CHAPTER 3: Visual Overview

CHAPTER 3: Visual Overview

Objective: To describe the objectives of the International Financial Reporting Standards Foundation and
its relationship with the development, scope and use of International Financial Reporting Standards (IFRS
Standards).
3.1.1 Introduction to the Regulatory Framework
1.1 Introduction to the Regulatory Framework
The financial statements display relevant information to internal and external users. The information
displayed will influence decisions that stakeholders may make about the future of a particular business.
Regulations are set in place for businesses to prepare their financial statements according to
standardised principles and rules so that users of financial statements can rely on the financial
information as fairly represented.
The issuance of International Financial Reporting Standards (IFRS) and guidance comes from the
International Accounting Standards Board (IASB), which the IFRS Foundation governs.
The governance structure of setting standards can be summarised in the diagram from the IFRS website
below.

The formation of accounting standards can be represented in a three-tier structure:

• Independent Standard-Setting and Related Activity
There are two independent standard-setting boards of experts:
o International Accounting Standards Board (IASB), whose role is to
develop and publish accounting standards. The Interpretations Committee works
closely with IASB to support the application of the standards.
o International Sustainability Standards Board (ISSB), whose role is to
develop a baseline of sustainability-related disclosure standards.
• Governance, Strategy and Oversight
The development of standards by IASB and ISSB is governed and overseen by Trustees
(IFRS Foundation Trustees). The IFRS Advisory Council provides advice and counsel to the
Trustees and the boards
• Public Accountability
The Trustees are accountable to a monitoring board of public authorities (IFRS Foundation
Monitoring Board).
These regulatory bodies do not have the power to force companies to comply with their
requirements. It is up to national accounting standard-setting bodies or regulators to adopt the standards,
and only then will they become enforceable in a country.
National bodies can do this in different ways, including:
• adopting IFRSs as standards for their own country
 • using IFRSs as a basis for developing their guidance
• developing their requirements but comparing them to IFRSs to determine if their standards
are sufficient.

3.1.2 IFRS Foundation – Trustees

1.2 IFRS Foundation – Trustees
The Trustee foundation is an independent body that oversees the International Accounting Standards
Board (IASB) and the International Sustainability Standards Board (ISSB).
The Trustees are accountable to the Monitoring Board, a body of publicly accountable market authorities.
The Trustees are not involved in any technical matters relating to IFRS Standards. This responsibility
rests solely with the boards.
The IFRS Foundation Trustees focus on the needs of emerging economies and small and medium-sized
entities. This includes profit and non-profit-making organisations such as charities.
Each Trustee member is expected to understand and is sensitive to international issues relevant to the
success of an international organisation responsible for developing high-quality global accounting and
sustainability disclosure standards for use in the world's capital markets and by other users.

3.1.3 International Accounting Standards Board (IASB)

1.3 International Accounting Standards Board (IASB)
Key Point

The Board is an independent group of experts with an appropriate mix of recent practical experience in setting
accounting standards, preparing, auditing, or using financial reports, and accounting education. Board members
are responsible for the development and publication of IFRS Standards.

The IASB is committed to developing, in the public interest, a single set of high-quality, understandable,
and enforceable global accounting standards (IFRS Standards) that require transparent and comparable
information in general-purpose financial reports.
The objective of general-purpose financial reports is to provide financial information about the reporting
entity that is useful to primary users (investors and creditors).
The Board is also responsible for approving interpretations of IFRSs that the IFRS Interpretations
Committee develops.

1.3.1 Constitution
According to the IFRS Foundation Constitution:
• The IASB Board will typically comprise 14 members whom the trustees appoint. The primary
qualifications are professional competence and recent relevant experience.
• The Board has:
o complete responsibility for all board technical matters, including the issue of IFRS
Standards (other than IFRIC Interpretations) and Exposure Drafts
o complete discretion in developing the technical agenda for standard setting
Publishing standards, exposure drafts and final interpretations require a “supermajority”.
3.1.4 International Sustainability Standards Board (ISSB)
1.4 International Sustainability Standards Board (ISSB)
International investors with global investment portfolios are increasingly calling for high-quality,
transparent, reliable and comparable reporting by companies on sustainability issues such as climate and
other environmental, social and governance (ESG) matters.
In September 2020, the IFRS Foundation Trustees published a consultation paper to determine whether
there is a need for international sustainability standards and whether the IFRS Foundation should play a
role in developing such standards.
As a result, the Trustees announced the creation of a new board (ISSB) in November 2021 to meet the
demand for sustainability standards.
ISSB’s role is to deliver comprehensive global sustainability-related disclosure standards that provide
investors and other capital market participants with information about companies’ sustainability-related
risks and opportunities.

