Foundations in Accountancy/ ACCA FINANCIAL ACCOUNTING (FFA/FA) BPP Learning Media is an ACCA Approved Content Provider for the Foundations in Accountancy qualification. This means we work closely with ACCA to ensure this Interactive Text contains the information you need to pass your exam, In this Interactive Text, which has been reviewed by the ACCA examining team, we: © Highlight the most important elements in the syllabus and the key skills you need © Signpost how each chapter links to the syllabus and the study guide + Provide lots of exam focus points demonstrating what the examining tear will want you to do © Emphasise key points in regular fast forward summaries © Test your knowledge in quick quizzes Examine your understanding in our practice question bank + Reference all the important topics in cur fll index BPP's Practice & Revision Kit also supports the Financial Accounting syllabus. FOR EXAMS FROM 1 SEPTEMBER 2020 TO 31 AUGUST 2021 mae—-aAoOrFrwmamMmMaAaz— axma BPP LEARNING MEDIAFirst edition March 2011 Ninth eeion February 2020 ISBN 9781 5097 2946 3 (Previous 'SBN) 9781 5097 2417 8 eISBN 9781 5097 2986 9 British Library Cataloguing in-Publication Data ‘catalogue record for this book 's available from the Bish Library Published by ‘BPP Learning Media Lts [BPP House, Adie Place London W12 BAA, ‘ro-bpp.conveamingmedia Pited in China Media Lt, are printed on pape obtain frm trapeable sustainable sources, Al our rights reserved. No part of this publication may be reproduced, stored ina retrieval system or ‘transmitted, in ny fom or by any means, electronic, ‘mechanical, photocopying, recording or otherwise, without the prior writen permission of BPP Leeming Media, Contains public sector information licensed under the Open Goverment licence v3.0. 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Contact the IFRS Foundation for further details ‘The IFRS Foundation logo, the IASB logo, the IFRS for SMES logo, the "Hexagon Dovieo, “IFRS Foundation", “elFRS", “IAS, “IASB, "IFRS for SMES", “IAS, IFRS", “IFRSS", Intemational Accounting Standards” and “International Financial Reporting Standards’, "IFRIC", "SIC" and "IFRS Taxonomy” are Trade Marks ofthe IFRS Foundation. Further details ofthe Trade Maris including details of countries where the Trade Marks are registred of applied for ‘are available fom the Licensor on request. GESIFRS BPP LEARNING MEDIACONTENTS Contents Introduction Helping you to pass Chapter features. Studying FFAVFA... ‘The computer-based examination. Tackling multiple choice questions. Part A The context and purpose offancialreprting 1. Introduction to accounting 3 2 The regulatory framework : 19 Part B_ The qualitative characteristics of financial information 3. The qualitative characteristics of financial information, sevssnnnnee BY Part © The use of double entry and accounting systems 4 Sources, records and books of prime entry. 45 5 Ledger accounts and double entry. 59, 6 From tial balance to financial statements.. 89 Part D Recording transactions and events: 7 Inventory : 8 Tangible non-current asses. 9 Intangible non-current assets. 10 Accruals and prepayments 11 Provisions and contingencies... 12 Iecoverable debts and allowances... 13° Sales tax... Part E Preparing atrial balance 14 Contl accounts. 15 Bank reconciations... 16. Corecton of errors Part F Preparing basic financial statements 17 Incomplete records 18 Preparation of financial statements for sole traders 19 Introduction to company accounting... 20. Preparation of financial statements for companies... 21 Events after the reporting period... 22. Statements of cash flows... Part G Preparing simple consolidated financial statements 23 Introduction to consolidated financial statements. 403 24 The consolidated statement of financial position... a7 25 The consolidated statement of profit or loss. 443, Part H__ Interpretation of financial statements: 26 Interpretation of financial statements... . : 457 Practice question bank 485 Practice answer bank sil Bibliography... . cco eee ocd) index. 527 Review form BPP LEARNING MEDIABPP LEARNING MEDIAINTRODUCTION Helping you to pass BPP Learning Media - ACCA Approved Content Provider ‘As an ACCA Approved Content Provider, BPP Learning Media gives you the opportunity to use study materials reviewed by the ACCA examining team. By incorporating the examining team’s comments and ‘suggestions regarding the depth and breadth of syllabus coverage, the BPP Learning Media Interactive ‘Text provides excellent, ACCA-approved support for your studies. ‘These materials are reviewed by the ACCA examining team, The objective of the review is to ensure that ‘the material properly covers the syllabus and study guide outcomes, used by the examining team in setting the exams, in the appropriate breadth and depth. The review does not ensure that every eventuality, combination or application of examinable topics is addressed by the ACCA Approved Content. Nor does the review comprise a detailed technical check of the content as the Approved Content Provider has its own quality assurance processes in place in this respect. BPP Learning Media do everything possible to ensure the material is accurate and up to date when. sending to print. In the event that any errors are found after the print date, they are uploaded to the following website: www.bpp.convleamingmedia/Errata, The PER alert! To become a Certified Accounting Technician or qualify as an ACCA member, you not only have to pass all your exams but also fulfil a practical experience requirement (PER). To help you to recognise areas of the syllabus that you might be able to apply in the workplace to achieve ditferent performance objectives, we have Introduced the ‘PER alert’ feature. You will fin this feature throughout the Interactive Text to remind you that what you are learning in order to pass your Foundations in Accountancy and ACCA exams is equally useful to the fulfilment of the PER requirement. Tackling studying Studying can be a daunting prospect, particularly when you have lots of other commitments. The different features of the Interactive Text, the purposes of which are explained fully on the Chapter features page, will help you whilst studying and improve your chances of exam success. Developing exam awareness (Our Interactive Texts are completely focused on helping you pass your exer. Our advice on Studying FFA/FA outlines the content of the exam, the recommended approach to studying and any brought forward knowledge you are expected to have. Exam focus points are included within the chapters to highlight when and how specific topics might be examined. Testing what you can do Testing yourself helps you develop the skills you need to pass the exam and also confirms that you can recall what you have learnt. We include Questions ~ lots of them — both within chapters and in the Practice Question Bank, as well ‘as Quick Quizzes at the end of each chapter to test your knowledge of the chapter content. BPP LEARNING MEDIAEach chapter contains @ number of helpful features to guide you through each topic. Topic list Introduction Study Guide ep) Fast Forward EXAMPLE Key Term wy Bau Focus T Formula a PER Alert a Question Chapter Roundup Quick Quiz Practice Question Bank vi Tells you what you will be studying in this chapter and the relevant section numbers, together with ACCA syllabus references. Puts the chapter content in the context of the syllabus as a whole. Links the chapter content with ACCA guidance. ‘Summarises the content of main chapter headings, allowing you to preview and review each section easily. Demonstrates how to apply key knowledge and techniques. Definitions of important concepts that can often eam you ‘easy marks in exams. Tells you how specific topics may be examined, Formulae which have to be learnt, This feature gives you a useful indication of syllabus areas that closely relate to performance objectives in your Practical Experience Requirement (PER). Gives you essential practice of techniques covered in the chapter. A tull list of the Fast Forwards included in the chapter, providing an easy source of review. ‘A quick test of your knowledge of the main topics in the chapter, Found at the back of the Interactive Text with more exam= style chapter questions. Cross referenced for easy navigation BPP LEARNING MEDIAINTRODUCTION STUNT alates How to use this Interactive Text Aim of this Interactive Text To provide the knowledge and practice to help you suc ‘Accounting. To pass the examination you need a thorough understanding in all areas covered bythe syllabus and teaching guide. Recommended approach (2) To pass you need to be able to answer questions on everything specified by the syllabus and teaching guide. Read the Interactive Text very carefully and do not skip any of it. (b) Learning is an active process. Do all the questions as you work through the Interactive Text so ‘you can be sure you really understand what you have read. (c) After you have covered the material in the Interactive Text, work through the Practice Question Bank, checking your answers catefully against the Practice Answer Bank. (a) Before you take the exam, check that you stil remember the material using the following quick revision plan, (Read through the chapter topic list at the beginning of each chapter. Are there any gaps in your knowledge? If so, study the section again. (i) Read and learn the key terms. (iil) Look at the exam focus points. These show the ways in which topics might be examined. (iv) Read the chapter roundups, which are 2 summary of the fast forwards in each chapter. (¥) Do the quick quizzes again. If you know what you're doing, they shouldn't take long. ‘This approach is only a suggestion. You or your college may well adapt it to suit your needs. Remember this is a practical course. (a) Try to relate the material to your experience in the workplace or any other work experience you may have had. (b) Try to make as many links 2s you can to other Applied Knowledge and Applied Skills modules. ae ae En [ ror practice and revision, use BPP Leaming Media's Practice & Revision Kit and Passe: moe LEARNING vilWhat FFA/FA is about FFAVFA aims to develop your knowledge and understanding of the underlying principles, concepts and regulations relating to