C orpor at e R epor ting (Int
ernational and Unit
ed King dom) Study T ext
A
CC
A
P2
For e xams up t o June 2015ACCA
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Paper P2Corporate Reporting (International and United Kingdom)
This ACCA Study Text for Paper P2 Corporate Reporting (International and United Kingdom) has been comprehensively reviewed by the ACCA examining team. This review guarantees appropriate depth and breadth of content and comprehensive syllabus coverage.
In addition to ACCA examining team reviewed material you get:
• A user-friendly format for easy navigation • Exam focus points describing what the examining team will want you to do
• Regular Fast Forward summaries emphasising the key points in each chapter
• Questions and quick quizzes to test your understanding
• A practice question bank containing exam- standard questions with answers
• A full index
• All you need in one book
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Paper P2
Corporate Reporting
(International and United Kingdom)
Study Text for exams
up to June 2015
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Study Text
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PAPER P2
CORPORATE REPORTING
(INTERNATIONAL AND
UNITED KINGDOM)
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Contents
Page
Introduction
Helping you to pass – the ONLY P2 Study Text reviewed by the examiner! v
Studying P2 vii
Important note for UK students vii
The exam paper xxxiii
Part A Regulatory and ethical framework
1 Financial reporting framework 3
2 Professional and ethical duty of the accountant 27
3 Environmental and social reporting 57
Part B Accounting standards
4 Non-current assets 87
5 Employee benefits 133
6 Income taxes 155
7 Financial instruments 181
8 Share-based payment 231
9 Provisions, contingencies and events after the reporting period 245
10 Related parties 261
11 Leases 269
Part C Group financial statements
12 Revision of basic groups 291
13 Complex groups and joint arrangements 337
14 Changes in group structures 363
15 Continuing and discontinued interests 393
16 Foreign currency transactions and entities 401
17 Group statements of cash flows 423
Part D Performance reporting
18 Performance reporting 449
19 Current developments 507
20 Reporting for specialised entities 523
21 Reporting for small and medium-sized entities 549
Practice question and answer bank
561Mathematical tables
647Index
651A note about copyright
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Helping you to pass – the BPP Learning Media Study
Text reviewed by the ACCA examining-team!
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As ACCA’s Approved Learning Partner – content, BPP Learning Media gives you the opportunity to use
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The PER alert
Before you can qualify as an ACCA member, you not only have to pass all your exams but also fulfil a three year 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 different performance objectives, we have introduced the ‘PER alert’ feature. You will find this feature throughout the Study Text to remind you that what you
are learning to pass your ACCA exams is equally useful to the fulfilment of the PER requirement.
Your achievement of the PER should now be recorded in your on-line My Experience record.
Tackling studying
Studying can be a daunting prospect, particularly when you have lots of other commitments. The
different features of the 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 Texts are completely focused on helping you pass your exam.
Our advice on Studying P2 outlines the content of the paper, the necessary skills you are expected to be
able to demonstrate 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 were
examined, or how they might be examined in the future.
Using the Syllabus and Study Guide
You can find the syllabus and Study Guide on pages ix – xxxii of this Study Text
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 Exam Question Bank, as well as Quick Quizzes at the end of each chapter to test your knowledge of the chapter content.
Chapter features
Each chapter contains a number of helpful features to guide you through each topic.
Topic list
Topic list Syllabus reference What you will be studying in this chapter and the relevant
section numbers, together with ACCA syllabus references.
Introduction
Puts the chapter content in the context of the syllabus as a whole.Study Guide
Links the chapter content with ACCA guidance.Exam Guide
Highlights how examinable the chapter content is likely to be and the ways in which it could be examined.Knowledge brought forward from earlier studies What you are assumed to know from previous studies/exams.
Summarises the content of main chapter headings, allowing you to preview and review each section easily.
Examples
Demonstrate how to apply key knowledge and techniques.Key terms
Definitions of important concepts that can often earn you easy marks in exams.Exam focus points
When and how specific topics were examined, or how they may be examined in the future.Formula to learn
Formulae that are not given in the exam but which have to be learnt.Gives you a useful indication of syllabus areas that closely relate to performance objectives in your Practical Experience Requirement (PER).
Question
Gives you essential practice of techniques covered in the chapter.Case Study
Real world examples of theories and techniques.Chapter Roundup
A full list of the Fast Forwards included in the chapter,providing an easy source of review.
Quick Quiz
A quick test of your knowledge of the main topics in the chapter.Exam Question Bank
Found at the back of the Study Text with more comprehensive chapter questions. Cross referenced for easy navigation.Studying P2
Paper P2 Corporate Reporting is a tough paper, reflecting the demands that will be made upon the professional accountant in his or her working life. At the Fundamentals level, you will have studied the essentials of financial statement preparation and analysis, including those of group accounts. At the Professional level, these essentials will be assumed knowledge. You will be required to apply them, assuming the role of a professional adviser and analyst to the management as well as the shareholders and other stakeholders.
What P2 is about
The P2 syllabus comprises eight main areas:
A The professional and ethical duty of the accountant B The financial reporting framework
C Reporting the financial performance of entities D Financial statements of groups of entities E Specialised entities
F Implications of changes in accounting regulation on financial reporting G The appraisal of financial performance and position of entities
H Current developments
There is, of course, some overlap between these areas. For example, if you are discussing current developments (H), you might be talking about the proposed changes to accounting for business combinations (D) and considering the implications of changes in accounting regulation (F) and perhaps even the ethical duty of the accountant to report those changes fairly and accurately (A).