3.1.5 IFRS Advisory Council (IFRSAC)

1.5 IFRS Advisory Council (IFRSAC)
The IFRS Advisory Council advises the IFRS Foundation Trustees and the standards-setting boards
(IASB and ISSB). Its members include investors, academics, auditors and members of local standard-
setting bodies.
The board consults the IFRSAC on their agenda, priorities, and issues related to the application and
implementation of IFRSs.
The Advisory Council comprises 30 or more members appointed by the trustees (for a renewable term of
three years).
• The council provides a forum for participation by other interested parties (e.g. the
Organisation for Economic Change and Development (OECD), the United States Financial
Accounting Standards Board (FASB) and the European Commission).
• Its primary responsibility is to advise the standards-setting board on agenda issues, work
priorities and the views of IFRS Advisory Council members on the development of standards
projects.

3.1.6 IFRS Interpretations Committee (IFRS IC)

1.6 IFRS Interpretations Committee (IFRS IC)
The IFRS IC reviews and provides guidance on issues arising when IFRSs have been implemented.
These include the different ways of accounting for different types of transactions, doubt about correct
accounting treatments or unclear disclosure requirements. The IFRS IC also provides guidance on issues
not addressed in IFRSs.
The IFRS Interpretations Committee (IFRS IC) is the interpretative body of the IASB. The trustees appoint
14 voting members and a non-voting chairperson.
The committee’s responsibilities include:
• interpreting the application of IFRS Standards
• Provide timely guidance on financial reporting issues not explicitly addressed in IFRS Standards.
It publishes draft interpretations for public comment and considers comments before finalising them. It
reports to the Board and obtains the Board’s approval for final interpretations.
 Key Point

The exam may question students on the roles of each body.

Activity 1

Match the accounting body to the correct example of work carried out.
Accounting body Activity

Providing a forum for a wide range of users to discuss

IFRS Foundation (IFRSF) IFRSs

International Accounting Standards Board Advising national authorities on the process for adopting
(IASB) IFRSs

IFRS Interpretations Committee (IFRS IC) Issuing a draft of a new IFRS

IFRS Advisory Council (IFRS AC) Advising on how a current IFRS should be applied

3.2.1 Global Accounting Standards

2.1 Global Accounting Standards

The International Accounting Standards Board (IASB) develops and publishes International Financial
Reporting Standards (IFRS). Each standard is created to cover a specific aspect of accounting.
• The term IFRS includes all standards and interpretations issued under the previous
constitution (IASC) that the Board has approved.
• International Accounting Standards (IASs) and Interpretations issued by the Standards
Interpretations Committee (SIC) that have been so approved continue to be applicable until
they are withdrawn.

3.2.2 Objectives
2.2 Objectives
IASB’s Mission Statement sets out its objectives: “To develop IFRS Standards that bring transparency,
accountability and efficiency to financial markets around the world. Our work serves the public interest by
fostering trust, growth and long-term financial stability”.
The goals of the IFRS Standards are to:
• bring transparency by enhancing the international comparability and quality of financial
information so investors can make informed economic decisions.
• strengthen accountability by reducing the information gap between the providers of capital
(investors) and those to whom they have entrusted their money (management).
If the investors are not involved in the day-to-day business, they will not have access to the
same information that managers have. Managers may exploit the differences in information
for their benefit. IFRS Standards provide information that is needed to hold management to
account.
 • contribute to economic efficiency by helping investors identify opportunities and risks
worldwide, improving capital allocation. (A single, trusted accounting language lowers the
cost of capital and reduces international reporting costs for businesses.)