financial accounting. You will need to demonstrate technical proficiency In the use of double entry techniques, including the preparation of basic financial statements for incorporated and unincorporated entities, as well as simple consolidated financial statements for groups, You also need to be abe to conduct a basic interpretation of financial statements. If you plan to progress through the ACCA qualification, the skills you learn at FF/VFA will be built on in Financial Reporting (FR) and Strategic Business Reporting (SBR). Approach to examining the syllabus FFAVFA is a two-hour examination. The questions in the computer-based examination are objective test uestions ~ multiple choice, number entry and multiple response. (See page ix for frequently asked questions about computer-based examinations.) ‘The examination is structured as follows: ‘Number of marks Section A 36 compulsory objective test questions of two marks each 70 Section B 2 compulsory multi-task questions of 15 marks each a Mult-task questions are a series of short questions relating to one scenario. These short questions can take a number of formats, eg drop down lists, multiple choice, number entry and multiple response, Syllabus and Study guide ‘The complete FFA/FA syllabus and study guide can be found by visiting the exam resource finder on ACCA'S website; werw.accaglobal.com/uk/en/student/exam-support-resources. html BPP LEARNING MeDInINTRODUCTION The computer-based examina ‘Computer-based examinations (CBES) are availabe for most ofthe Foundations in Accountancy exams. ‘The OBES forthe first seven modules can be taken at any time, these are referred to as “exams on demand’. The Option exams can be sat in June and December of each year, these are referted to as “exams on sitting’. FAU and FFM are moving from paper-based exams (PBE) to CBE format from the December 2019 exam sitting, and FTX will follow from the June 2020 exam sitting. There will be no parallel running of PBEs and CBEs. Computer-based examinations must be taken at an ACCA CBE Licensed Centre. How do CBEs work? * Questions are displayed on a monitor. ‘© Candidates enter their answer directly onto the computer. ‘© Candidates have two hours to complete the examination. '® Candidates sitting exams on demand are provided with a Provisional Result Notification showing their results before leaving the examination room. © The CBE Licensed Centre upioads the results to the ACCA (as proof of the candidate's performance) within 72 hours. © Candidates sitting the Option exams will receive their results approximately five weeks after the ‘exam sitting once they have been expert marked. © Candidates can check their exam status on the ACCA website by logging into myACCA. Benefits ‘© Flexibility —the frst seven modules, exams on demand, can be sat at any time ‘© Resits for the first seven modules can also be taken at any time and there is no restriction on the ‘number of times a candidate can sit a CBE, ‘© Instant feedback for the exams on demand as the computer displays the results at the end of the RE. For more information on CBES, visit the ACCA website, ‘wwnw.accaglobal, com/gb/en/student/exam-entry-and-administration/computer-based-exams.htm! BPP LEARNING MEDIAMCQs are part of all Foundations in Accountancy exams and ACCA AB, MA, and FA. ‘The MCQs in your exam contain four possible answers, You have to choose the option that best answers the question. The incorrect options are called distracters. There is a skill in answering MCQs ‘quickly and correctly. By practising MCQs you can develop this skil, giving you a better chance of passing the exam. You may wish to follow the approach outlined below, or you may prefer to adapt it. ‘Skim read all the MCQs and identity what appear to be the easier questions. Attempt each question ~ starting with the easier questions identified in Step 1. Read the question thoroughly. You may prefer to work out the answer before looking at the options, or you may prefer to look at the options at the beginning. Adopt the method that works best for you Read the options and see if one matches your own answer. Be careful with numerical questions, as the distracters are designed to match answers that incorporate common errors, Check that your calculation is correct. Have you followed the requirement exactly? Have you included every stage of the calculation? You may find that none of the options match your answer. © Re-read the question to ensure that you understand it and are answering the requirement ‘+ Eliminate any obviously wrong answers ‘* Consider which of the remaining answers is the most likely to be correct and select the option It you are stil unsure make a note and continue to the next question, Revisit unanswered questions. When you come back to a question after 2 break you often find you are able to answer it correctly straight away. If you are still unsure have a guess, You are not penalised for incorrect answers, so never leave a question unanswered! After extensive practice and revision of MCQs, you may find that you recognise a question when you sit the exam, Be aware that the detail and/or requirement may be different. Ifthe question seems familiar read the requirement and options carefully ~ do not assume that itis identical, ‘Tempting though it might be, don't try to predict where the correct answers might fall based on any kind of pattem you think you might perceive in this section, The distribution of the correct answers do not follow any predictable pattern in this exam! BPP LEARNING wepart The context and purpose of financial reporting BPP fi en wtbin2 BPP LEARWING weeCHAPTER ‘We wil begin by looking a the aim of FFA/FA, as laid out in ACOA’ syllabus and Study Guide and discussed already in the Introductory pages to this Interactive Text (it you havent ead throug the intraductory pages, do so now — the information in there i extremely important). ‘aien To develop knowledge and understanding ofthe underlying principles and concepts relating to financial accounting and technical paticieney in the use of doubleventry accounting techniques including the preparation of basic financial statements’ Betore you leam how to prepare financial reports, is important to understand why they are prepared. Sections 1 to 3 of this chapter introduce some basic ideas about financial reports and give an indication oftheir purpose. You will also be introduced tothe funetions which accountants carryout inancial accounting and management accounting. These functions wil be developed in detail in your later studies, Section 4 identifies the main users of financial statements and their needs. Section 5 considers the responsibilities fer inancial reporting of those charged with governance. Finally, in Section 6, we will look at the main financial Statements: the statement of financial postion and the statement ‘of profit or loss; as well as the main elements of assets, liailtes, ‘equity, revenue and expense. Introduction to accounting TORIC LIST DaroMA> ‘The purpose of financial reporting ‘Types of business entity Nature, principles and scope of financial reporting Users’ and stakeholders’ needs Governance ‘The main elements of financial reports SYLLABUS REFERENCE l(a) AL(o)-(a) Alle) Aa) G(a),(b) A3(@),(b)A The context and purpose of financial reporting 41 The scope and purpose of financial statements for external reporting (a) Define financial reporting - recording, analysing and summarising financial data. K (b)_ Identify and define types of business entity ~ sole trader, ir partnership, limited liability company. (c)_ Recognise the legal differences between a sole trader, i partnership and a limited liability company. (@_ Identify the advantages and disadvantages of operating as a i limited liability company, sole trader or partnership. (e) Understand the nature, principles and scope of financial rm reporting, 2 Users’ and stakeholders’ n (2) Identify the users of financial statements and state and i differentiate between their information needs. 3° The main elements of financial reports (@)_ Understand and identify the purpose of each of the main i financial statements. (b) Define and identify assets, liabilities, equity, revenue and te expenses 5 Duties and responsibilities of those charged with ‘governance (2) Explain what is meant: by governance specifically in the i context of the preparation of financial statements, (6) Describe the duties and responsibilities of directors and ir other parties covering the preparation of the financial statements. Lead yeTigefeSseohniiatslerede Uh iteyeol at ass 1.1 What is financial reporting? — Financial data is the name given to the actual transactions carried out by a business eg sales of goods, purchases of goods, payment of expenses. These transactions are recorded in books of prime entry, The transactions are analysed in the books of prime entry and the totals are posted to the ledger accounts. Finally, the transactions are summarised in the financial statements. BPP LEARNING MEDIACHAPTER 1 // INTRODUCTION TO ACCOUNTING QUESTION Financial reporting Financial reporting is only carried out by large quoted companies. Is this statement comect? A Yes B No ANSWER The correct answer is B. Financial reporting is carried out by all businesses, no matter what their size or structure. Types of business entity 2.1 What is a business? opp + Businesses of whatever size or nature exist to make a profit. : ‘There are a number of different ways of looking at a business. Some ic as are lsted below. © Abusiness is a commercial or industrial concen which exists to deal in the manufacture, resale ‘or supply of goods and services. © business is an organisation which uses economic resources to create goods or services which customers will buy. * _Abbusiness is an organisation providing jobs for people. ‘© Acbusiness invests money in resources (for example buildings, machinery, employees) in order to make even more money for its owners. This last definition introduces the important idea of profit. Businesses vary from very small businesses (the local shopkeeper or plumber) to very large ones (Vodafone, IKEA, Google). However, all of them want to eam profits. Profit is the excess of income (revenue) over expenditure. When expenditure exceeds income (revenue), One of the jobs of an accountant is to measur straightforward a task as it may seem, ‘ome and expenditure, and so profit. It is not as 2.2 Types of business entity ‘There are three main types of business entity. or two assistants and controling their work. The individual's business and personal affairs are, for legal 2 Sole traclers. A sole tradership is a business owned and run by one individual, perhaps employing one “eam 3nd tax purposes, identical. Limited ability companies. Limited lability status means that the business debts and the personal debts ofthe business’ owners (shareholders) are legally separate. The shareholders cannot be sued for the debts of the business unless they have given some personal guarantee. This is called limited liability. Partnerships. These are arrangements between individuals to carry on business in common with a view to profit. A partnership, however, involves obligations to others, and so a partnership is usually governed by 2 partnership agreement. Unless itis a limited liability partnership (LLP), partners will be fully liable for debts and lables, for example ifthe partnership is sued. BPP 5 LEARNING mipIn law, sole traders and partnerships are not separate entities from their owners. However, a limited liability company is legally a separate entity from its owners. Contracts can therefore be issued in the company's name. For accounting purposes, all three entities are treated as separate from their owners. This is called the business entity concept. 