- STRUCTURE OF THE IASC FOUNDATION
In 1999, in a move that reflected the growing importance of international accounting standards, the board of the International Accounting Standards Board (IASB) recommended and later adopted a new constitution and structure.
As a result, the International Accounting Standards Committee Foundation was established in the USA in 2001. An independent not-for-profit organisation, it is governed by 22 IASC Foundation Trustees, who are required to have a comprehensive understanding of international issues relevant to accounting standards for use in the world’s capital markets. The main objectives of the IASC are:
- To develop a single set of understandable and enforceable global accounting standards which of are high quality
- To require high quality, transparent and comparable information in financial statements to help users in making economic decisions.
- To promote the use and application of these standards.
- To bring about convergence of national accounting standards and international accounting standards.
The IASC Foundation has a number of subsidiary bodies:
- The International Accounting Standards Board (IASB)
- The International Financial Reporting Interpretations Committee (IFRIC)
- The Standards Advisory Council (SAC)The IASB The IASB is made up of 14 members and has the same objectives as the IASC Foundation. It has sole responsibility for issuing International Financial Reporting Standards (IFRS’s), following rigorous and open due process. The IASB cannot enforce compliance with its standards and therefore it relies upon the co-operation of national standard setters.
All the most important national standard setters are represented on the IASB and their views are taken into account so that a consensus is reached. These national standard setters can also issue discussion papers and exposure drafts for comment in their own countries so that the views of all preparers and users of financial statements can be represented.
With all the major national standard setters now committed to the international convergence project, the IASB aims to develop a single set of understandable and enforceable, high quality worldwide accounting standards.
THE Standards Advisory Council provides a forum for experts from different countries and different business sectors with an interest in international financial reporting to offer advice when drawing up new standards. Its main objective is to give advice to the Trustees and the IASB on agenda decisions and work priorities and on the major standard-setting projects.
This committee has taken over the work of the previous Standing Interpretations Committee. In reality, it is a compliance body whose role is to provide rapid guidance on the application and interpretation of international accounting standards where contentious or divergent interpretations have arisen.
It operates an open due process in accordance with its approved procedures. Its pronouncements (known as SICs and IFRICs) are important because financial statements cannot be described as being in compliance with IFRSs unless they also comply with the interpretations.
The IASB has enhanced its reputation and credibility even further by developing its relationship with the International Organisation of Securities Commissions (IOSCO). This is a very influential organisation of the world’s stock exchanges.
In 1995, the then International Accounting Standards Committee agreed to develop a core set of standards which, when endorsed by IOSCO, would be used as an acceptable basis for cross-border listings. This was achieved in 2000, arguably making the international accounting standards the first steps towards global accounting harmonisation. Furthermore, since 2005, as part of its harmonisation process, the European Union requires all listed companies in all member states to prepare their consolidated financial statements using IFRSs.
National standard setters (such as the UK’s Accounting Standards Board and The USA’s Financial Accounting Standards Board) have a role to play in the formulation of international accounting standards. Seven of the leading national standard setters work closely with the IASB, which the IASB sees as a “partnership” between the IASB and the national standard setters, as they work towards the convergence of accounting standards worldwide. Often the IASB will ask members of national standard setting bodies to work on particular projects in which those countries have greater experience or expertise. Many countries that are committed to closer integration with IFRSs will publish domestic standards equivalent (if not identical) to IFRSs on a concurrent timescale.
DEVELOPMENT OF AN IFRS
As mentioned above, the IASB is responsible for the development and publication of international accounting standards. The standard requires the votes of at least eight of the fourteen IASB members. The procedure is as follows:
- The IASB (advised by the SAC) identifies a subject and appoints an advisory committee to advise on the issues relevant to the subject area. If the subject matter is complex and of high importance, the IASB may publish Discussion Documents for public comment.