3.2.3 Developing IFRS Standards

2.3 Developing IFRS Standards
2.3.1 Due Process
IFRS Standards are developed through a due process which ensures that standard setting is transparent
and considers a wide range of views from interested parties such as:
• accountants, financial analysts and other users of financial statements
• the business community
• stock exchanges
• regulatory and legal authorities
• academics
• other interested individuals and organisations throughout the world.
The Board consults the Advisory Council on significant projects, agenda decisions and work priorities and
discusses technical matters in meetings open to public observation.

2.3.2 Project Development

Due process for projects typically, but not necessarily, involves the following steps:
• Setting the Agenda
When deciding what standards to develop, the IASB focuses on the relevance of the
information to investors. It also looks at the availability of existing guidance and whether
publishing an IFRS will lead to adopting a common approach.
• Planning the Project
The IASB draws up a project plan. The board may develop the standard itself or with another
standard setter, for example, the US standard-setting body, Financial Accounting Standards
Board.
National accounting requirements and practices are studied, and the board exchanges views
about the issues with national standard setters. The board consults with the Advisory Council
about adding the topic to the Board's agenda, and an advisory group (working group) is
formed to advise the Board on the project.
• Developing and Publishing a Discussion Paper
A discussion paper is developed and published for public comment (also called a discussion
document). The discussion paper gives an overview of the issues, such as a summary of
possible approaches and the initial views of the authors.
A discussion paper must be approved by a majority of the Board’s members.
• Developing and Publishing an Exposure Draft
• After considering comments and dissenting opinions (alternative views) received, an exposure draft is
developed. The draft is then published again for public comment. The IASB may publish a second
exposure draft if comments identify significant issues.
An exposure draft must be approved by a supermajority of the Board:M
o Nine of the 14 members or
o Eight if there are 13 or fewer members
• Developing and Publishing an IFRS
After the IASB has considered all the comments received and is satisfied that it has
addressed all the points raised during the consultation process, it drafts the final version of
the IFRS. IASB then has the final draft externally reviewed and obtains approval from its
members that it should be published.
 • Procedures after an IFRS is issued
After publication, the IASB may discuss with interested parties any unforeseen issues that
have happened because of the IFRS being applied. In time, the IASB may formally review the
standard if, for example, the financial reporting and legal environment have changed.
Useful Information

IFRSs used to be called International Accounting Standards (IASs), and several IASs are still in force
because there has not been a need to update them.
In many countries, there is a collection of commonly followed accounting rules, legal requirements and
standards for financial reporting referred to as the local GAAP (generally accepted accounting
practice).

3.2.4 Scope and Application

2.4 Scope and Application

IFRS Standards apply to published financial statements of any commercial, industrial or business
reporting entity (whether public or private sector).
• They apply to separate and consolidated financial statements (where applicable).
• Any limitation on the applicability of specific standards is made clear in an IFRS.
• A standard applies from a date specified in the standard and is not retroactive (unless stated
otherwise).
• Exclusions where IFRS Standards are not required to be applied:
o Non-business aspects of public sector entities.
o Private sector not-for-profit (NFP) entities.

3.2.5 Advantages and Disadvantages of IFRS Standards

2.5 Advantages and Disadvantages of IFRS Standards
The advantages of using IFRS in preparing financial statements of a business include:
• Comparisons between businesses in different countries also using IFRSs will be easier.
• Foreign investors may trust financial statements prepared in compliance with IFRSs, meaning
that companies find it easier to raise money from abroad.
• Companies operating in several countries can use IFRSs as a shared basis for preparing
their financial statements.
• National authorities can adopt IFRSs as ready-made requirements without developing their
guidance.
• Other organisations that operate internationally, for example, accountancy firms, will find it
easier to deal with a common set of standards.
The disadvantages of using IFRS in preparing financial statements of a business include:
• There will be costs involved in adopting IFRSs for the first time.
• IFRSs may not be as rigorous as national guidance in some areas.
• Adopting IFRSs may be challenging in some countries because some of its requirements
may conflict with local law.
3.3.1 Introduction to Corporate Governance
3.1 Introduction to Corporate Governance
3.1.1 Global Definitions
The Organisation for Economic Cooperation and Development (OECD) defines corporate governance as:
"The system by which business corporations are directed and controlled. The corporate
governance structure specifies the distribution of rights and responsibilities among different participants in
the corporation and spells out the rules and procedures for making decisions on corporate affairs. It also
provides the structure through which the company objectives are set, and the means of attaining those
objectives and monitoring performance."
The Australian Securities Exchange defines corporate governance as:
"The system by which companies are directed and managed. It influences how the objectives of the
company are set and achieved, how risk is monitored and assessed, and how performance is optimised.
Good corporate governance structures encourage companies to create value (through entrepreneurism,
innovation, development and exploration) and provide accountability and control systems commensurate
with the risks involved."