2.3 Sole traders This is the oldest and most straightforward structure for a business. Sole traders are people who work for themselves. Of course, it doesnt necessarily mean that the business has only one worker. The sole trader can employ others to do any or all of the work in the business. A sole trader owns and runs @ business, contributes the capital to start the enterprise, runs it with or without employees, and ears the profits or stands the loss of the venture. Typical sole trading organisations include smal local shops, hairdressers, plumbers and IT repair services. Sole traders tend to operate in industries where the barriers to entry are low and where limited capital is required on start up. In law, a sole trader is not legally separate from the business they operate. The owner is legally responsible for the business. AA sole trader must maintain financial records and produce financial accounts. However, there is no legal requirement to make these accounts publicly available; they are usually only used to calculate the tax due to the tax authorities on the profits of the business. Banks and other financiers may request to see the financial accounts of the business when considering applications for loans and overdraft facilites. 2.3.1 Advantages of being a sole trader This type of structure is ideal ifthe business is not complicated, and especially if it does not require a reat deal of outside capital. Advantages include: (a) Limited paperwork and therefore cost in establishing this type of structure (b) Owner has complete control over the business (c) Owner is entitled to profits and the ownership of assets (d) Less stringent reporting obligations compared with other business structures — no requirement to ‘make financial accounts publicly available, no audit requirement {e) Can be highly flexible 2.3.2 Disadvantages of being a sole trader (a) Owner is personally liable for all debts (unlimited liability) (b) Personal property may be vulnerable for debts and other business liabilities (c) Large sums of capital are less likely to be available to a sole trader, leading to reliance on ‘overdrafts and personal savings (2) May lead to long working hours without the normal employee recteation leave and other benefits (©) May be issues of continuity of business in the event of death or illness of the owner 2.4 Partnerships Partnerships occur when two or more people decide to run a business together. Examples include an accountancy practice, a medical practice and a legal practice. Partnerships are generally formed by contract. Partnership agreements are legally binding and are designed to outline the proportionate amount of capital invested, allocation of profits between parties, the responsibilities of each of the parties, allocation of salaty and procedures for dissolving the partnership. Some countries have specific legislation for partnerships. In the UK, the provisions of the Partnership Act 1890 apply where no partnership agreement exists. BPP LEARNING MEDIABPP LEARNING MEDIA chapteR 1 //-inTRODUETION To ACCOUNTING Like sole traders, partnerships are not separate legal entities from their owners. To overcome the problematic risk factors associated with unlimited personal liability for the debts of the business @ new fotm of LLP has been created in some countries. {As with sole traders, partnerships must maintain financial records and produce financial accounts. However, there is no legal requirement to make these accounts publicly available, unless the partnership has LLP status. 2.4.1 Advantages of partnerships (a) Less stringent reporting obligations ~ no requirement to make financial accounts publicly available, no audit requirement, unless the partnership has LLP status (b) Additional capital can be raised because more people are investing in the business (c)__ Division of roles and responsibilities and an increased skill set (a) Sharing of risk and losses between more people (e) No company tax on the business (profits are distributed to partners and then subject to personal tax) 2.4.2 Disadvantages of partnerships (a) Partners are jointly personally liable forall debts (unlimited liability) unless they have formed an ue (b) There are costs associated with setting up partnership agreements (©) There may be issues of continuity of business in the event of death or iliness of the partners, (a) Slower decision making due to the need for consensus between partners (e) Unless a clause is written into the original agreement, when one partner leaves, the partnership is automatically dissolved and another agreement is required between existing partners, 2.5 Limited liability companies Limited liability companies are incorporated to take advantage of ‘limited liability’ for their owners (sharenolders). This means that, while sole traders and partners are personaly responsible for the amounts owed by their businesses, the shareholders ofa limited liability company are only responsible for the amount paid for their shares. They are not responsible for the company’s debts unless they have given personal guarantees (of a bank loan, for example). However, they may lose the money they have invested in the company if it fails. ‘Shareholders may be individuals or other companies. Limited liability companies are formed under specific legislation (eg in the UK, the Companies Act 2006). A limited lability company is legally a separate entity from its owners, and can confer various rights and duties. ‘There is a clear distinction between shareholders and directors of limited companies. (a) Shareholders are the owners, but have limited rights as shareholders over the day to day running, of the company. They provide capital and receive a return (dividend). (b) The board of directors are appointed to run the company on behalf of shareholders. In practice, they have a great deal of autonomy. Ditectors are often shareholders. ‘The reporting requirements for limited liability companies are much more stringent than for sole traders or partnerships. In the UK, there is a legal requirement for a company to: © Be registered at Companies House; © Complete a Memorandum of Association and Articles of Association to be deposited with the Registrar of Companies;Have at least one director (two for a public limited company (PLC) who may also be a shareholder; Prepare financial accounts for submission to Companies House; Have its financial accounts audited (larger companies only); and Distribute the financial accounts to all shareholders. 2.5.1 Advantages of trading as a limited liability company (@ O) © @ ) Limited liability makes investment less risky than being a sole trader or investing in a partnership. However, lenders to a small company may ask for a shareholder's personal guarantee to secure any loans. Limited liability makes raising finance easier (eg through the sale of shares) and there is no limit ‘on the number of shareholders. A limited liability company has a separate legal identity from its shareholders. So a company continues to exist regardless of the identity ofits owners, There are tax advantages to being a limited liability company. The company is taxed as a separate entity from its owners and the tax rate on companies may he lower than the tax rate for individuals. Its relatively easy to transfer shares from one owner to another, In contrast, it may be difficult to find someone to buy a sole trader's business or to buy a share in a partnership. 2.5.2 Disadvantages of trading as a limited liability company (a) Limited lability companies have to publish annual financial statements. This means that anyone (including competitors) can see how well (or badly) they are doing. In contrast, sole traders and partnerships do nat have to publish their financial statements, (b) Limited liability company financial statements have to comply with legal and accounting requirements. In particular, the financial statements have to comply with accounting standards, Sole traders and partnerships may comply with accounting standards, eg for tax purposes. (c) The financial statements of larger limited liability companies have to be audited, This means that the statements are subject to an independent review to ensure that they comply with legal requirements and accounting standards. This can be inconvenient, time consuming and expensive. (@) Share issues are regulated by law. For example, it is difficult to reduce share capital. Sole traders and partnerships can increase or decrease capital as and when the owners wish. QUESTION Financial accounts Mark the following statements as true or false. ‘A Shareholders receive annual accounts, prepared in accordance with legal and professional requirements. 