reserves
Some jurisdictions require firms to donate 10% of annual profit to a reserve
that cannot be distributed to shareholders (except in liquidation). Such
regulations may be of concern to investors, as this will limit dividends.
9

The amount of equity, shown in the balance sheet, depends on the
measurement of assets and liabilities. Normally, the aggregate amount of
equity only by coincidence corresponds with the aggregate market value of the
shares of the undertaking, or the sum that could be raised by disposing of the
net assets on a piecemeal basis, or the undertaking as a whole on a going
concern basis.
EXAMPLE- market valuations
The market valuation of your firm is much higher than the value of net assets.
This is due to investors valuing your firm for its anticipated future dividends,
rather than its passed performance.
Commercial, industrial and business activities are often undertaken by means
of sole proprietorships, partnerships, trusts and various types of government
business undertakings. The legal and regulatory framework for such
undertakings is often different from that applying to corporate undertakings.
There may be few restrictions on the distribution to owners (or other
beneficiaries) of amounts included in equity. Nevertheless, the definition of
equity, and the other aspects of this framework that deal with equity, are
appropriate for such undertakings.
Performance – Income Statement
Profit is used as a measure of performance, or as the basis for other measures
(such as return on investment, or earnings per share). The elements directly
related to profit are income and expenses. The recording and measurement of
income and expenses (and hence profit) depends on the concepts of capital
and capital maintenance used (see below).
The elements of income and expenses are defined as follows:
(i) Income creates increases in benefits, 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.
(ii) Expenses are decreases in benefits, in the form of outflows (or
depletions) of assets, (or increases in liabilities) that result in
decreases in equity, other than distributions to equity participants.
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IFRS Framework for the Preparation and Presentation of Financial Statements
Income and expenses may be presented in the income statement in different
ways, to provide information for decision-making. It is common practice to
distinguish between those items of income (and expenses) that arise in the
course of the ordinary activities, and those that do not.
This distinction is made for evaluating the ability to generate cash in the future.
Incidental activities, such as the disposal of a long-term investment, do not
recur on a regular basis.
Consideration needs to be given to the nature of the undertaking, and its
operations. Items that arise from the ordinary activities of one undertaking,
may be unusual in another.
EXAMPLE – ordinary activities
For many firms, buying and selling property is a rare event.
To house builders and property developers, it is an ordinary activity.
Distinguishing between items of income and expense, and combining them in
different ways, also allows several measures of undertaking performance to be
displayed.
For example, the income statement could display:
- gross margin,
- profit from ordinary activities before taxation,
- profit from ordinary activities after taxation, and
- net profit.
Income
Income encompasses both revenue and gains. Revenue arises from the
ordinary activities of an undertaking, and includes:
- sales,
- fees,
- interest,
- dividends,
- royalties and
- rent.
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 IFRS Framework for the Preparation and Presentation of Financial Statements

Gains represent other items of income, and may (or may not) arise in the
course of the ordinary activities of an undertaking. Gains represent increases
in benefits, and are no different in nature from revenue.

Gains include those arising on the disposal of non-current assets. The

definition of income also includes unrealised gains: those arising on
revaluations of marketable securities, and from increases in the carrying
amount of long term assets.

EXAMPLE-unrealised gain
You have revalued your head office (but have not sold it). The revaluation gain
is unrealised, and will remain so, until you sell it.

When gains are recorded in the income statements, they are displayed
separately, because knowledge of them is useful for decisions. Gains are often
reported net of related expenses.

EXAMPLE- gains on foreign currencies

You are an importer. You make currency gains (and losses) as a result of
foreign trading transactions. These are shown as a separate line in your
income statement. These are shown net of bank (currency) transaction
charges.

Various kinds of assets may be received (or enhanced) by income: cash,

receivables, and goods (and services) received in exchange for goods (and
services) supplied.

Income may also result from the settlement of liabilities. An undertaking may
provide goods (and services) to a lender, in settlement of an outstanding loan.

