Financial Statements (IAS 1)
3.2 SCOPE OF THE STANDARD IAS 1 outlines
3.6.12 Table 3.3 provides an overview of some of the ratios that can be calculated using each of the classification areas discussed in 3.6.7
3.6.13 When performing an analysis for specific purposes, various elements from different ratio classification groupings can be combined, as seen in table 3.4.
Financial statement item
Aggressive treatment
(bending the intention of IFRS) “Conservative” treatment
Revenue Aggressive accruals Installment sales or cost recovery
Inventory FIFO-IFRS treatment LIFO (where allowed—not allowed per
IFRS anymore) Depreciation Straight line (usual under IFRS) with
higher salvage value
Accelerated-consumption-pattern methods (lower salvage value)
Warranties or bad debts High estimates Low estimates
Amortization period Longer or increasing Shorter or decreasing
Discretionary expenses Deferred Incurred
Contingencies Footnote only Accrue
Management compensation Accounting earnings as basis Economic earnings as basis
Prior period adjustments Frequent Infrequent
Change in auditors Frequent Infrequent
Costs Capitalize Expense
TABLE 3.2 Manipulation of Earnings via Accounting Methods that Distort the Principles of IFRS
28 Chapter 3 Presentation of Financial Statements (IAS 1)
1. Liquidity
Numerator Denominator Current Current assets Current
liabilities Quick Cash + marketable
securities + receivables
Current liabilities
Cash Cash + marketable securities
Current liabilities Receivables
turnover
Net annual sales Average receivables
Cost of goods sold Average inventory
Cost of goods sold Average trade payables
2. Solvency (Business and Financial Risk Analysis)
Numerator Denominator
Standard deviation of net income
Mean net income
Sales variability Standard deviation of sales Mean sales Operating leverage Mean of absolute value
of % change in operating expenses
Percentage (%) change in sales
Debt-equity Total long-term debt Total equity Long-term debt
ratio
Total long-term debt Total long-term capital Total debt ratio Total debt Total capital Interest coverage EBIT (Earnings before
interest and taxes)
Interest expense
Fixed financial cost coverage
EBIT Interest expense +
one-third of lease payments Fixed charge
coverage
EBIT + lease payments Interest payments + lease payments
Net income + depreciation expense + increase in deferred taxes
Interest expense
Cash flow coverage of fixed financial cost coverage
Traditional cash flow + interest expense + one-third of lease payments
Net income + depreciation expense + increase in deferred taxes
Book value of long-term debt
Cash flow to total debt
Net income + depreciation expense + increase in deferred taxes
Total debt
Financial risk Volatility caused by firm’s use of debt
N/A TABLE 3.3 Ratio Categories
Chapter 3 Presentation of Financial Statements (IAS 1) 29
TABLE 3.3 Ratio Categories (continued)
3. Operational Efficiency (Activity)
Numerator Denominator Total asset
turnover
Net sales Average net assets Fixed asset
turnover
Net sales Average total fixed assets
Payout ratio Common dividends Gross profit margin Gross profit Net sales Operating profit margin Operating profit (EBIT) Net sales
Net profit margin Net income Net sales
Return on total capital Net income + interest expense
Average total capital
Return on total equity Net income Average total equity Return on common
Net profit margin Net income Revenue
× Asset turnover Revenue Average assets
× Financial leverage Average assets Average equity
Du Pont 2: ROE Net income Equity
Operating profit margin Operating profit (EBIT) Revenue
× Interest burden Earnings before tax (EBT)
Operating profit (EBIT)
× Tax burden Net income Earnings before tax
(EBT)
× Asset turnover Revenue Average assets
× Financial leverage Average assets Average equity
30 Chapter 3 Presentation of Financial Statements (IAS 1)
TABLE 3.4 Combining Ratios for Specific Analytical Purposes Ratio used
Debt/equity Dividend payout
rate
Return on equity (ROE)
Market price to book rate value
Interest coverage RR (retention
rate)
Current ratio Total debt ratio Dividend payout Asset size Market value of stock
Equity turnover Net profit
margin (ROE)
Total debt ratio Working capital to sales ratio
Return on assets (ROA)
Par value of bonds
Chapter 3 Presentation of Financial Statements (IAS 1) 31
of analysis Liquidity Liquidity
Solvency
(activity) Growth Growth ProfitabilityProfitability
External External liquidity liquidity Cash flow to total
debt
Current Cash flow to total Cash flow to total debt
Total debt ratio EBIT to total EBIT to total
assets
Quick (acid test) Operating Operating leverage
32 Chapter 3 Presentation of Financial Statements (IAS 1)
3.7 COMMENTARY
3.7.1 The IASB and the U.S. FASB are currently collaborating on a project to develop a new, joint standard for financial statement presentation. This is part of the IASB’s project to align IFRS with U.S. GAAP. Under IFRSs, the new standard will replace the existing IAS 1 and IAS 7. The boards are conducting the project in three phases:
– Phase A—A complete set of financial statements and requirements for presenting comparative information. This phase has been completed and incorporated in the currently effective version of IAS 1.