8B The accounts of limited liability companies are sometimes filed with the Registrar of Companies. C Employees always receive the company's accounts and an employee report. D The tax authorities will receive the published accounts and as much supplementary detail as they need to assess the tax payable on profits. £ Banks frequently require more information than is supplied in the published accounts when ‘considering applications for loans and overdraft facilites. BPP LEARNING MEDIAchapter 1 // INTRODUCTION TO ACCOUNTING ANSWER Twe ‘A Yes, and in addition, companies listed on the stock exchange have to comply with the regulations in the stock exchange's Listing Rules, D Yes. E Yes, banks may require cash flow and profit forecasts and budgets prepared to show management's estimates of future activity in the business False B The accounts of limited lfability companies must always be filed with the Registrar of Companies and be available for public inspection. In addition, the company itself will often distribute these accounts on request to potential shareholders, the bank and financial analysts. These accounts are all that is usvally available to suppliers and customers. C Employees will not necessarily receive company accounts (uniess they are shareholders for example), but many companies do distribute the accounts to employees as a matter of policy. ‘Some companies produce employee reports which summarise and expand on matters which are covered in the annual accounts and are of particular interest to them. iples and scope of financial reporting 2) | Financial accounting and management accounting are different. The FFAVFA syllabus focuses on * financial accounting, ‘You may have a wide understanding of what accounting and financial reporting is about. Your job may be in one area or type of accounting, but you must understand the breadth of work which an accountant undertakes. 3.1 Financial accounting So far we have dealt with financial accounts. Financial accounting is mainly a method of reporting the financial performance and financial position of a business. It is not primarily concerned with providing information towards the more efficient running of the business. Although financial accounts are of interest to management, their principal function is to satisfy the information needs of persons not involved in running the business. They provide historical information. 3.2 Management accounting The information needs of management go far beyond those of other account users. Managers have the responsibilty of planning and controlling the resources of the business. Therefore they need much more detailed information, They also need to plan for the future (eg budgets, which predict future revenue ‘and expenditure). provide information as a basis for managerial action. The concern of a management accountant is to Management (or cost) accounting is a management information system which analyses data to /atay present accounting information in the form most helpful to management. ‘You need to understand this distinction between management accounting and financial accounting, ‘The principles of financial reporting will be dealt with in Chapter 3. BPP 9 LEARNING MEDIA10 ‘There are various groups of people who need information about the activities of a business, : 4.1 The need for financial statements. ‘Why do businesses need to produce financial statements? If @ business is being cun efficiently, why should it have to go through all the bother of accounting procedures in order to produce financial information? ‘The International Accounting Standard, IAS 1 Presentation of Financial Statements states: ‘The objective of financial statements is to provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic, decisions.’ {IAS 1, para. 9) In other words, a business should produce information about its activities because there are various groups of people who want, or need, to know that information, This sounds rather vague: to make it clearer, we will study the classes of people who need information about a business. We also need to think about what information in particular is of interest to the members of each class, Large businesses are of interest to a greater variety of people and so we will consider the case of a large public company, whose shares can be purchased and sold on a stock exchange. 4.2 Users of financial statements and accounting information ‘The following people are likely to be interested in financial information about a large company with shares that are listed on @ stock exchange, (a) Managers of the company are appointed by the company’s owners to supervise the day to day activities of the company, They need information about the company's financial situation as itis currently and as it is expected to be in the future. This is to enable them to manage the business efficiently and to make effective decisions. (b) Shareholders of the company, ie the company's owners, want to assess how welt its management is performing, They want to know how profitable the company’s operations are and how much profit they can afford to withdraw from the business for their own use. (c) Trade contacts include suppliers who provide goods for the company on credit and customers ‘who purchase the goods or services provided by the company. Suppliers want to know about the company ability to pay its debts; customers need to know that the company Is @ secure source cf supply and is in no danger of having to close down. (4) Providers of finance to the company might include a bank which allows the company to operate an overdraft, or provides longer-term finance by granting a loan. The bank wants to ensure that the company is able to keep up interest payments, and eventually to repay the amounts advanced, (e) The taxation authorities want to know about business profits in order to assess the tax payable by the company, including sales taxes. (1) Employees of the company should have a right to information about the company's financial situation, because their future careers and the size of their wages and salaries depend on it (@) Financial analysts and advisers need information for their clients or audience. For example, stockbrokers need information to advise investors. Credit agencies want information to advise Potential suppliers of goods to the company. Journalists need information for their reading public. (h) Government and their agencies are interested in the allocation of resources and therefore in the activities of business entities. They also require information in order to provide a basis for national statistics BPP LEARNING MEDIAos BPP LEARNING MEDIA () The public. Entities affect members of the public in a variety of ways. For example, they may ‘make a substantial contribution to a local economy by providing employment and using local suppliers. Another important factor is the effect of an entity on the environment, for example as regards pollution. ‘Accounting information is summarised in financial statements to satisfy the information needs of these different groups. Not ail will be equally satisfied 4.3 Needs of different users Managers of a business need the most information, to help them make their planning and control decisions, They obviously have ‘special access to information about the business, because they are able to demand whatever internally produced statements they require. When managers want a large amount of information about the costs and profitability of individual products, or different parts of their business, they can obtain it through a system of cost and management accounting, QUESTION Information for managers Which of the following is mast useful for managers? ‘A Financial statements for the last financial year B Tax records for the past five years © Budgets for the coming financial year D Bank statements for the past year ANSWER The correct answer is C. Managers need to look forward and make plans to keep the business profitable. Therefore the most useful information for them would be the budgets for the coming financial year. In addition to management information, financial statements are prepared (and perhaps published) for the benefit of other user groups, which may demand certain information. (a) The national laws of a country may provide forthe provision of some accounting information for shareholders and the public, {b) National taxation authorities will receive the information they need to make tax assessments. (©) Abank might demand a forecast of a company’s expected future cash flows as a precondition of granting an overdraft (a) The IASB is esponsibie for issuing International Financial Reporting Standards (IFRSs). These require companies to publish certain additional information. Accountants, as members of professional bodies, are placed under a strong obligation to ensure that company financial statements conform to the requirements of FRSS. (e) Some companies voluntarily provide specially prepared financial information for issue to their employees. These statements are known as employee reports “ CHAPTER 1 // INTRODUCTION TO ACCOUNTING12 | Those charged with governance of a company are responsible forthe preparation of the financial : | statements ' Miele erel hth ‘The ACCA examining team reported that questions on governance have been particularly badly answered in the past. Make sure you read this section carefully and be prepared to answer questions cn it in your exam. Corporate governance is the system by which companies and other entities are directed and controlled Good corporate governance is important because the owners of a company and the people who manage the company are not always the same, which can lead to conflicts of interest. The board of directors of a company are usually the top management and are those who are charged with governance of that company. The responsibilities and duties of directors are usually laid down in Jaw and are wide ranging. 