- Following the receipt and review of comments, the IASB then develops and publishes an Exposure Draft for public comment. The Exposure Draft is a draft version of the intended subject. The normal comment period for both the Discussion document and the Exposure Draft is ninety days.
- After the review of any comments received, an International Financial Reporting Standard (IFRS) is issued. The IASB also publishes a Basis for Conclusions, which explains how it arrived at its conclusions and helps users to apply the standard in practice. Sometimes, the IASB will conduct public hearings at which the proposed standards are openly discussed and occasionally, field tests are conducted to ensure that proposals are practical and workable around the world.
It is important to note that the IASC Foundation, the IASB and the accountancy profession itself does not have the power to enforce compliance with the IFRSs. However, some countries do adopt the IFRSs as their local standards, with others ensuring that there is no significant difference between their standards and IFRs. Over the last decade or so, the profile and status of the IASB has increased with the result being a commensurate increase in the persuasive force of the IFRSs globally.
The purpose of a regulatory framework is to regulate both the format and content of financial statements. Accounting disclosure is regulated through a combination of:
- National company law and EU directives
- Stock exchange rules
Accounting standards by themselves would not be a sufficient regulatory framework. Legal and market regulations are also required to ensure the full regulation of both the preparation and publication of financial statements.
A regulatory framework is desirable for the following reasons:
- Financial statements are based on principles and rules that can vary significantly from country to country are prepared for users. There is also a wide range of users of these financial statements (for example, investors, lenders, customers, government). Preparation of accounts based on different principles makes it difficult, if not impossible, for investors to analyse and interpret the information. A regulatory framework would ensure consistency in financial reporting.
- The information needs to be comparable, as without this quality the credibility of the financial reports would be undermined. This could have a negative impact on investment. A regulatory framework would increase the users understanding of and confidence in the financial statements.
- Increasingly, globalisation has resulted in trans-national financing, foreign direct investment and securities trading. Thus, a single set of rules for the measurement and recognition of assets, liabilities, income and expenses is required.
- A regulatory framework would also regulate the behaviour of companies towards their investors, protecting the users of the financial statements. It would help ensure that the financial statements give a true and fair view of the company’s financial performance and position.
- THE CONCEPTUAL FRAMEWORK
A conceptual framework can be defined as a coherent system of interrelated objectives and fundamental principles. It is framework which prescribes the nature, function and limits of financial accounting and financial statements. It can be thought of as an outline of the generally accepted principles which form the theoretical foundation for financial reporting. The IASB follows the principles-based approach to financial reporting (as opposed, say, to the rules-based approach favoured by the FASB in the USA).
The establishment of these principles provide the basis for both the development of new accounting standards and an appraisal of the standards already in issue.
There are a number of arguments in favour of having a conceptual framework:
- It allows both accounting standards and generally accepted accounting practice (GAAP) to be developed in line with agreed principles. It would be extremely difficult to attempt to address all technical issues that would satisfy the needs of every user.
- It helps avoid a situation where accounting standards are developed in an ad hoc and piecemeal fashion, as a kneejerk response to specific problems and/or abuses. This sort of “fire-fighting” can lead to inconsistencies between different accounting standards.
- The conceptual framework enables critical issues to be addressed. For example, until relatively recently, no accounting standard contained a definition of basic terms such as “asset” or “liability”.
- With certain types of transactions becoming more and more complex over the years, a conceptual framework aids accountants and auditors to deal with transactions not covered per se by an accounting standard. It can give guidance of the general principles on how transactions should be recorded and presented in the financial statements.
- Where a conceptual framework exists, an issue not yet covered by an accounting standard can be dealt with temporarily by providing an interim approach until a specific standard is issued.
- It is believed that standards that are based on principles are more difficult to circumvent than a rules-based approach (the “cookbook” approach).
- It makes it less likely that the standard setting process can be influenced or even hijacked by vested interests, for example large corporations or business sectors. This enhances the credibility of the IFRSs and the accounting profession.