Skills you have to demonstrate
At the Fundamentals level, the questions would be more easily categorised into syllabus areas. However, at this level you may need to demonstrate knowledge, skills and thinking from outside the syllabus area that the question seems to be about on the surface. The examiner has stated:
Students should be capable of relating professional issues to relevant concepts and practical situations. The evaluation of alternative accounting practices and the identification and
prioritisation of issues will be a key element of the paper. Professional and ethical judgement will need to be exercised, together with the integration of technical knowledge when addressing corporate reporting issues in a business context.
So the paper is not predictable. That said, clear guidance has been given. The compulsory Section A question, worth 50 marks, will always be on group accounts. It will also deal with issues in financial reporting and will be case study based. In Section B, questions could be on any area of the syllabus, but we have been told that two questions will be scenario based and one question will be an essay. You have a choice of two from three.
Increasingly, questions are discursive rather than numerical, so it is vital that you get practice at answering this type of question.
Important note for UK students
If you are sitting the UK P2 paper you will be studying under International standards and up to 20 marks will be for comparisons between International and UK GAAP. The ACCA UK Syllabus and Study Guide gives the following advice:
International Financial Reporting Standards (IFRS) are the main accounting standards examined in the preparation of financial information. The key differences between UK GAAP and International Financial Reporting Standards are looked at on a subject by subject basis. The comparison between IFRS and UK GAAP will be based on the new UK GAAP as set out in FRSs 100-102, so the standard by standard
comparisons that appeared in previous editions of this study guide are now combined in outcome C11 (d): Discuss the key differences between the IFRS for SMEs and UK GAAP.
This Study Text covers all the topics you need to know under International Financial Reporting Standards. An online supplement will be available at www.bpp.com/learning-media, covering the additional UK issues.
Exam technique for P2
Do not be needlessly intimidated
There is no shortcut to passing this exam. It looks very difficult indeed, and many students wonder if they will ever pass. But many do. How do they do this?
Easy marks
All the questions are demanding, but there are many easy marks to be gained. Suppose, for example, you had a consolidated statement of cash flows with a disposal, some foreign exchange complications and an impairment calculation. There will be easy marks available simply for the basic cash flow aspects, setting out the proforma, setting up your workings, presenting your work neatly. If you recognise, as you should, that the disposal needs to be taken into account, of course you will get marks for that, even if you make a mistake in the arithmetic. If you get the foreign exchange right, so much the better, but you could pass the question comfortably omitting this altogether. If you’re short of time, this is what you should do.
Be ruthless in ignoring the complications
Look at the question. Within reason, if there are complications – often only worth a few marks – that you know you will not have time or knowledge to do, cross them out. It will make you feel better. Than tackle the bits you can do. This is how people pass a seemingly impossible paper.
Answer all questions and all parts of questions
The examiner frequently comments that students don't do this, so they miss easy opportunities to gain marks.
Be ruthless in allocating your time
At BPP, we have seen how very intelligent students do one almost perfect question, one averagely good and one sketchy. For a fifty mark question, the first twenty marks are the easiest to get. Then you have to push it up to what you think is thirty to get yourself a clear pass. For a twenty-five mark question, the first eight to ten marks are the easiest to get, and then you must try to push it up to fifteen.
Do your best question either first or second, and the compulsory question either first or second. The compulsory question, being on groups, will always have some easy marks available for consolidation techniques.
Syllabus and Study Guide
The P2 syllabus and study guide can be found below.
The exam paper
The paper will comprise two sections.
Number of marks
Section A: 1 compulsory case study 50
Section B: Choice of 2 from 3 questions (25 marks each) 50
100
Section A will be a scenario-based question which will include:
The preparation of consolidated financial statements (including consolidated statements of cash flows) with adjustments on other syllabus areas
A written part normally covering a particular accounting treatment and ethical and social issues in financial reporting.
Section B will normally include:
Two scenario or case study-based questions (covering a range of standards and syllabus topics, one usually in the context of a particular industry)
A essay-style discussion question, often encompassing current developments in corporate reporting, which may also include some short calculations.
Analysis of past papers – by sitting
December 2013
Section A
1 Consolidated statement of cash flows with acquisition of subsidiary and adjustments for deferred tax, a government grant and a pension plan; classification of cash flows; ethics
Section B
2 Revenue recognition; impairment loss; sale and leaseback
3 Specialised industry question set in a bank, covering debt versus equity, hedging and the application of IFRS 10 in determining which party is the acquirer
4 IAS 8: use of judgement in selecting accounting policies; prior period errors (three scenarios)
June 2013
Section A
1 Consolidated statement of financial position with a ‘D’-shaped group; comparison of methods for valuing non-controlling interest; ethics
Section B
2 Segment reporting, revenue recognition, provisions and property-related matters
3 In-depth analysis of whether a lease was a finance lease, a discontinued operation and fair value of an investment property
December 2012
Section A
1 Consolidated statement of financial position with sub-subsidiary, associate and disposal group; discussion on IFRS 5; ethical considerations of accounting treatment
Section B
2 Government grant; foreign exchange and cash flows; IFRS 10 and control; taxation and prior period adjustment
3 Investment property; leasing (substance of transaction); provision; impairment
4 IFRS 13 Fair value measurement: principles, three-level hierarchy; IFRS 13 fair valuing of asset and
liability with computations
June 2012
Section A
1 Consolidated statement of financial position with business combination achieved in stages and joint operation; de-recognition of financial asset; ethics
Section B
2 Sale and leaseback, defined benefit pension plan, cash-settled share-based payment and contingent liability in the context of a business combination
3 Measuring fair value, impairment of goodwill, deferred tax liabilities and the fair value option for an accounting mismatch; shares as financial liability or equity