5.1 Legal responsibilities of directors Directors have @ duty of care to show reasonable competence and may have to indemnify the company against loss caused by their negligence. Ditectors are also said to be in a fiduciary position in relation to the company, which means that they must act honestly in what they consider to be the best interest of the company and in good faith. In the UK, the Companies Act 2006 sets out seven statutory duties of directors. Directors should: © ‘act within their powers; © promote the success of the company; © exercise independent judgement; exercise reasonable skill, care and diligence; avoid conflicts of interest; not accept benefits from third parties; and declare interest in a proposed transaction or arrangement’ (Companies Act 2006, Sections 171-177) ‘An overriding theme of the Companies Act 2006 is the principle that the purpose of the legal framework surrounding companies should be to help companies do business. A director's main aim should be to create wealth for the shareholders. {In essence, this principle means that the law should encourage long-termism and regard for all stakeholders by directors and that stakeholder interests should be pursued in an enlightened and inclusive way, ‘When exercising this duty directors should consider ‘The consequences of decisions in the lang term ‘The interests of their employees ‘The need to develop good relationships with customers and suppliers The impact of the company on the local community and the environment The desirability of maintaining high standards of business conduct and a good reputation The need to act fairly as between all members of the company ‘This lst identities areas of particular importance and modern day expectations of responsible business behaviour, for example the interests of the companys employees and the impact of the company's, ‘operations on the community and the environment, BPP LEARNING MEDIA5.2 Responsibility for the financial statements Directors are responsible for the preparation of the financial statements of the company. Specifically, directors are responsible fr: +The preparation ofthe financial statements of the company in accordance with the applicable ‘nancial reporting framework (eg IFRSs) + The internal cantrols necessary to enable the preparation of financial statements that are free ‘from material misstatement, whether due to error or fraud ‘©The prevention and detection of fraud It is the directors’ responsibility to ensure that the entity complies with the relevant laws and regulations. Directors should explain their responsibility for preparing accounts in the financial statements. They should also report that the business is @ going concer, with supporting assumptions and qualifications ‘as necessary. Directors should present a balanced and understandable assessment of the company's position and prospects in the annual accounts and other reports, such as interim reports and reports to regulators. ‘The directors should also explain the basis on which the company generates or preserves value and the strategy for delivering the company’s longer-term objectives. Companies over a certain size limit are subjected to an annual audit of their financial statements. An ‘audit Is an independent examination of the accounts to ensure that they comply with legal requirements ‘and accounting standards, Note that the auditors are not responsible for preparing the financial statements. The findings of an audit are reported to the shareholders of the company. An aucit gives the shareholders assurance that the accounts, which are the responsibilty ofthe directors, fairly present the financial performance and position of the company. An audit therefore goes some way in helping the shareholders assess how well management have carried out their responsibility for stewardship of the ‘companys assets. 16 Ogee tanececlcntnes ouenflareVacs ty 2 BPP { The principal financial statements of a business are the statement of financial position and the | statement of profit or loss, 6.1 Statement of financial position ‘The statement of financial position is simply alist of all the assets owned and all the liabilities owed by a business as ata particular date It is a snapshot of the financial position of the business at a particular moment. Monetary amounts are attributed to each of the assets and liabilities. 6.1.1 Assets ‘An asset Is something valuable which a business owns or can use. The Intemational Accounting, ‘Standards Board (IASB) defines an asset in its document, the Conceptual Framework for Financial Reporting 2018, as follows: ‘An asset is a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits.’ (Conceptual Framework for Financial Reporting 2018, paras. 4.3 and 4.4) 13 LEARNING. MEDIA14 Examples of assets are factories, office buildings, warehouses, delivery vans, lrries, plant and ‘machinery, computer equipment, office furniture, cash and goods held in store awaiting sale to customers. Some assets are held and used in operations for a long time. An office building is occupied by staff for years. Similarly, a machine has a productive life of many years before it wears out. Otiner assets are held for only a short time. The owner of a newsagent shop, for example, has to sell their daily newspapers on the same day that they get thern. The more quickly a business can sell the {goods it has in store, the more profit it is likely to make; provided, of course, that the goods are sold at a higher price than what it cost the business to acquire them. 6.1.2 Liabilities A liability is something which is owed to somebody else. ‘Liabilities’ is the accounting term for the debts of a business. The IASB's Conceptual Framework for Financial Reporting 2018 defines a lability as follows: ‘A liability is a present obligation of the entity to transfer economic resource as a result of past events. ‘An obligation is a duty of responsibilty that the entity has no practical ability to avoid.’ (Conceptual Framework for Financial Reporting 2018, paras. 4.26 and 4,29) Examples of liabilities are amounts owed to a supplier for goods bought on credit, amounts owed to a bank (or other lender), a bank overdraft and amounts owed to tax authorities (eg in respect of sales tax), Some liabilities are due to be repaid fairly quickly (eg suppliers). Other liabilities may take some years to repay (eg a bank loan). QUESTION Assets and liabi Which of the following is an asset according to the definition in the Conceptual Framework? A Bank overdraft B Factory buildings C Payables D Amounts owed to tax authorities ANSWER ‘The correct answer is B, Factory buildings. is the only one which the business owns rather than owes. 6.1.3 Capital or equity The amounts invested in a business by the owner are amounts that the business owes to the owner. ‘This is a special kind of lability, called capital In a limited liability company, capital usually takes the form of shares. Share capital is also known as equity. The IASB's Conceptual Framework for Financial Reporting 2018 defines equity as follows, "Equity is the residual interest in the assets of the entity after deducting al its liabilities.” (Conceptual Framework for Financial Reporting 2018, para. 4.63) BPP LEARNING. MeDIscuaeTeR 1 // INTRODUCTION To ACCOUNTING 6.1.4 Form of the statement of financial position A staternent of financial position used to be called a balance sheet. The former name is apt because assets will always be equal to liabilities plus capital (or equity). An example of a very simple statement of financial position for a sole trader is shown below. A TRADER STATEMENT OF FINANCIAL POSITION AS AT 30 APRIL 20X7 Assets Plant and machinery 56,000 Inventory 5,000 Receivables (from customers) 1,500 Cash at bank 500 Totay assets 82,000 Capital Balance brought forward Profit forthe year Balance carried forward Liabilities Bank loan Payables (to supoliers) Total capital plus liabilities 6.2 Statement of profit or loss A statement of profit or loss is a record of income generated and expenditure incurred over a given period. The statement shows whether the business has had more revenue than expenditure (a profit) or vive versa (loss), 6.2.1 Revenue and expenses Revenue is the income generated by the operations of a business fora perio. Expenses are the costs of running the business for the same period, The IASBs Conceptual Framework for Financial Reporting 2018 defines Income and expenses as follows: ‘Income is increases in assets or decreases in liabilities that result in increases in equity, other than those relating to contributions from holders of equity claims.’ (Conceptual Framework for Financial Reporting 2018, para. 4.68) “Expenses are decreases in assets or increases in lables that result in decreases in equity, other than those relating to distributions to holders of equity claims. (Conceptual Framework for Financial Reporting 2018, para. 4.69) 6.2.2 Form of the statement of profit or loss The period chosen will depend on the purpose for which the statement is produced. The statement of profit or loss which forms part of the published annual financial statements of a limited liability company will usually be for the period of a year, commencing from the date of the previous years statements. On the other hand, management might want to keep a closer eye on a company's profitability by making up quarterly or monthly statements. 15 LEARNINGEe es 16 {A simple statement of profit or loss for a sole trader is shown below. ATRADER STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 30 APRIL 20x7 Revenue Cost of sales Gross profit Other expenses Profit for the year Once again, this example is given purely for illustrative purposes. 