- THE FRAMEWORK FOR THE PREPARATION AND PRESENTATION OF FINANCIAL INFORMATION
The “Framework for the Preparation and presentation of Financial Information” (or simply, “The Framework”) is a conceptual accounting framework that sets out the concepts and principles that underpin the preparation and presentation of financial statements for external users. It applies to the financial statements of both private and public entities.
The purpose of the framework is to:
- Assist the IASB in its role of developing future accounting standards and reviewing existing IFRSs/IASs.
- Assist the IASB by providing a basis for reducing the number of alternative accounting treatments permitted by the IFRSs
- Assist national standard setting bodies in developing national standards.
- Assist those preparing financial statements to apply IFRSs and also to deal with areas where there is no relevant standard
- Assist auditors when they are forming an opinion as to whether financial statements conform with IFRSs
- Assist users of financial statements when they are trying to interpret the information in financial statements which have been prepared in accordance with IFRSs
- Provide information to other parties that are interested in the work of the IASB
The Framework identifies the users of financial statements, and their main information needs, to be:
- Investors: concerned about the risk and return of their investments.
- Employees: concerned about risks to their continuing employment and remuneration
- Lenders: concerned about the entities ability to service and repay loans and interest
- Suppliers and other trade creditors: concerned about whether they will be paid in full and on time
- Customers: concerned about the ability of the entity to continue in business
- Governments and their agencies: concerned about taxation national statistics etc.
- The public: concerned about local economy, environmental issues, employment opportunities etc.
The Framework has seven chapters:
- The objective of financial statements
- Underlying assumptions
- The qualitative characteristics of financial statements
- 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
The salient points of each chapter will be outlined here.
Objective of financial statements
According to the Framework, the objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions.
The Framework points out that financial statements prepared for this purpose should meet the common needs of most users, whilst also showing the results of the stewardship and accountability of management. It is important to remember that the information is based on historical information. However, if the information is reliable, its predictive value (i.e. its use in assessing future performance) is greatly enhanced. Users can then use this information in making their economic decisions.
The Framework makes reference to two specific underlying assumptions:
- Accruals basis of accounting
Transactions are recognised when they occur and are recorded and reported in the accounting periods to which they relate, regardless of the timing of the cash flows arising from these transactions.
- Going concern
Financial statements are prepared (normally) on the assumption that an enterprise is a going concern and will continue in operation for the foreseeable future. If it is management’s intention to liquidate (or significantly reduce the scale of its operations) the accounts would have to be prepared on a different basis (e.g. the “break-up basis) and this would have to be disclosed.
The qualitative characteristics of financial information
The Framework identifies four qualitative characteristics (all are subject to a threshold quality of materiality):
Information provided by financial statements needs to be relevant. Information that is relevant has predictive and confirmatory value. Information is considered relevant if : • It has the ability to influence the economic decisions of users: and
- It is provided in time to influence those decisions
Information that is reliable can be depended upon to present a faithful representation and is neutral, error free, complete and prudent. It also depends on the concept of substance over form, because by applying this concept, users will see the economic reality of transactions.
- Comparability Users must be able to:
- Compare the financial statements of an entity over time to identify trends in its financial position and performance
- Compare the financial statements of different entities to evaluate their relative financial performance and financial position
In order to achieve this, there must be both consistency and adequate disclosure. Users must be informed of the accounting policies employed in the preparation of the financial statements as well as any changes in those policies in the period and the effects of such changes. Furthermore, to compare the performance of the entity over time, it is important that the financial statements show comparative information for the preceding period(s).
It is assumed that users have a reasonable knowledge of business and economic activities and are willing to study the information provided with reasonable diligence.
For information to be understandable, users needs to be able to perceive its significance. Information that is relevant and reliable should not be excluded from the financial statements simply because it is difficult for some users to understand.
The elements of financial statements
The Framework provides definitions of the elements of financial statements. When applied with the recognition criteria, the definitions provide guidance on how and when the financial effect of transactions or events should be recognised in the financial statements.