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4. Expenses
The definition of expenses encompasses losses, as well as those expenses
that arise in ordinary activities of the undertaking.
Expenses that arise in the course of the ordinary activities include cost of
sales, wages and depreciation. They usually take the form of an outflow (or
depletion) of assets, such as cash and cash equivalents, inventory, property,
plant and equipment.
Losses represent other items that meet the definition of expenses, and may (or
may not) arise in the course of ordinary activities. Losses represent decreases
in benefits, and they are no different in nature from other expenses.
Losses include those resulting from disasters such as fire and flood, as well as
those arising on the disposal of non-current assets.
The definition of expenses also includes unrealised losses, for example, those
arising from increases in the rate of exchange for a foreign currency, in respect
of the borrowings of an undertaking in that currency.
EXAMPLE- losses on foreign currencies
You are an importer. You make currency losses (and gains) as a result of
foreign trading transactions. These are shown as a separate line in your
income statement. These are shown net of bank (currency) transaction
charges.
When losses are recorded in the income statement, they are usually displayed
separately, as knowledge of them is useful for decisions. Losses are often
reported net of related income.
EXAMPLE - revaluation reserve
You have revalued your head office (but have not sold it). The revaluation gain
is shown in the revaluation reserve.
Recognition of the Elements of Financial Statements
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IFRS Framework for the Preparation and Presentation of Financial Statements
Recognition is the process of recording (in the balance sheet or income
statement) an item that meets the definition of an element, and satisfies the
criteria for recognition.
It involves the depiction of the item in words, and by a monetary amount, and
the inclusion of that amount in the balance sheet (or income statement) totals.
Items that satisfy the recognition criteria should be recorded in the balance
sheet, or income statement.
The failure to record such items is not rectified by disclosure of the policies
used, nor by notes or explanatory material.
EXAMPLE- warranties unbooked
You know that you will have to pay warranty claims for goods that you have
sold. You have not included a warranty provision in your accounts. It is not
sufficient to mention in the notes that this has not been done. The warranty
provision should be made in the accounts themselves.
An item that meets the definition of an element should be recorded if:
(i) it is probable that any benefit of the item will flow to (or from) the
undertaking; and
(ii) the item has a cost, or value, that can be measured with reliability.
In assessing whether an item meets these criteria, regard needs to be given to
the materiality considerations above.
The Probability of Future Benefit
The concept of probability refers to the degree of uncertainty that the benefits
associated with the item will flow to (or from) the undertaking. Assessments of
the uncertainty of the flow of benefits are made on the evidence available,
when the financial statements are prepared.
When it is probable that a receivable will be paid, it is justifiable to record the
receivable as an asset. For a large population of receivables, some degree of
non-payment is normally considered probable; hence an expense representing
the expected reduction in benefits is recorded.
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EXAMPLE- probability of future benefit
You know that some of your inventory is obsolete. Any benefit will be limited to
its scrap value. You make an obsolescence provision to reduce this inventory’s
carrying value.
Reliability of Measurement
The second criterion (for the recognition of an item) is that it has a cost (or
value) that can be measured with reliability. Cost (or value) may be estimated,
and does not undermine their reliability.
When an estimate cannot be made, the item is not recorded in the balance
sheet (or income statement). The expected proceeds from a lawsuit may meet
the definitions of both an asset, and income, as well as the probability criterion
for recognition.
If the claim cannot be measured reliably, it should not be recorded as an
asset, or as income; the existence of the claim should be disclosed in the
notes, explanatory material or supplementary schedules. (see IAS 37)
An item that, at first, fails to meet the recognition criteria may qualify for
recognition at a later date, as a result of subsequent events.
EXAMPLE- later recognition
At the start of a lawsuit, the result may be difficult to estimate, and only a
contingent liability can be noted.
As a lawsuit nears conclusion, the result may be estimable, and a provision or
asset may be recorded.
An item that possesses the characteristics of an element, but fails to meet the
criteria for recognition, may nonetheless warrant disclosure in the notes.
This is appropriate when knowledge of the item is relevant to the evaluation of
the financial position, performance and changes in financial position of an
undertaking.
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IFRS Framework for the Preparation and Presentation of Financial Statements
Recognition of Assets
An asset is recorded when it is probable that the benefits will flow to the
undertaking, and the asset has a cost (or value) that can be measured reliably.
An asset is not recorded when costs have been incurred, but it is improbable
that benefits of this expenditure will flow beyond the current accounting period.
Such a transaction results in the recognition of an expense in the income
statement.
EXAMPLE- asset recognition
General administration salaries are expensed when incurred, and not treated
as an asset. There is a presumption that no benefits, related to them, will flow
beyond the current accounting period.
Recognition of Liabilities
A liability is recorded when it is probable that an outflow of resources will result
from the settlement of an obligation, and the amount can be measured reliably.
EXAMPLE-No obligation, no liability
Liabilities for inventory ordered (but not yet received) are not recorded as
liabilities.
Recognition of Income
Income is recorded when an increase in benefits, related to an increase in an
asset (or a decrease of a liability) has arisen that can be measured reliably.
Recognition of income occurs simultaneously with the recognition of increases
in assets (or decreases in liabilities). Examples are: the net increase in assets
arising on a sale of goods (or services), or the decrease in liabilities from the
waiver of a debt payable.
EXAMPLE- debt waiver (see IAS 20)
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Some government grants are given in the form of loans. As the firm meets the
terms of the grant (such as the number of jobs that are to be created), the
government may cancel part of the loan. This cancellation is shown as income,
(and should be matched with the related expenditure).
Procedures restrict the recognition (as income) to items that can be measured
reliably, and have a sufficient degree of certainty.
Recognition of Expenses
Construction contracts involve a number of accounting periods, involving a
spreading of both revenue and costs on a systematic basis.
This is necessary in recording the expenses associated with the using up of
assets such as property, plant, equipment, goodwill, patents and trademarks.
Such expense is referred to as depreciation, or amortisation. These allocations
are intended to record expenses in the periods in which the benefits are
consumed, or expire.