6.3 Purpose of financial statements Both the statement of financial position and the statement of profit or loss are summaries of accumulated data. For example, the statement of profit or loss shows a figure for revenue earned from selling goods to customers. This is the total amount of revenue eared from all the individual sales made during the period. One of the jobs of an accountant is to devise methods of recording such individual transactions, so as to produce summarised financial statements from them. ‘The statement of financial position and the statement of profit ar loss form the basis of the financial statements of most businesses. For limited liability companies, other information by way of statements and notes may be required by national legislation and/or accounting standards, for example a statement of profit or loss and other comprehensive income and a statement of cash flows (which will be dealt with in detail in Chapters 20 and 22 respectively). QUESTION Accounting information ‘The financial statements of a limited liability company will consist solely of the statement of financial position and statement of profit or loss. Is this statement true or false? A Tue Bo False ANSWER The correct answer is B, false. As noted above, other statements, such as a statement of cash flows, are usually needed. (ne of the competences you requ to ull perfomance objective POS Le of the PER is the ability to manage time and tasks effectively to meet business needs and p ‘commitments, and be capable of working under pressure. In the course of your FFAVFA studies, you will be demonstrating this competence. BPP LEARNING MEDIACHAPTER ROUNDUP QUICK QUIZ CHAPTER 1 // INTRODUCTION TO ACCOUNTING. Financial reporting is a way of recording, analysing and summarising financial data. G Businesses of whatever size or nature exist to make a profit. G Financial accounting and management accounting are different, The FFAVFA syllabus focuses on financial accounting, G__ There are various groups of people who need information about the activities of a business. G Those charged with governance of a company are responsible for the preparation of the financial statements, G The principal financial statements of a business are the statement of financial position and the statement of profit or loss. 1 Fillin the blanks. Financial reporting is a way of .. and vw financial data, 2 Abbusiness entity is owned and run by Alpha, Beta and Gamma, ‘What type of business is this an example of? A Sole trader B Partnership C Limited liability company D Public company Identify seven user groups who need accounting information, 4 What are the two main financial statements drawn up by accountants? ‘The directors of a company are responsible for the preparation of the financial statements of a company. True of fase? 6 Which of the following is en example ofa liability? A ventory B Receivables Plant and machinery D Loan BPP LEARNING MEDIA a73 oe x S 3 G ° e n ce i 2 a Zz a 18 Financial reporting is a way of recording, analysing and summarising financial data. B_— Apartnership, as it is owned and run by three people ‘See Section 4.2. ‘The statement of profit or loss and the statement of financial position oho ‘True. Those charged with governance of that company, ie the directors, are responsible for the preparation of the financial statements. ° D —Aloan. The rest are all assets. Attempt the questions below from the Practice Questian Bank (at the back of this bool) Qs 1-5 BPP LEARNING NiEDIAIn this chapter, we introduce the regulatory system run by the Intemational Accounting Standards Board (IASB), We are ‘concemed with the IASBIs relationship with other bodies, and ‘with the way the IASB operates, "You must ty to understand and appreciate the contents ofthis ‘chapter. The ACCA examining team isnot only interested in ‘whether you can add up; they want to know whether you can ‘think about a subject which, after all, fs your future career. The regulatory framework TOPIC LIST 4. The regulatory system 2 The international Accounting Standards Board (ASB) 3 International Financial Reporting Standards (FRSs)20 A The context and purpose of financial reporting 4 The regulatory framework (@)_Understand the role of the regulatory system, including the K roles of the IFRS Foundation (IFRSF), the International Accounting Standards Board (IASB), the IFAS Advisory Council (IFRS AG) and the IFAS Interpretations Cammittee (OFRS IC). (b) Understand the role of the International Financial Reporting K ‘Standards. ‘The regulatory system ‘A number of factors have shaped the development of financial accounting. 1.1 Introduction Although new to the subject, you will be aware from your reading of the press that there have been some considerable upheavals in financial reporting, mainly in response to criticism, The details of the regulatory framework of accounting, and the technical aspects of the changes made, will be covered later in this chapter and in your more advanced studies. The purpose ofthis section is to give a general picture of some of the factors which have shaped financial accounting, We will concentrate on the accounts of limited liability companies, as these are the accounts most closely regulated by statute or otherwise, ‘The following factors that have shaped financial accounting can be identitied Nationai/local legislation Accounting concepts and individual judgement Accounting standards Other international influences Generally accepted accounting principles (GAAP) © Fair presentation 1.2 National/local legislation In most countries, limited liability companies are required by law to prepare and publish accounts, annually. The form and content of the accounts is regulated primarily by national legislation. 1.3 Accounting concepts and individual judgement fundamental accounting assumptions and conventions. This can lead to subjectivity. Accounting standards were developed to try to address this subjectivity Financial statements are prepared on the basis of a number of fundamental accounting assumptions ‘and conventions. Many figures in financial statements are derived from the application of judgement in putting these assumptions into practice, Itis clear that different people exercising their judgement on the same facts can arrive at very different conclusions. BPP MEDIACHAPTER 2 // THE REGULATORY FRAMEWORK EXAMPLE ‘An accountancy training firm has an excellent reputation among students and employers. How would you value this? The firm may have relatively litle in the form of assets that you can touch; perhaps a building, desks and chairs. If you simply drew up a statement of financial position showing the cost of the assets owned, then the business would not seem to be worth much, yet its income earning potential ‘might be high. This is true of many service organisations where the people are among the most valuable assets idan alanine UlAbiidodnititinentiainilnitas Other examples of areas where the judgement of different people may vary are as follows. (a) Valuation of buildings in times of rising property prices (b) Research and development: is it right to treat this only as an expense? In a sense itis an investment to generate future revenue, (c) Accounting for inflation (@) Brands such as ‘Or Pepper’ and Cadbury Dairy lift truck is an asset? | Are they assets in the same way that a fork Working from the same data, different groups of people produce very different financial statements. If the exercise of judgement is completely unfettered, there will be no comparability between the accounts of different organisations. This will be all the more significant in cases where deliberate manipulation ‘occurs, in order to present accounts in the most favourable light. 1.4 Accounting standards In an attempt to deal with some of the subjectivity, and to achieve comparability between different organisations, accounting standards were developed. These are developed at both a national level (in ‘most countries) and an international level. The FFA/FA syllabus is concerned with Intemational Financial Reporting Standards (IFRSs). IFRSs are produced by the International Accounting Standards Board (IASB). [2] The International Accounting Standards Board (IASB). e)> ' financial reporting and eventually bring about global harmonisation of accounting standards. BPP LEARNING MEDIA ‘The IASB develops IFRSs. The main objectives of the IFRS Foundation are to raise the standard of ‘The International Accounting Standards Board (IASB) is an independent, privately funded body that develops and approves IFRSs. Prior to 2003, standards were issued as Intemational Accounting Standards (IASs). In 2003 IFRS 1 was issued and all new standards are now designated as IFRSs. Therefore IFRSs encompass both IFRSs, and IASs still in force (eg IAS 7). IMPORTANT The members of the IASB come from several countries and have a variety of backgrounds, with a mix of auditors, preparers of financial statements, users of financial statements and academics. The IASB operates under the oversight of the IFRS Foundation, 24es aie 2.1 The IFRS Foundation ‘The IFRS Foundation ("ormally called the International Accounting Standards Committee Foundation or IASCF) is a not for profit, private sector body that oversees the IASB, The objectives of the IFRS Foundation, summarised from its document /FRS Foundation Constitution, 2013 are to: © Develop a single set of high quality, understandable, enforceable and globally accepted IFRSs ‘through its standard-setting body, the IASB; © Promote the use and rigorous application of those standards; © Take account of the financial reporting needs of emerging economies and small and medium- sized entities (SMEs); and © Bring about convergence of national accounting standards and IFRSs to high quality solutions, (para. 2) At the time of writing, the IFRS Foundation Constitution has been reviewed for proposed amendments, but these are nat yet effective, ‘As at January 2017, the IFRS Foundation is made up of 20 named trustees, who essentially monitor and fund the IASB, the IFRS Advisory Council and the IFRS Interpretations Committee, The Trustees are appointed from a variety of geographical and functional backgrounds. 2.1.1 IFRS Advisory Council ‘The IFRS Advisory Council (formerly called the Standards Advisory Council or SAC) is essentially a forum used by the IASB to consult with the outside world. It consults with national standard-setters, academics, user groups and a host of other interested partias to advise the IASB on a range of issues, {rom the IASB's work programme for developing new IFRSs to giving practical advice on the implementation of particular standards. ‘The IFRS Advisory Council meets the IASB at least three times a year and puts forward the views ofits members on current standard-setting projects. 