3.2.1 Concept of Corporate Governance

Corporate governance is a set of rules intended to create transparency and protect the interests of
shareholders and stakeholders. It sets to prescribe the roles and responsibilities of directors as the
stewards of the company, which helps align the directors' interests with that of the shareholders.
The way corporate governance operates will vary significantly between companies. In some companies,
the owner will own all the shares or a great majority of them, and corporate governance procedures will
be simple. In other companies, no single party holds a majority of shares, but some financial institutions
may have significant shareholdings.
Corporate governance mechanisms are needed to ensure that companies not only take account of the
views of powerful shareholders with more considerable shareholdings but also act in the interests of
shareholders owning a smaller proportion of shares.
The concept of corporate governance revolves around these three aspects:
• Risk Management
A company’s management must manage the level of risk the business faces and refrain from
making decisions that will create uncontrollable risk. The management should also disclose
to its stakeholders the existence and standing of faced risk in the financial statements.
Companies should maintain sound internal control systems to manage their risk levels.
For example, a company having repeatedly breached lending covenants would be on the
verge of having its borrowing facilities withdrawn. This constitutes poor risk management as
such actions would affect its ability to trade.
• Quality of Information
The company’s management should ensure that proper accounting and information systems
are in place to produce reliable financial statements. Information provided should be relevant,
timely, accurate and represent a true and fair view of the company's position.
For example, a company investing in accounting software to streamline its trading activities
ensures that information is accurate and produced on time. The company employs proper
corporate governance as the quality of information is secured.
• Stewardship
A company’s management should be open and transparent and present critical decisions on
the business's performance. They should also explain the overall strategy and their intentions
for the future so that investors can decide whether these align with their expectations.
 For example, a company portrays stewardship by providing financial information on how it
has performed over the year and the strength of its asset base.

3.3.2 Corporate Governance and Financial Statements

3.2 Corporate Governance and Financial Statements
The UK Corporate Governance Code (which applies to all listed companies but is also considered best
practice for unlisted companies and non-corporate entities) states that:
• The board of directors must:
o present a balanced and understandable assessment of the company's position
by issuing a set of financial statements
o maintain a sound system of internal control concerning risk management
• An audit committee (consisting of at least three independent non-executive directors) must:
o monitor the integrity of the financial statements
o review the internal controls and risk management systems
o monitor the internal and external auditors.

3.2.1 Duties and Responsibilities of Directors

The directors of a company have a fiduciary duty to act in good faith on behalf of the company. A
business’s directors are responsible for preparing the financial statements, ensuring appropriate
accounting systems are in place and keeping proper records.
Concerning financial statements, a company's board of directors is collectively responsible for their:
• preparation every financial year to show a “true and fair view.”
• presentation to and approval by the shareholders.
To satisfy this responsibility, the directors should:
• Only approve the financial statements if they are satisfied that the financial statements give a true and
fair view of the assets, liabilities, financial position and profit or loss
• State in the financial statements that the responsibility of preparing them lies with the directors
• Consider the appropriateness of their use of going concern principles and convey the message in the
financial documents
• Explain the company’s business model and its strategy for delivering the objectives of the company in
the financial statements
• Ensure that the financial statements are prepared per the form and content as prescribed by law and
GAAP (e.g. IFRS)
• Ensure that adequate accounting records are kept from which the financial statements are prepared.
The accounting records must be adequate to:
o show and explain the company's transactions
o disclose the company's financial position with reasonable accuracy
o prepare accounts which comply with the appropriate legal requirements
o show day-to-day entries of all sums of money received and paid (and the matters
in respect of which the receipts and payments take place)
o record the company's assets and liabilities
• Ensure that the financial statements are filed according to law. (For example, in the UK, public
companies must file the financial statements with Companies House within six months after the
reporting date.)
Other responsibilities of the directors of an organisation include:
• Prevention of Fraud – They have a duty to prevent and detect fraud. This goes beyond the financial
statements, although misstatements may be made for fraudulent reasons.
• Cooperate with Auditors - Directors should cooperate with the company's auditors and not collude,
mislead or deceive them. They must provide the auditors with the information and explanations they
need to conduct their audit.
In reviewing the financial statements, the external auditor should clearly state its independent
position and ensure no conflict of interest is evident.
 Key Point

The fiduciary duties of directors concerning the financial statements are explicitly stated in the company law of most
jurisdictions.