Expenses are recorded when a decrease in benefits (related to a decrease in An expense is recorded immediately in the income statement when an
an asset, or an increase of a liability) has arisen, that can be measured expenditure produces no benefits.
reliably.
An expense is also recorded when a liability is incurred without the recognition
Recognition of expenses occurs with the recognition of an increase in of an asset, as when a liability under a product warranty arises.
liabilities, or a decrease in assets (for example, the accrual of employee
entitlements, or the depreciation of equipment).

Expenses are recorded on the basis of a direct association between the costs
incurred, and the earning of specific items of income. This is called the
matching of costs with revenues. It involves the recognition of revenues and
expenses that result directly, and jointly, from the same transactions.

EXAMPLE-matching
When goods are sold, the cost of those sales, and all costs of delivery and
commission should be booked to provide the full transaction.

Various components of expense, comprising the cost of goods sold, are

recorded at the same time as the income, derived from the sale of the goods.
The application of the matching concept does not allow the recognition of
items in the balance sheet, which do not meet the definition of assets, or
liabilities.

When benefits arise over several periods, and the link to income can only be
broadly determined, expenses are recorded in the income statement, on the
basis of systematic (and rational) allocation procedures.

EXAMPLE-construction contracts (see IAS 11)

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 IFRS Framework for the Preparation and Presentation of Financial Statements

net cash outflows, which will be required to settle the liabilities, in the
5. Accounting Measurement normal course of business.

EXAMPLE-present value
Measurement is the process of determining the amounts at which transactions You have a provision for decommissioning costs for a mine. The work will not
are recorded, and carried in the balance sheet and income statement. This be carried out for 20 years, and the amount is material. You discount the cost
involves the selection of the particular basis of measurement. to present value (see IAS 37).

A number of different measurement bases are employed in financial

The measurement basis most commonly is historical cost. This is usually
statements. They include the following:
combined with other bases. Inventories are usually carried at the lower of cost
(i) Historical cost. Assets are recorded at the amount of cash paid (or and net realisable value, marketable securities may be carried at market value
the fair value of the consideration given). Liabilities are recorded at the and pension liabilities are carried at their present value.
amount received in exchange for the obligation, or for items such as
income taxes, at the amounts to be paid to satisfy the liability, in the Some undertakings use the current cost basis, due to the inability of the
normal course of business. historical cost accounting to deal with the impact of inflation of non-monetary
assets.
(ii) Current cost. Assets are carried at the amount that would have to
be paid if the same (or an equivalent) asset was acquired today.
Liabilities are carried at the undiscounted amount that would be
required to settle the obligation today.