2.1.2 IFRS Interpretations Com ‘The IFRS Interpretations Committee (formerly called the International Financial Reporting Interpretations Comittee or IFRIC) was set up in March 2002 and provides guidance on specific practical issues in the interpretation of IFRSs. Note that despite the name change, interpretations issued by the IFRS Interpretations Committee are still known as IFRIC Interpretations. In your exam, you may see the IFRS Interpretations Committee referred to as the IFRS IC. ee ‘The IFRS Interpretations Committee has two main responsibilities: + To review, on a timely basis, newly identified financial reporting issues not specifically addressed in IFRSs. © To clarify issues where unsatisfactory or conflicting interpretations have developed, or seem likely to develop in the absence of authoritative guidance, with a view to reaching a consensus on the appropriate treatment BPP LEARNING. goin 22CHAPTER 2 / THE REGULATORY FRAMEWORK El International Financial Reporting Standatds (IFRSs) IFRSs are created in accordance with due process. There ate currently 28 IASs and 16 IFRSs in issue. 3.1 The use and application of IFRSs IFRSs have helped to both improve and harmonise financial reporting around the world. The standards are used in the following ways. As national requirements {As the basis forall or some national requirements {As an international benchmark for those countries which develop their own requirements, By regulatory authorities for domestic and foreign companies By companies themselves ‘The consolidated accounts of listed companies in the UK have had to be produced in accordance with JFRSs since January 2005. This is a result of an EU regulation called "JAS Regulation’ that requires listed ‘companies of EU member states to prepate their consolidated financial statements under IFRS. However in June 2016, the UK voted to leave the EU and is set to leave by early 2019. Until this time the UK is still an EU member state, but after it leaves, it wll no longer be a member and will not be subject to EU. Jaw. Therefore, this reporting requirement could change after the exit. 3.2 Standard-setting process The IASB prepares IFRSs in accordance with due process. You do not need to know this for your exam, but the following diagram may be of interest. The procedure can be summarised as follows. Consultative Group + Board On acceptance + ‘Steering Committe (chaired |-»[ Discussion Paper Public comment by board members) + Exposure daft Public comment Y IFRS BPP ea LEARNING. MEDIA24 oe a 3.2.1 Current IFRSs ‘The current list is as follows, Those examinable in FFAVFA are marked with a *, IAS 18 Revenue has been replaced by IFRS 15 Revenue from Contracts with Customers for reporting periods beginning on or after 1 January 2018. IFRS 15 is now examinable in FFAVFA, not |AS 18, Conceptual Framework for Financial Reporting 2018 * IFRS 1 IFRS 2 IFRS 3* IFRS 4 IFRS 5 IFRS 6 IERS 7. IFRS 8 IFRS 9 IFRS 10* IFRS 11 IFRS 12 IFRS 13, IFRS 14 IFRS 15* IFRS 16" Mas 1* las 2* Mas 7* IAs 8 las 1o* aS 11 las 12 as 16* las 17! las 18, Ins 19 las 20 IAs 21 Ins 23 IAS 24 IAS 26 IAs 27* IAS 28* IAS 29 IAs 32 IAS 33, las 34 IAs 36 as 37* las 38" IAs 39 as 40 IAs 41 First-time Adoption of International Financial Reporting Standards ‘Share-based Payment Business Combinations Insurance Contracts Non-current Assets Held for Sale and Discontinued Operations Exploration for the Evaluation of Mineral Resources Financial instruments: Disclosures Operating Segments Financial Instruments Consolidated Financial Statements Joint Arrangements Disclosure of interests in Other Entities Fair Value Measurement Regulatory Deferral Accounts Revenue from Contracts with Customers Leases Presentation of Financial Statements Inventories Statement of Cash Flows Accounting Policies, Changes in Accounting Estimates and Errors Events After the Reporting Period Construction Contracts Income Taxes Property, Plant and Equipment Leases Revenue Employee Benefits (2011) ‘Accounting for Government Grants and Disclosure of Government Assistance The Effects of Changes in Foreign Exchange Rates Borrowing Costs Related Party Disclosures ‘Accounting and Reporting by Retirement Benefit Plans Separate Financial Statements (2011) Investments in Associates and Joint Ventures (2011) Financial Reporting in Hyperintlationary Economies Financial Instruments: Presentation Earnings per Share Interim Financial Reporting Impairment of Assets Provisions, Contingent Liabilities and Contingent Assets Intangible Assets Financial Instruments: Recognition and Measurement Investment Property Agriculture “IAS 17 will be replaced by IFRS 16 from 1 January 2019, however earlier adoption is permitted if an entity is also applying IFRS 15. Various exposure drafts and discussion papers are currently at different stages within the IFRS process, but these are not of concern to you at this stage. BPP LEARNING MEDIACHAPTER 2 // THE REGULATORY FRAMEWORK BPP LEARNING. MEDIA 3.3 Scope and application of IFRSs 3.3.1 Scope Any limitation ofthe applicability ofa speciic IFRS is made clear within that standard, IFRSs are not intended to be applied to immaterial items, nor are they retrospective. Each individual standard lays cut its scope atthe beginning ofthe standard. 3.3.2 Application Within each individual country local regulations govern, to a greater of lesser degree, the issue of financial statements. These local regulations include accounting standards issued by the national regulatory bodies and/or professional accountancy bodies in the country concerned. QUESTION Standards How far do the accounting standards in force in your country diverge from the IFRSs you will over in this Interactive Text? I you have the time, perhaps you could find out. 25a > a 2 5 3° v4 cc im e a z xz 6 N 5 a x 2 5 oa 26 ‘A number of factots have shaped the development of financial accounting. ‘Many figures in financial statements are derived from the application of judgement in applying fundamental accounting assumptions and conventions. This can lead to subjectivity. Accounting, standards were develaped to try to adress this subjectivity. ‘The IASB develops IFRSs, The main objectives of the IFRS Foundation are to raise the standard of financial reporting and eventually bring about global harmonisation of accounting standards. IFRSs are created in accordance with due process, There are currentiy 28 IASs and 16 IFRSs in issue. Which of the following is nat an objective of the IFRS Foundation? A Toenforce IFRSs in most countries B To develop IFRSs through the IASB © To bring about convergence of accounting standards and IFRSS D To take account of the financial reporting needs of SMEs Fill in the blanks, The IFRS oosscesstes otsesee seers ISSUES IFRS, which aid users’ interpretation of How many IASs and IFRSs are currently in issue? What change was introduced in 2005 for listed companies in the UK? ‘A IERSs to be used for al financial statements B _IFRSs to be used for consolidated financial statements ‘The IASB is responsible for the standard-setting process. True or false? BPP LEARNING. MEDIAANSWERS TO QUICK QUIZ 1 A___The IFRS Foundation has no powers of enforcement, 2 The IFRS Interpretations Committee issues IFRIC interpretations which aid users’ interpretation of IFRSs. 3 44: 28 IASs and 16 IFRS. 8 _IFRSs to be used for consolidated financial statements 5 The = Attempt the questions below from the Practice Question Bank Os 6-7 BPP LEARNING. MEDIA28 BPP Laan vepart The qualitative characteristics of financial information BPP LEARNING30 BPP LEARNING. MEDIACHAPTER ‘The purpose ofthis chapter isto encourage you to think more deeply about the assumptions on which financial statements are prepared, This chapter deals with the accounting conventions which lie behind accounts preparation and wich you wll meet in Part ofthis Interactive Text, in the chapters on bookkeeping. In Part D, you will see how conventions and assumptions are put into practice. You will also deal with cetain items whieh ate the subject of accounting standards. The qualitative characteristics of financial information TOPIC List 11 Background 2 The |ASB's Conceptual framework 3 The qualitative characteristics of financial information 4 Other accounting conceptscee erp epee sniietyeseneny 1 The qualitative characteristics of financial information (9) Define, understand and apply qualitative characteristics: in @ Relevance (i) Faithful representation Gi) Comparability (w)—Verifiabitity Timeliness (i) Understandability (b) Define, understand and apply accou J Materiality i) Substance over form Going concern iv) Business entity concept Accruals (i Prudence (vid Consistency and have picked out the main points of the question. This may sound obvious but the ra team regularly comments that students have failed to read the question. > 1 in prey ‘Accounting practice has developed gradually over time. Many ofits procedures are operated automatically by people who have never questioned whether alternative methods exist which have equal validity. However, the procedures in common use imply the acceptance of certain concepts which are by ‘no means self-evident; nor are they the only possible concepts which could be used to build up an accounting framework. ur next step is to look at some of the more important concepts which are taken for granted in preparing accounts. In this chapter we shal single out the important assumptions and concepts for discussion. BPP 32 LEARNING esiCHAPTER 3 // THE QUALITATIVE CHARACTERISTICS OF FINANCIAL INFORMATION The |ASB's Conceptual Framework | The 1ASB's Conceptual Framework isthe basis on which \FRSs are formulated. 1 The main assumption for financial statements is going concern. 2.1 Introduction to the Conceptual Framework ‘The Conceptual Framework for Financial Reporting 2018 (Conceptual Framework} is a set of principles which underpin the foundations of financial accounting. Its conceptual framework on ‘which all IFRSs are based and hence determines how financial statements are prepared and the information they contain. The Conceptual Framework is not an accounting standard in ise. ‘The Conceptual Framework is currently as follows. Chapter 1: The objective of general purpose financial reporting Chapter 2: Qualitative characteristics of useful financial information Chapter 3: Financial statements and the reporting entity Chapter 4: The elements of financial statements Chapter 5: Recognition and derecognition, Chapter 6: Measurement Chapter 7: Presentation and disclosure Chapter &: Concepts of capital and capital maintenance (Conceptual Framework for Financial Reporting 2018) We are only concerned with Chapter 2 and parts of Chapter 4 for the FFA/FA syllabus. 