Assets are resources controlled by the entity as a result of past events, from which future economic benefits are expected to flow to the entity.
Liabilities are an entity’s obligations to transfer economic benefits, as a result of past transactions and/or events.
- Equity Interest
Equity interest is the residual amount found be deducting all liabilities of the entity from all of the entity’s assets.
Income is an increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decrease in liabilities that result in increases in equity (other than those relating to contributions from equity participants).
This definition follows a statement of financial position approach rather than the more traditional income statement approach to recognising income>
Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurring of liabilities that result in decreases in equity (other than those relating to contributions from equity participants).
Recognition of the elements of financial statements
Recognition is the depiction of an element in words and by monetary amount in the financial statements.
In order to be recognised in the financial statements, an item must meet the definition of an element (see above). In addition, the Framework has two other criteria which must be met before it can be recognised:
- It is probable that any future economic benefit associated with the item will flow to or from the enterprise; and
- The item has a cost or value that can be measured with reliability.
Measurement of the elements of financial statements
Once an item meets the above criteria and is to be recognised in the financial statements, it is necessary to decide on what basis it is to be measured. The item must, of course, have a monetary value attached to it. The Framework outlines four measurement bases that are frequently used in reporting; historic cost, current cost, realisable value, and present value. It mentions that historic cost is the most commonly adopted , although often within a combination of bases, for example valuing inventories at the lower of cost and realisable value or impairing a receivable to the present value of the amount considered collectible.
- Historic cost
Assets are recorded at cash paid at the date of acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation (e.g. loan notes) or the amount of cash expected to be paid to satisfy the liability (e.g. taxation).
- Current cost
Assets are recorded at cash that would have to be paid to acquire the same or equivalent asset. Liabilities are carried at the undiscounted amount of cash required to settle the obligation.
- Realiable value
Assets are recorded at cash that would be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement values (i.e. the undiscounted amounts of cash expected to be paid to satisfy the liabilities in the normal course of business.
- Present Value
Assets are recorded at the present discounted value of future net cash flows that the item is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of the future net cash outflows that are expected to be required to settle the liabilities in the normal course of business.
Concepts of capital maintenance
The Framework refers to two concepts of capital; the financial concept of capital and the physical concept of capital. The great majority of enterprises adopt the financial concept of capital, which deals with the net assets of the entity. The physical concept of capital may be more applicable where the users of the financial information are more concerned with the operating capability of the enterprise.
The needs of the user should determine the most appropriate basis to adopt.
- Financial concept
- profit is earned if the financial amount of the net assets at the end of the period is greater than that at the beginning of the period (excluding any distributions to and contributions from the owners). Financial capital maintenance is measured in either nominal monetary units or units of constant purchasing power.
- Physical concept
- profit is earned if the physical productive capacity (operating capacity) of the enterprise (or the resources needed to achieve that capacity) at the end of the period is greater than at the beginning of the period (excluding any distributions to and contributions from the owners).
- COMMONLY USED CONCEPTS IN FINANCIAL REPORTING
Though the Framework mentions two accounting policies that underpin the financial statements of the company, other concepts can be employed too, to varying degrees:
Prudence Cautious presentation of the entity’s financial position. Profits are recognised only when realised while losses are provided for as soon as they are foreseen Consistency There is similar accounting treatment of like items within each accounting period and from one period to the next Entity That the accounts recognise the business as a distinct separate entity from its owners Money Measurement Accounts only deal with those items to which a monetary value can be attributed Materiality If omission, misstatement or non disclosure affects the view given, item is material and disclosure is required Substance over Legal Form Recognises economic substance from legal form e.g. assets acquired on hire purchase Stable Monetary Unit That the value of the monetary unit used is consistent over time Accounting Periods Accounts are prepared for discrete time periods
THE REGULATORY FRAMEWORK