4 Changing rules on provisions (discussion and calculation)
December 2011
Section A
1 Consolidated statement of financial position with business combination achieved in stages; segment reporting; ethics
Section B
2 Internal reconstruction
3 Intangible assets and impairment testing rules 4 Revenue recognition: principles and application
June 2011
Section A
1 Groups with a foreign subsidiary, other adjustments and the remainder on ethical issues
Section B
2 Specialised industry question with IFRS 1, IFRS 3 intangible assets and restructuring plans and provisions
3 Specialised industry question with reclassification of long-term debt, correction of an error, revenue recognition, related party disclosures and classification of a employee benefit plan
4 Change to IFRS 9 rules for financial assets; change to expected loss model for impairment of financial assets
December 2010
Section A
1 Consolidated statement of cash flows; ethics of changing method
Section B
2 Share-based payment; derivatives
3 Provisions, contingent liability, significant influence; share-based payment 4 Small and medium-sized entities
June 2010
Section A
1 Groups with complex group and two disposals and the remainder on ethical issues
Section B
2 A range of topics including deferred tax, impairments, a deemed disposal/discontinuation and retirement benefits
3 Specialised industry with derivatives, hedge accounting, brands and the purchase of retail outlets through companies
4 Flaws in lease accounting; application of Framework, sale and leaseback
December 2009
Section A
1 Consolidated statement of financial position with changes in group structure
Section B
2 Impairment: discussion and calculation
3 Revenue recognition; recognition of assets; joint control 4 Complexity in financial instruments
June 2009
Section A
1 Business combination achieved in stages; ethics
Section B
2 Financial instruments: fair value, convertible bonds, derecognition, foreign subsidiary’s debt, interest on employee loan
3 Revenue recognition, assets
4 Employee benefits: problems of current treatments
December 2008
Section A
1 Group statement of cash flows with adjustments and interpretation; ethics
Section B
2 Changes to accounting for business combinations 3 Tangibles, intangibles and revenue recognition 4 Accounting standards and disclosure
June 2008
Section A
1 Groups with a foreign subsidiary, other adjustments and the remainder on ethical issues
Section B
2 Segment reporting and revenue recognition in a specialised industry 3 Retirement benefits and financial instruments
4 Transition to IFRS
December 2007
Section A
1 Piecemeal acquisition; factored receivables; environmental provision and report; ethical and social attitudes
Section B
2 Employee benefits; provisions
3 Discontinued operations; deferred tax; impairment; lease 4 Conceptual Framework
Pilot paper
Section A
1 Statement of cash flows; criteria for consolidation; ethical behaviour
Section B
2 Environmental provision; leasing; EARP; share-based payment 3 Deferred tax with pension scheme and financial instruments 4 Adoption of IFRS; proposals on business combinations
Analysis of past papers – by syllabus topic
The table below provides details of when each element of the syllabus has been examined and the question number and section in which each element appeared. Further details can be found in the Exam Focus Points in the relevant chapters.
Covered in Text
chapter paper Pilot
June 2011 Dec 2011 June 2012 Dec 2012 June 2013 Dec 2013
THE PROFESSIONAL AND ETHICAL DUTY OF THE ACCOUNTANT
3
Professional behaviour and compliance with accounting standards
Q1(b) Q1(b) Q1(c) Q1(b) Q1(c) Q1(b) Q1(b)
3 Ethical requirements of corporate reporting and the consequences of unethical behaviour
Q1(c) Q1(b) Q1(b) Q1(c) Q1(c) Q1(c)
3 Social responsibility Q4
THE FINANCIAL REPORTING FRAMEWORK
1 The contribution and limitations of financial statements in meeting users' and capital markets' needs 1
The applications, strengths and weaknesses of an accounting framework
Critical evaluation of principles and practices
– Revenue recognition 3(b) Q4 Q2 Q2
1
– Substance over form issues Q1(a)
REPORTING THE FINANCIAL PERFORMANCE OF ENTITIES
18 Performance reporting
Non-current assets
– Property, plant and equipment Q1(a) 1(a) Q2, Q3
– Intangible assets Q1(a),
3(c)
Q2(c) Q1(a) Q3
Q1(a)
– Impairment Q1(a) Q1(a), Q3 Q1(a), Q3 Q1(a), Q3 Q2
– Investment properties Q1(a) Q3 Q3
– Government grants
4
– Borrowing costs
7 Financial instruments Q1(a), Q2, Q3 Q4 Q1(a), Q3 Q1(a), Q3 Q1(a), Q3 Q3
11 Leases Q1, Q2 Q2 Q3 Q2
18 Segment reporting Q1(b) Q2
5 Employee benefits Q1(a) Q3(d) Q1(a) Q2
6 Income taxes Q1(a) Q3 Q3
Provisions, contingencies and
events after the reporting period Q2(d) Q2 Q3, Q4
– Provisions, contingency
liabilities and contingent assets Q3 Q4 Q2
9
– Events after the reporting period Q3
10 Related parties Q3 Q3(c)
8 Share-based payment Q2, Q3 Q2
Covered in Text
chapter paper Pilot
June 2011 Dec 2011 June 2012 Dec 2012 June 2013 Dec 2013 FINANCIAL STATEMENTS OF GROUPS OF ENTITIES
Group accounting including
statements of cash flow Q3
– Complex groups Q1(a) Q1(a)
– Associates Q1(a) Q1(a)
– Joint ventures Q3 Q1(a) Q2
12, 13, 17
– Group statements of cash flows Q1 Q2 Q1(a)
13 Continuing and discontinued interests
– Discontinued operations Q3
– Non-current assets held for sale Q1(a), (b)
Changes in group structure – Mid year acquisitions
– Disposals Q1(a), (b)
14
– Business combinations
achieved in stages Q1(a) Q1(a) Q1(a) Q 1(a)
– Group reorganisations Q2
Foreign transactions and entities
– Foreign currency transactions Q1(a) Q2 16
– Foreign subsidiaries
SPECIALISED ENTITIES
20 Financial reporting in specialised, not-for-profit and public sector
entities Q3 Q2, Q3 Q3
IMPLICATIONS OF CHANGES IN ACCOUNTING REGULATION ON FINANCIAL REPORTING
21 The effect of changes in accounting standards on accounting systems
12 Proposed changes to accounting standards Q2(a), (b)
THE APPRAISAL OF FINANCIAL PERFORMANCE AND POSITION ENTITIES
18 The creation of suitable accounting policies Q4
18 Analysis and interpretation of financial information and measurement of performance
Q4
CURRENT DEVELOPMENTS
3, 19 Environmental and social reporting 19 Convergence between national and international reporting standards 19 Comparison of national reporting requirements
Current reporting issues – Conceptual Framework – Fair value measurement
– Management commentary
1, 6, 19
– Pensions Q1(a)
Regulatory and ethical
framework
P
A
R
T
A
Topic list Syllabus reference
1 International Financial Reporting Standards (IFRSs) A1
2 Corporate governance C1
3 Conceptual framework B2
4 Revenue recognition A2, B1
Financial reporting
framework
Introduction
Welcome to the Corporate Reporting paper using International Financial Reporting Standards (IFRS). This paper is about thinking and applying your knowledge of the IFRS. Most of the standards and topics have been covered in your earlier studies. However, at the Professional level, you need to think critically about them and show an understanding of topical issues. In the exam, you will need to put yourself in the role of an adviser to a business entity, using your knowledge to give practical advice.