– Phase B—Work on more fundamental issues regarding the presentation of informa-tion in the financial statements. A discussion paper “Preliminary View on Financial Statement Presentation” was released in October 2008 and the comment period closed in April 2009. In the discussion paper the boards propose a presentation model that requires an entity to present information about its business activities (the way it creates value) and its financing activities (how it finances/funds those activi-ties) separately. The boards are currently considering the comments received.
– Phase C—Presentation and display of interim financial information in U.S. GAAP.
The IASB may also reconsider the requirements of IAS 34 Interim Financial Reporting.
3.7.5 As mentioned previously the management of publicly traded companies in certain jurisdictions, such as the United States, is required to provide a discussion and analysis of the company’s operations and prospects. The publication of management commentary is cur-rently not a requirement of IFRSs. The IASB released an exposure draft on management com-mentary in June 2009, with a comment period that closed on March 1, 2010.
3.7.6 The proposals presented in the exposure draft will not result in an IFRS. It will not be a requirement for an entity to comply with the framework for the preparation and presenta-tion of management commentary as a condipresenta-tion for asserting compliance with IFRS.
Chapter 3 Presentation of Financial Statements (IAS 1) 33
3.8 IMPLEMENTATION DECISIONS
The following table sets out some of the strategic and tactical decisions that should be con-sidered when applying IAS 1.
Strategic decisions Tactical decisions Problems to overcome
Determining what information will be presented on the face of the statement of financial position, income statement, and statement of changes in equity, and what information will be presented in the notes to the annual financial statements.
When determining what information will be presented on the face of the various statements and in the notes to the financial statements, management needs to ensure that their presentation is in line with the presentation of other entities within the same industry.
Ensuring that the financial reporting and management reporting systems are adequate to obtain all the information that is required to be presented in terms of IAS 1.
IAS 1 permits presentation on the statement of financial position based on either a current and noncurrent split or on a liquidity basis.
Management should determine what information to present on the face of the statement of financial position, income statement, statement of changes in equity and what information to present in the notes to the annual financial statements. Industry practice and user requirements are useful guidelines.
Where the current/noncurrent basis of presentation is selected, management needs to define what is regarded as current and noncurrent based on the entity’s normal operating cycle and the guidance provided in IAS 1.
Ensuring that the financial reporting system is adequate to obtain the information required regarding the amounts expected to be recovered or settled within 12 months after the reporting period and more than 12 months after the reporting period.
What information will be presented as forming part of the financial statements and what supplementary information required by certain users will also be presented in the annual report.
Management, in conjunction with the external auditors, should decide what level of assurance will be applied to additional information presented in the annual report.
The annual report should clearly distinguish between information that forms part of the annual financial statements and is subject to sign-off by the auditors. This may necessarily interfere with the flow of commentary.
IAS 1 also provides a choice to present either a single statement of comprehensive income or two statements (an income statement and separate statement of comprehensive income). This decision is primarily dependent on industry practice although entity specific issues may also be relevant
Whether the components of other comprehensive income will be presented net of the related tax effects or gross of the related tax effects, with a single line presented for the tax effects, on the face of the statement of other comprehensive income.
Management reporting systems should be able to provide the following information for each component of comprehensive income:
• gains or losses arising in the current year;
• reclassification adjustments recognized in profit or loss for the period; and
• related income tax effect.
What accounting policies are considered to be significant. Based on this analysis determine which accounting policies will be disclosed in the annual financial statements.
When considering whether a specific accounting policy should be presented, consider whether it would assist users in understanding how transactions, other events, and conditions are reflected in the financial statements.
Consideration should also be given to whether the disclosure of certain accounting policies is required by a specific standard.
34 Chapter 3 Presentation of Financial Statements (IAS 1)