EXAMPLE- current cost

You hold assets and liabilities in foreign currency. At the balance sheet date,
you revalue them to reflect the current exchange rates (‘marking to market’).
(iii) Realisable (settlement) value. Assets are carried at the amount that
could currently be obtained by selling the asset (in the normal course
of business). Liabilities are carried at their settlement values: the
undiscounted amounts to be paid to satisfy the liabilities, in the normal
course of business.
EXAMPLE- realisable value
For certain assets, you chose to use ‘fair values’ in the balance sheet. You find
the market prices, and apply them to the assets.
(iv) Present value. Assets are carried at the present discounted value of
the net cash inflows that the item will generate, in the normal course of
business. Liabilities are carried at the present discounted value of the
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6. Concepts of Capital and Capital
Maintenance
Concepts of Capital
A financial concept of capital is adopted by most undertakings in preparing
their financial statements. Under a financial concept of capital, such as
invested money, or invested purchasing power, capital is synonymous with the
net assets (or equity) of the undertaking.
EXAMPLE- financial concept of capital
Your national inflation =10% per year. If an investment in your company yields
less than 10%, investors’ purchasing power will have fallen.
If you provide a return of more than 10%, investors will deduct their loss of
purchasing power from the return that you have generated.
In summary, only returns above the national rate of inflation will be considered
to be profits.
Under a physical concept of capital, such as operating capability, capital is
regarded as the productive capacity of the undertaking, based on units of
output.
EXAMPLE- physical concept of capital
Your national inflation =10% per year. However, oil is your basic raw material,
and your costs have increased by 25%.
If an investment in your company yields less than 25%, the company’s
operating capability will have fallen.
In summary, only returns above the company’s rate of inflation will be
considered to be profits.
The selection of the appropriate concept of capital by an undertaking should
be based on the needs of users. A financial concept of capital should be
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IFRS Framework for the Preparation and Presentation of Financial Statements
adopted if the users are primarily concerned with the maintenance of nominal
invested capital, or the purchasing power of invested capital.
If the main concern of users is with the operating capability of the undertaking,
a physical concept of capital should be used.
The concept chosen indicates the goal to be attained in determining profit,
even though there may be some measurement difficulties in making the
concept operational.
Concepts of Capital Maintenance and the Determination of
Profit
Financial capital maintenance. Under this concept, a profit is earned if the
financial amount of the net assets at the end of the period exceeds those at
the beginning of the period. (This excludes any distributions to, and
contributions from, owners during the period.) Financial capital maintenance
can be measured in either nominal monetary units, or units of constant
purchasing power.
Physical capital maintenance. Under this concept, a profit is earned only if
the physical productive capacity (or operating capability) of the undertaking at
the end of the period exceeds the capacity at the beginning of the period, (after
excluding any distributions to, and contributions from, owners during the
period).
Only inflows of assets, in excess of amounts needed to maintain capital, may
be regarded as profit, and as a return on capital.
EXAMPLE- working capital in times of inflation
During times of high inflation (either for the individual firm, or for the nation)
extra working capital (inventory and accounts receivable minus accounts
payable) will be needed just to continue operating at the same level. Each
replacement item of inventory will be more expensive, as will each account
receivable, though mitigated by higher accounts payable.
The firm needs more cash to finance operations. At the same time, investors
want higher returns, due to the loss in purchasing power.
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Profit is the residual amount that remains after expenses (including capital
maintenance adjustments) have been deducted from income. If expenses
exceed income, the shortfall is a net loss.
The physical capital maintenance concept requires the adoption of the current
cost basis of measurement.
EXAMPLE- physical capital maintenance concept –inventory
Inventory needs to be valued at current cost, rather than historic cost, to
record the cost of the inventory replacement at its replacement cost.
If inflation is high, there may be a substantial difference between historic and
current cost.
The financial capital maintenance concept does not require the use of a
particular basis of measurement. The basis under this concept is dependent
on the type of financial capital that the undertaking is seeking to maintain.
The principal difference between the two concepts of capital maintenance is
the impacts of changes in the prices of assets, and liabilities, of the
undertaking.
An undertaking has maintained its capital, if it has as much capital at the end
of the period as it had at the beginning of the period. Any amount above that is
profit.
that exceeds inflation is regarded as profit. The rest of the increase is treated
as a capital maintenance adjustment, and as part of equity.
Under the concept of physical capital maintenance, when capital is defined in
terms of capacity, profit represents the increase in that capital over the period.
All price changes affecting the assets (and liabilities) are viewed as changes in
the measurement of the physical productive capacity of the undertaking: they
are treated as capital maintenance adjustments, that are part of equity, and not
as profit.
The selection of the measurement bases, and concept of capital maintenance,
will determine the accounting model used in the preparation of the financial
statements.
Different accounting models exhibit different degrees of relevance and
reliability, and management must seek a balance between relevance and
reliability.
This framework is applicable to a range of accounting models and provides
guidance on preparing and presenting the financial statements constructed
under the chosen model.

Under the concept of financial capital maintenance, where capital is defined in

terms of nominal monetary units, profit represents the increase in nominal
money capital over the period. Increases in the prices of assets held over the
period, (‘holding gains’), are conceptually, profits. They may not be recorded
as such, until the assets are disposed of.

EXAMPLE-holding gain
You hold a property. That property has appreciated, at the balance sheet date.
You choose not to revalue the property. At the balance sheet date, you have
an (unrealised) ‘holding gain’.

When the concept of financial capital maintenance is defined in terms of

constant purchasing power units, profit represents the increase in invested
purchasing power over the period. Only the increase in the prices of assets

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 IFRS Framework for the Preparation and Presentation of Financial Statements

This publication has been produced with the assistance of the European Union. The contents of this publication are the sole responsibility of ZAO
“PricewaterhouseCoopers”, ACCA, FBK and Agriconsulting and can in no way be taken to reflect the views of the European Union.

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