2.2 Going concern assumption ‘The Conceptual Framework sets out one important assumption for financial statements, the going concem concept. 2.2.1 Going concern ‘going concern and will continue in operation for the foreseeable future. Hence, itis assumed that the entity has neither the intention nor the need to enter into liquidation or to cease trading. If such an intention or need exists, the financial statements may have to be prepared on a different basis. If so, the financial statements describe the basis used.’ 2 "Going concern. The financial statements are normally prepared on the assumption that an entity is @ TERM (Conceptual Framework for Financial Reporting 2018, para. 3.9) ‘This concept assumes that, when preparing a normal set of accounts, the business will continue to ‘operate in approximately the same manner for the foreseeable future (at least the next 12 months). In particular, the entity will not go into liquidation or scale down its operations in a material way. ‘The main significance of the going concern concept is that the assets should not be valued at their ‘break-up’ value (the amount they would sell for if they were sold off piecemeal and the business were broken up). BPP LEARNING Eo Meoes as “4 QUESTION Going concer A retailer commences business on 1 January and buys inventory of 20 washing machines, each costing $100. During the year they sell 17 machines at $150 each. How should the remaining machines be valued at 31 December in the following circumstances? A They are forced to close down their business at the end of the year and the remaining machines wil realise only $60 each in a forced sale. 8 They intend to continue their business into the next year. ANSWER A If the business is to be closed down, the remaining three machines must be valued at the amount they will realise in a forced sale, ie 3 x $60 = $180. B Ifthe business is regarded as a going concern, the Inventory unsold at 31 December will be cartied forward into the following year, when the cost of the three machines will be matched against the eventual sale proceeds in computing that year's profits, The three machines will therefore be valued at cost, 3 x $100 = $300. If the going concem assumption is not followed, that fact must be disclosed, together with the following information, {a) The basis on which the financial statements have been prepared (b) The reasons why the entity is not considered to be a going concern 2.2.2 Actuals basis Accruals basis, The effects of transactions and other events are recognised when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relat. ‘The accruals basis is not an underlying assumption but para. 1.17 of the Conceptual Framework for Financial Reporting 2018 makes it clear that financial statements should be prepared on an accruals basis. Entities should prepare their financial statements on the basis that transactions are recorded in ther, not as the cash is paid or received, but as the revenues or expenses are earned or incurred in the accounting period to which they relate, According to the accruals assumption, in computing profit revenue earned must be matched against the ‘expenditure incurred in earning it. Ths is also known as the matching convention. Example: accruals basis Emma purchases 20 T-shirts in her first month of trading (May) at a cost of $5 each. She then sells all of them for $10 each. Emma has therefore made a profit of $100, by matching the revenue ($200) ‘earned against the cost ($100) of acquiring them. All of Emma's sales and purchases are on credit and no cash has been received or paid. If, however, Emma only sells 18 T-shirts, itis incorrect to charge her statement of profit or loss with the cost of 20 T-shirts, as she still has two T-shirts in inventory. Therefore, only the purchase cost of 18 T-shirts (18 x $5 = $90) should be matched with her sales revenue (18 x $10 = $180}, leaving. her with a profit of $90. BPP LEARNING MEDIACHAPTER 3 // THE QUALITATIVE CHARACTERISTICS OF FINANCIAL INFORMATION Her statement of financial position will look like this. $ Assets Inventory (at cost, ie 2 x $5) 10 Accounts receivable (18 x $10) 180 190 Capital and tiabilities: aaa Proprietor’ capital (profit forthe period) Accounts payable (20 x $5) However, if Emma had decided to give up selling T-shirts, then the going concern assumption no longer applies and the value of the two T-shirts in the statement of financial position is break-up valuation not cost. Similarly if the two unsold T-shirts are unlikely to be sold at more than their cost of $5 each (say, because of damage or a fall in demand) then they should be recorded on the statement of financial position at their net realisable value (ie the likely eventual sales price less any expenses incurred to ‘make ther saleable) rather than cost. This shows the application of the prudence concept. The Conceptual Framework 2018 views prudence as a component of neutrality, which is a characteristic of faithful representation, Prudence is described as: ‘the exercise of caution when making judgements under conditions of uncertainty. The exercise of prudence means that assets and income are not overstated and liabilities and expenses are not understated.’ (Conceptual Framework 2018, para. 2.16) ‘As an accountant, its important to exercise caution when making accounting estimates. {in this example, the concepts of going concern and accruals are inked. Since the business is assumed to be a going concem, itis possible to carty forward the cost of the unsold T-shitts as a charge against profits of the next period. EXAM FOCUS POINT : ‘The ACCA examining team commented that questions on the Conceptual Framework have been particulatly well answered in past exams. BPP ‘The Conceptual Framework states that qualitative characteristics are the attributes that make the information provided in financial statements useful to users. | The two fundamental qualitative characteristics are relevance and faithful representation, | Enhancing qualitative characteristics are comparability, verifiability, timeliness and understandability. 3.1 Relevance Only relevant information can be useful. Information should be released on a timely basis to be relevant to users "Relevance. Relevant financial information is capable of making a difference in the decisions made by users... Financial information is capable of making a difference in decisions i it has predictive value, confirmatory value or both.’ (Conceptual Framework for Financial Reporting 2018, paras. 2.6-7) 35 LEARNING MEDIA& 36 The predictive and confirmatory roles of information are interrelated. Information on financial position and performance is often used to predict future position and performance and other things of interest to the user, eg likely dividend, wage rises. The manner of showing information will enhance the ability to ‘make predictions, eg by highlighting unusual items. The relevance of information is affected by its nature and materiality. 3.1.1 Materiality "Materiality. Information is material if omitting it or misstating it could influence decisions that the primary users of general purpose financial reports make on the basis of those reports which provide financial information about a specitic reporting entity.’ (Conceptual Framework for Financial Reporting 2018, para. 2.11) Information may be judged relevant simply because of its nature. In other cases, both the nature and ‘materiality of the information are important. ‘An error which fs too trivial to affect anyone's understanding of the accounts is referred to as immaterial. In preparing accounts itis important to assess what is material and what is not, so that time and money are not wasted in the pursuit of excessive detail. Determining whether or not an item is material is a very subjective exercise. There is no absolute ‘measure of materiality. It is common to apply a convenient rule of thumb (for example, material items. are those with a value greater than 5% of net profits). However, some items disclosed in the accounts are regarded as particularly sensitive and even a very small misstatement of such an item is taken as a ‘material error. An example, in the accounts of a limited liability company, is the amount of remuneration (salaries and other rewards) paid to directors of the company. ‘The assessment of an item as material or immaterial may affect its treatment in the accounts. For example, the statement of profit or lass of a business shows the expenses incurred grouped under suitable captions (administrative expenses, distribution expenses etc); but in the case of very small expenses it may be appropriate to lump them together as ‘sundry expenses’, because a more detailed breakdown is inappropriate for such immaterial amounts. In assessing whether or not an item is material, itis not only the value of the item which needs to be considered. The context is also important, (a) _ If a statement of financial position shows non-current assets of $2 million and inventories of $30,000, an error of $20,000 in the depreciation calculations might not be regarded as material. However, an error of $20,000 in the inventory valuation would be material. In other words, the total of which the error forms part must be considered. {b) If @ business has a bank loan of $50,000 and a $55,000 balance on bank deposit account, it will be a material misstatement if these two amounts are netted off on the statement of financial position as cash at bank $5,000". In other words, ncorret presentation may amount to material misstatement even if there is no monetary en. 3.2 Faithful representation ‘Faithful representation. Financial reports represent economic phenomena in words and numbers. To bbe useful, financial information must not only represent relevant phenomena but must faithfully represent the substance of the phenomena that it purports to represent.’ (Conceptual Framework for Financial Reporting 2018, para. 2.12) To be a faithful representation information must be complete, neutral and free from error. A complete depiction includes all information necessary for a user to understand the phenomenon being, depicted, including all necessary descriptions and explanations, BPP LEARNING. MEDIA