In the exam, you will often be required to consider the impact of proposed changes to IFRS. Any such proposals are dealt with in this Study Text within the topic to which they relate.
Study guide
Intellectual level
A1 Professional behaviour and compliance with accounting standards
(a) Appraise the ethical and professional issues in advising on corporate
reporting 3
(b) Assess the relevance and importance of ethical and professional issues in
complying with accounting standards 3
A2 Ethical requirements of corporate reporting and the consequences of unethical behaviour
(a) Appraise the potential ethical implications of professional and managerial
decisions in the preparation of corporate reports 3
B1 The applications, strengths and weaknesses of an accounting framework
(a) Evaluate the valuation models adopted by standard setters
C1 Performance reporting
(a) Prepare reports relating to corporate performance for external stakeholders 3
B2 The applications, strength and weaknesses of an accounting framework
(a) Evaluate the valuation models adopted by standard setters 3 (b) Discuss the use of an accounting framework in underpinning the production
of accounting standards
3 (c) Assess the success of such a framework in introducing rigorous and
consistent accounting standards
3
Exam guide
This chapter is partly background knowledge to set the scene about the reporting framework before you look at ethical issues. It also discusses the Management Commentary and the Conceptual Framework. The examiner has stated that revenue recognition is important.
1 International Financial Reporting Standards (IFRSs)
One of the competences you need to fulfil Objective 10 of the Practical Experience Requirement (PER) is to recognise and apply the external legal and professional framework and regulations to financial reporting. You can apply the knowledge you obtain from this section of the Text to demonstrate this competence. To date the IASB has the following standards in issue.
1.1 Current accounting standards and documents examinable at P2
The documents listed as being examinable are the latest that were issued before 1 September 2013, and will be examinable in December 2014 and June 2015. This Study Text is for exams in December 2014 and June 2015.
The study guide offers more detail guidance on the depth and level at which the examinable documents will be examined. The study guide should be read in conjunction with the examinable documents list.
Title Date issued International Accounting Standards (IASs) / International
Financial Reporting Standards (IFRSs)
IAS 1 Presentation of financial statements Dec 03, rev. Sept
07 and June 11
IAS 2 Inventories Dec 03
IAS 7 Statement of cash flows Dec 92
IAS 8 Accounting policies, changes in accounting estimates and errors
Dec 03
IAS 10 Events after the reporting period Dec 03
IAS 12 Income taxes Nov 00
IAS 16 Property, plant and equipment Dec 03
IAS 17 Leases Dec 03
IAS 18 Revenue Dec 93
IAS 19 Employee benefits Nov 00, revised
2011 IAS 20 Accounting for government grants and disclosure of
government assistance
Jan 95 IAS 21 The effects of changes in foreign exchange rates Dec 03
IAS 23 Borrowing costs Dec 93
IAS 24 Related party disclosures Dec 03
IAS 27 Separate financial statements Dec 03, revised
2011
IAS 28 Investments in associates and joint ventures Dec 03, revised 2011
IAS 32 Financial Instruments: presentation Dec 03
IAS 33 Earnings per share Dec 03
IAS 34 Interim financial reporting Feb 98
IAS 36 Impairment of assets June 98
IAS 37 Provisions, contingent liabilities and contingent assets Sept 98
IAS 38 Intangible assets Sept 98
IAS 39 Financial Instruments: recognition and measurement Dec 03
IAS 40 Investment property Dec 03
IAS 41 Agriculture Feb 01
IFRS 1 First-time adoption of International Financial Reporting Standards
June 03
IFRS 2 Share-based payment Feb 04
IFRS 3 Business combinations Mar 04, revised
Jan 08 IFRS 5 Non-current assets held for sale and discontinued operations Mar 04
IFRS 7 Financial instruments: disclosures Aug 05
IFRS 8 Operating segments Nov 06
Title Date issued
IFRS 10 Consolidated financial statements May 11
IFRS 11 Joint arrangements May 11
IFRS 12 Disclosure of interests in other entities May 11
IFRS 13 Fair value measurement May 11
IFRS For Small and Medium-sized Entities July 09
Other Statements
Conceptual Framework for Financial Reporting Practice Statement: Management Commentary
Consultation Draft of the International Integrated Reporting Framework
EDs, Discussion Papers and Other Documents
ED Financial instruments: Expected credit losses ED Revenue from contracts with customers ED Leases
ED Sale or contribution of assets between an investor and its associate or joint venture Draft IFRS IFRS 9 Chapter 6 Hedge accounting
ED Equity method: share of other net asset changes
ED Improvements to IFRSs
ED Acquisition of an interest in a joint operation
Discussion Paper A review of the Conceptual Framework for Financial Reporting
Note. The accounting of financial assets and financial liabilities is accounted for in accordance with
IFRS 9 to the extent that this standard was in issue as at 1 September 2013. For any elements
of the study guide deemed as examinable and not covered by IFRS 9, these elements should be dealt with by studying IAS 39.
2 Corporate governance
Corporate governance has been important in recent years and in the current syllabus it is important in the
context of ethical behaviour.
One of the major business debates recently is about corporate governance, particularly in the UK and the USA.
Corporate governance is the system by which companies are directed and controlled. (Cadbury Report)
The trigger for this debate was the collapse of major international companies during the 1980s, including
Maxwell, BCCI and Polly Peck. These collapses were often unexpected, and dubious (or even fraudulent) activities were sometimes attributed to their owners and managers. These events represented a nasty shock for countries, such as the UK and the USA, that felt they had well-regulated markets and strong company legislation. It became obvious, however, that part of the problem was the way in which regulation was spread between different national authorities for these global conglomerates, so that no
one national authority had the whole picture of the affairs of such companies, nor full powers over the whole of the business.
Individual countries began to develop better guidelines for corporate governance, and efforts have been
made to produce an international standard on corporate governance.
Key term
Corporate governance is covered in other papers, so is not examinable in P2. This is for background information only.
3 Conceptual framework
12/07
The 1989 Framework for the Preparation and Presentation of Financial Statements was replaced in 2010 by the Conceptual Framework for Financial Reporting. This is the result of a joint project with the FASB.
3.1 The search for a conceptual framework
A conceptual framework, in the field we are concerned with, is a statement of generally accepted
theoretical principles which form the frame of reference for financial reporting. These theoretical principles provide the basis for the development of new accounting standards and the evaluation of those already in existence.
The financial reporting process is concerned with providing information that is useful in the business and economic decision-making process. Therefore a conceptual framework will form the theoretical basis for determining which events should be accounted for, how they should be measured and how they should be communicated to the user.
Although it is theoretical in nature, a conceptual framework for financial reporting has highly practical final aims.
The danger of not having a conceptual framework is demonstrated in the way some countries' standards
have developed over recent years; standards tend to be produced in a haphazard and fire-fighting approach. Where an agreed framework exists, the standard-setting body acts as an architect or designer,
rather than a fire-fighter, building accounting rules on the foundation of sound, agreed basic principles. The lack of a conceptual framework also means that fundamental principles are tackled more than once in different standards, thereby producing contradictions and inconsistencies in basic concepts, such as those of prudence and matching. This leads to ambiguity and it affects the true and fair concept of financial reporting.
Another problem with the lack of a conceptual framework has become apparent in the USA. The large number of highly detailed standards produced by the Financial Accounting Standards Board (FASB) has created a financial reporting environment governed by specific rules rather than general principles. This would be avoided if a cohesive set of principles were in place.
A conceptual framework can also bolster standard setters against political pressure from various 'lobby groups' and interested parties. Such pressure would only prevail if it was acceptable under the conceptual framework.
3.2 Advantages of a conceptual framework
The advantages arising from using a conceptual framework may be summarised as follows.
(a) The situation is avoided whereby standards are being developed on a piecemeal basis, where a
particular accounting problem is recognised as having emerged, and resources were then channelled into standardising accounting practice in that area, without regard to whether that particular issue was necessarily the most important issue remaining at that time without standardisation.
(b) As stated above, the development of certain standards (particularly national standards) have been subject to considerable political interference from interested parties. Where there is a conflict of interest between user groups on which policies to choose, policies deriving from a conceptual framework will be less open to criticism that the standard-setter buckled to external pressure.
Exam focus
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Key term
(c) Some standards may concentrate on the statement of profit or loss and other comprehensive income (formerly statement of comprehensive income, see Chapter 18 for the details of the change of name) whereas some may concentrate on the valuation of net assets (statement of financial position).
3.3 Counter-argument
A counter-argument might be as follows:
(a) Financial statements are intended for a variety of users, and it is not certain that a single conceptual framework can be devised which will suit all users.
(b) Given the diversity of user requirements, there may be a need for a variety of accounting standards, each produced for a different purpose (and with different concepts as a basis).
(c) It is not clear that a conceptual framework makes the task of preparing and then implementing standards any easier than without a framework.
Before we look at the IASB's attempt to produce a conceptual framework, we need to consider another term of importance to this debate: generallyaccepted accounting practice; or GAAP.
3.4 Generally Accepted Accounting Practice (GAAP)
This term has sprung up in recent years and its signifies all the rules, from whatever source, which govern accounting. In individual countries this is seen primarily as a combination of:
National corporate law National accounting standards Local stock exchange requirements
Although those sources are the basis for the GAAP of individual countries, the concept also includes the effects of non-mandatory sources such as:
International financial reporting standards Statutory requirements in other countries
In many countries, like the UK, GAAP does not have any statutory or regulatory authority or definition, unlike other countries, such as the USA. The term is mentioned rarely in legislation, and only then in fairly limited terms.
3.5 GAAP and a conceptual framework
A conceptual framework for financial reporting can be defined as an attempt to codify existing GAAP in order to reappraise current accounting standards and to produce new standards.
3.6 The IASB Conceptual Framework
The IASB Framework for the Preparation and Presentation of Financial Statements was produced in 1989 and is gradually being replaced by the new Conceptual Framework for Financial Reporting. This is the result of an IASB/FASB joint project and is being carried out in phases. The first phase, comprising Chapters 1 and 3, was published in September 2010. Chapter 2 entitled ‘The reporting entity’ has not yet been published. The current version of the Conceptual Framework includes the remaining chapters of the 1989 Framework as Chapter 4.
The Conceptual Framework for Financial Reporting is currently as follows: Chapter 1: The objective of general purpose financial reporting
Chapter 2: The reporting entity (to be issued)
Chapter 3: Qualitative characteristics of useful financial information Chapter 4: Remaining text of the 1989 Framework:
Underlying assumption The elements of financial statements
Recognition of the elements of financial statements Measurement of the elements of financial statements Concepts of capital and capital maintenance
You have studied the 1989 Framework in your earlier studies. We will now look at some of these sections in more detail.
3.7 Introduction to the Conceptual Framework
The Introduction provides a list of the purposes of the Conceptual Framework:
(a) To assist the Board in the development of future IFRSs and in its review of existing IFRSs.
(b) To assist the Board in promoting harmonisation of regulations, accounting standards and
procedures relating to the presentation of financial statements by providing a basis for reducing the number of alternative accounting treatments permitted by IFRSs.
(c) To assist national standard-setting bodies in developing national standards.
(d) To assist preparers of financial statements in applying IFRSs and in dealing with topics that have
yet to form the subject of an IFRS.
(e) To assist auditors in forming an opinion as to whether financial statements comply with IFRSs.
(f) To assist users of financial statements in interpreting the information contained in financial
statements prepared in compliance with IFRSs.
(g) To provide those who are interested in the work of the IASB with information about its approach to
the formulation of IFRSs.
The Conceptual Framework is not an IFRS and so does not overrule any individual IFRS. In the (rare) case of conflict between an IFRS and the Conceptual Framework, the IFRS will prevail.
3.8 Chapter 1: The Objective of General Purpose Financial Reporting
The Conceptual Framework states that:
‘The objective of general purpose financial reporting is to provide information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.’
These users need information about: The economic resources of the entity;
The claims against the entity; and
Changes in the entity’s economic resources and claims
Information about the entity’s economic resources and the claims against it helps users to assess the
entity’s liquidity and solvency and its likely needs for additional financing.
Information about a reporting entity’s financial performance (the changes in its economic resources and claims) helps users to understand the return that the entity has produced on its economic resources.
This is an indicator of how efficiently and effectively management has used the resources of the entity and is helpful in predicting future returns.
The Conceptual Framework makes it clear that this information should be prepared on an accruals basis.
Information about a reporting entity’s cash flows during a period also helps users assess the entity’s ability to generate future net cash inflows and gives users a better understanding of its operations.
3.9 Chapter 3: Qualitative characteristics of useful financial information
Qualitative characteristics are attributes that make financial information useful to users.
Chapter 3 distinguishes between fundamental and enhancing qualitative characteristics, for analysis
purposes. Fundamental qualitative characteristics distinguish useful financial reporting information from information that is not useful or misleading. Enhancing qualitative characteristics distinguish more useful information from less useful information.
The two fundamental qualitative characteristics are:
(a) Relevance: Relevant information has predictive value or confirmatory value, or both. It is capable
of making a difference in the decisions made by users.
The relevance of information is affected by its nature and its materiality.
(b) Faithful representation: Information must be complete, neutral and free from error (replacing
'reliability').
Financial reports represent economic phenomena in words and numbers. To be useful, financial
information must not only represent relevant phenomena but must faithfully represent the
phenomena that it purports to represent.
A complete depiction includes all information necessary for a user to understand the phenomenon being
depicted, including all necessary descriptions and explanations.
A neutral depiction is without bias in the selection or presentation of financial information. This means
that information must not be manipulated in any way in order to influence the decisions of users.
Free from error means there are no errors or omissions in the description of the phenomenon and no
errors made in the process by which the financial information was produced. It does not mean that no inaccuracies can arise, particularly where estimates have to be made.
Substance over form
This is not a separate qualitative characteristic under the Conceptual Framework. The IASB says that to
do so would be redundant because it is implied in faithful representation. Faithful representation of a
transaction is only possible if it is accounted for according to its substance and economic reality.
3.9.1 Enhancing qualitative characteristics
Comparability
Comparability is the qualitative characteristic that enables users to identify and understand similarities in,
and differences among, items. Information about a reporting entity is more useful if it can be compared with similar information about other entities and with similar information about the same entity for another period or another date.
Consistency, although related to comparability, is not the same. It refers to the use of the same methods
for the same items (ie consistency of treatment) either from period to period within a reporting entity or in a single period across entities.
The disclosure of accounting policies is particularly important here. Users must be able to distinguish
between different accounting policies in order to be able to make a valid comparison of similar items in the accounts of different entities.
Comparability is not the same as uniformity. Entities should change accounting policies if those policies
become inappropriate.
Verifiability
Verifiability helps assure users that information faithfully represents the economic phenomena it purports
to represent. It means that different knowledgeable and independent observers could reach consensus that a particular depiction is a faithful representation.
Timeliness
Information may become less useful if there is a delay in reporting it. There is a balance between timeliness and the provision of reliable information.
If information is reported on a timely basis when not all aspects of the transaction are known, it may not be complete or free from error.
Conversely, if every detail of a transaction is known, it may be too late to publish the information because it has become irrelevant. The overriding consideration is how best to satisfy the economic decision-making needs of the users.
Understandability
Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information diligently. Some phenomena are inherently complex
and cannot be made easy to understand. Excluding information on those phenomena might make the information easier to understand, but without it those reports would be incomplete and therefore
misleading. Therefore matters should not be left out of financial statements simply due to their difficulty as
even well-informed and diligent users may sometimes need the aid of an adviser to understand information about complex economic phenomena.
The cost constraint on useful financial reporting
This is a pervasive constraint, not a qualitative characteristic. When information is provided, its benefits must exceed the costs of obtaining and presenting it. This is a subjective area and there are other
difficulties: others, not the intended users, may gain a benefit; also the cost may be paid by someone other than the users. It is therefore difficult to apply a cost-benefit analysis, but preparers and users should be aware of the constraint.
3.9.2 Underlying assumption
The 1989 Framework identified two underlying assumptions – accruals and going concern.
The Conceptual Framework makes it clear that financial information should be prepared on an accruals basis but only identifies one underlying assumption – going concern.
3.10 Exposure Draft: Chapter 2: The Reporting Entity
This ED was issued in March 2010. It presents the IASB's consideration of issues in the development of a reporting entity concept for inclusion in the Conceptual Framework for Financial Reporting. There are four sections.
3.10.1 The reporting entity concept
This deals with general issues relating to the reporting entity concept. For example, it considers whether a precise definition of a reporting entity is necessary and whether a reporting entity must be a legal entity. The Board's conclusion at this stage is that the conceptual framework should broadly describe rather than precisely define a reporting entity as a circumscribed area of business activity of interest to present and potential equity investors, lenders and other creditors who cannot directly obtain the information they need in making decisions about providing resources to the entity and in assessing whether management
and the governing board of the entity have made efficient and effective use of the resources provided. Examples of reporting entities include a sole trader, corporation, trust, partnership, association and group.
3.10.2 When does an entity control another entity?
Consolidated financial statements are presented when control exists. Control exists where an entity has
the power to direct the activities of another entity to generate benefits or limit losses to itself. If control is shared, no consolidated financial statements need be presented.
3.10.3 Portion of an entity
A portion of an entity could qualify as a reporting entity if the economic activities of that portion can be distinguished objectively from the rest of the entity and financial information about that portion of the entity has the potential to be useful in making decisions about providing resources to that portion of the entity.
3.10.4 Financial statements other than consolidated financial statements
This section considers two issues: (a) Parent-only financial statements
(b) Combined financial statements. These would include information about two or more commonly
controlled entities
The IASB's preliminary conclusion is that (a) parent-only financial statements may be presented
provided they are included in the same financial report as consolidated financial statements and (b) combined financial statements might provide useful information about commonly controlled entities
as a group.
3.11 Potential problems
The UK's Accounting Standards Board (ASB) has highlighted a number of potential objections that may be made to the proposals.
(a) Users. The ASB is concerned about the proposal that the objective of financial reporting should
focus only on decision-usefulness, with stewardship being subsumed within this rather than being referred to as a specific part of the objective, or a separate objective. The ASB believes that stewardship should be a separate objective. The ASB is also concerned that the shareholder user perspective is being downplayed.
(b) Qualitative characteristics: what happens to reliability? The DP proposes replacing the
qualitative characteristic of 'reliability' in the current Framework with 'faithful representation'. The ASB believes that faithful representation is a softer notion which, when combined with a lack of specific identification of substance over form as a principle, could lead to a number of problems. (c) Financial reporting or financial statements. The ASB believes the boundary between financial
statements and financial reporting has not been properly considered.
(d) Limited in scope. The Discussion Paper is limited to private enterprises, rather than, as the ASB
believes it should be, encompassing the not-for profit sector.
(e) Too theoretical. This may alienate preparers and auditors of accounts.
(f) Too piecemeal. This is likely to lead to internal inconsistency.
(g) The entity perspective is adopted without an in-depth comparison with other possible
perspectives (such as the proprietary perspective, the parent shareholder perspective and other hybrid models).
(h) The differentiation between fundamental and enhancing qualitative characteristics is artificial.
(j) In the proposed 'Reporting Entity' chapter, the entity perspective and the definitions of control have been insufficiently thought through. In addition, the 'risks and rewards' model is not
adopted, thereby losing a useful concept.
3.12 Discussion Paper: Review of the Conceptual Framework
As the first step towards a revised Conceptual Framework, the IASB issued a Discussion Paper Review of
the Conceptual Framework in July 2013. The Paper deals with the following issues.
(a) Definitions of assets and liabilities. The current definitions of assets and liabilities require a
probable expectation of future economic benefits or resource outflow. The IASB argues that the definitions of assets and liabilities should not require an expected or probable inflow or outflow as it should be sufficient that a resource or obligation can produce or result in a transfer of economic benefits. While the IASB believes that the current definitions have worked well in the past, it wishes to refine them in order to place more emphasis on the fact that an asset is a resource and a liability is an obligation. In addition, the notion of probability will be removed from the definitions. The proposed definitions are:
(i) An asset is a present economic resource controlled by the entity because of past events.
(ii) A liability is a present obligation of the entity to transfer an economic resource because of
past events.
Under the Discussion Paper, constructive obligations would qualify as liabilities and certain avoidable obligations, for example directors’ bonuses, could qualify.
(b) Recognition and derecognition of assets and liabilities. Generally all assets and liabilities are to
be recognised unless recognising an asset or a liability is considered irrelevant or not sufficiently relevant to justify the costs for doing so or no measurement of the item would lead to a sufficiently faithful representation. For the first time, the Conceptual Framework will give guidance on
derecognition. Generally entities should derecognise an asset or liability, or part of an asset or liability, when it no longer meets the recognition criteria.
(c) Measurement. This section considers the objectives of different categories of measurement,
noting that the use of only one measurement basis for all assets and liabilities would not be appropriate. The measurement basis selected must provide the most relevant information in the statement of financial position and statement of profit or loss and other comprehensive income. (d) Equity. This is still defined as a residual interest (in the assets of the entity after deducting all its
liabilities). However, there is a new departure: entities will be required to provide further
information about the claims of different classes of equity in order to show dilution effects. Finally the section addresses the question whether the most subordinated class of instruments should be treated as equity if an entity has issued no equity instruments. See Paragraph 3.12.1 below for more detail on the distinction between equity and liabilities.
(e) Profit or loss and other comprehensive income. This part of the Discussion Paper tackles the
distinction between profit or loss and other comprehensive income. Both profit or loss and other comprehensive income would be retained and marked by subtotals or totals. By default, all income and expense will be shown in profit or loss unless relating to the remeasurement of assets and liabilities - these would normally be shown in other comprehensive income with recycling generally permitted. There is no detailed definition of profit or loss. See Paragraph 3.12.2 below for more detail.
(f) Presentation and disclosure. This section is new, with no equivalent in the current Conceptual
Framework. The aim is to provide a framework for disclosure to ensure that the information
disclosed is relevant to investors. In the short term, this will result in amendments to IAS 1 and a new focus on materiality and on disclosure requirements in current projects. In the longer term it is likely that a replacement will be proposed for IAS 1, IAS 7 and IAS 8. Examples of types of
and amounts recognised in the financial statements. Other disclosures will relate to the reporting entity, for example group structure, business model and going concern.
(g) Other matters. This section includes a review of issues raised in the 2010 ED The Reporting Entity.
It also includes a summary of concerns raised in the feedback on the existing document with regard to stewardship, reliability and prudence.
3.12.1 Equity versus liabilities
The distinction between equity and liabilities is clarified through focus on the definition of a liability. The
paper identifies two types of approach: narrow equity and strict obligation.
(a) Narrow equity approach. Equity is treated as being only the residual class issued, with changes in
the measurement of other equity claims recognised in profit or loss.
(b) Strict obligation approach. All equity claims are classified as equity with obligations to deliver
cash or assets being classified as liabilities. Any changes in the measurement of equity claims would be shown in the statement of changes in equity.
Under the strict obligation approach, certain transactions now classified as liabilities would now be classified as equity because they do not involve an obligation to transfer cash or assets. An example of this is an issue of shares for a fixed monetary amount.
3.12.2 Profit or loss versus other comprehensive income
Currently, the Conceptual Framework does not contain principles to determine: (a) What items are recognised in profit or loss
(b) What items are recognised in other comprehensive income
(c) Whether, and when, items can be recycled from other comprehensive income to profit or loss
In response, the Discussion Paper proposes that the Conceptual Framework should:
(a) Require a profit or loss total or subtotal that also results, or could result, in some items of income
or expense being recycled.
(b) Limit the use of OCI (only to income and expenses resulting from remeasurements of assets and
liabilities).
The Discussion Paper proposes a narrow and broad approach to what should be included in other
comprehensive income, but the IASB has not yet decided which approach it will use.
(a) Narrow approach. Other comprehensive income would include bridging items and mismatched remeasurements.
Bridging items are items of income or expense which represent the difference between measurement used in determining profit or loss and remeasurement used in the statement of financial position. An example would be investments in equity instruments with changes in fair value recorded in other comprehensive income. Such items would have to be recycled as a consequence of the measurement basis presented in profit or loss.
Mismatched remeasurements represent the effects of part of a linked set of assets, liabilities or
past or planned transactions. It represents their effect so incompletely that, in the opinion of the IASB, the item provides little relevant information about the return that the entity has made on its economic resources in the period. An example would be a cash flow hedge, where fair value gains and losses are accumulated in other comprehensive income until the hedged transaction affects profit or loss. These amounts should be recycled when the item can be presented with the matched item.
(b) Broad approach. In addition to the narrow approach, this would also include transitory
remeasurements. Transitory remeasurements are remeasurements of long-term assets and
OCI - for example, the remeasurement of a net defined pension benefit liability or asset. The IASB would decide in each IFRS whether a transitory remeasurement should be subsequently recycled.
3.13 Recent developments
So far the other parts of the Conceptual Framework are still at the discussion stage. Below is a summary of progress at the time of writing (May 2014):
(a) Objectives and qualitative characteristics – see above.
(b) Elements and recognition. The Board has tentatively agreed that the focus of the definition of an
asset should be on a present economic resource rather than on future economic benefits and an assessment of likelihood should be removed from the definition of an asset. The definition should focus on the present rather than on past transactions or events. No definition of a liability has been agreed.
(c) Measurement. Various measurement bases have been discussed. They are divided into past
present and future. Past bases are: (i) Past entry price
(ii) Modified past entry amount (iii) Past exit price
Present bases are: (i) Current entry price (ii) Current exit price (iii) Current equilibrium price (iv) Value in use
Future bases are:
(i) Future entry price (ii) Future exit price (d) Reporting entity – see above
(e) Purpose and status – discussions pending
(f) Application to not for profit entities – discussions pending
(g) Remaining issues – discussions pending
The examining team have flagged this topic as important. Keep an eye on future developments by reading
Student Accountant and www.iasplus.com/agenda/framework.htm
4 Revenue recognition
6/08, 12/08, 6/11, 12/11, 6/13, 12/13
Revenue recognition is straightforward in most business transactions, but some situations are more
complicated.
4.1 Introduction
Accruals accounting is based on the matching of costs with the revenue they generate. It is crucially
important under this convention that we can establish the point at which revenue may be recognised so that the correct treatment can be applied to the related costs. For example, the costs of producing an item of finished goods should be carried as an asset in the statement of financial position until such time as it is sold; they should then be written off as a charge to the trading account. Which of these two treatments should be applied cannot be decided until it is clear at what moment the sale of the item takes place.
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