3.3.3 Audit Committee Responsibilities

3.3 Audit Committee Responsibilities
An audit committee is a branch of a business’s board of directors that takes charge of a company’s
financial reporting responsibilities and ensures internal controls are kept in place.
The responsibilities of the audit committee in a business include:
• Ensuring that the interests of shareholders are adequately protected concerning financial reporting and
internal control.
• Monitoring the integrity of the financial statements and announcements relating to the company’s
financial performance, including review of the significant financial reporting judgments made.
• Reviewing the company’s internal control, internal financial controls and risk management systems.
• Monitoring and reviewing the effectiveness of the internal audit function.
• Reviewing and monitoring the external auditor’s independence and objectivity and the effectiveness of
the audit process.
Activity 2
State whether the following statements about governance guidance are true or false.
1. The auditors act as the directors’ agents when they audit the financial statements.
2. Under corporate governance best practice, both directors and auditors should state their responsibilities
in the financial statements.
3. The auditors should state that the financial statements have been prepared on a going-concern basis.
4. To comply with the requirements of IFRSs, the directors should explain their strategy for delivering the
company’s objectives.

3.3.4 Ethics and Governance

3.4 Ethics and Governance
As well as being based on legal requirements, corporate governance is founded on a series of ethical
concepts.

3.4.1 ACCA’s Code of Ethics and Conduct

The ACCA Code of Ethics and Conduct is binding on all ACCA members, students, and partners in an
ACCA practice. The ethical concepts that apply to the preparation of accounting information are:
• Integrity
The Cadbury report on governance stressed that the integrity of reports depends on the
integrity of those who prepare the reports. Integrity is about being straightforward. It means
reporting financial information honestly, not misleading the users of financial statements, and
producing a balanced picture of the company’s affairs.
• Objectivity
In preparing financial statements, accountants should be unbiased when they make
judgements about what should be included in them. They should not be influenced by their
self-interest or pressures from others towards distorting the financial statements.
• Professional Competence and Due Care
Accountants preparing or reviewing financial statements must have sufficient knowledge to
do so properly. They also need to carry out their work carefully, avoiding errors.
• Professional Behaviour
 Professional behaviour includes compliance with the laws and standards related to financial
statements. It also has a broader meaning: avoiding behaving in a way that could generally
damage the accounting profession’s reputation.
• Confidentiality
Confidentiality means respecting the confidential nature of information acquired through
professional relationships. Confidential information should not be disclosed unless there is
specific permission or a legal or professional duty.
Scenario Walkthrough 1
Let’s discuss a famous business scandal where the accounting practices that the company used were
a significant issue.
Background
Enron was a massive energy sector company based in America and operating globally. It bought and
sold energy and controlled operating facilities. It stated that it aimed to transform the energy sector.
Instead, Enron collapsed in 2001 and is now best remembered as one of the biggest company
scandals in history. It also destroyed the major accountancy firm, Arthur Andersen, which was Enron’s
external auditor.
Enron’s collapse resulted in the development of the Sarbanes–Oxley Act, an essential set of laws on
corporate governance applicable to companies which report in the United States.
What happened
A significant element in the Enron scandal was its accounting policies. Enron also had other accounting
problems that internal accounting documents revealed. These included:
• Enron used connected businesses to hold assets and liabilities (particularly debt). Under the
accounting rules operating in the US, Enron did not need to show these businesses in its main
financial statements.
• Enron used its shares and not cash to fund businesses, which caused problems when the share
price of Enron began to fall.
• Enron immediately included income in the financial statements on contracts due to last for many
years. It also timed transactions so that they were accounted for at the end of a period to boost
earnings.
• Enron also hid what was happening through various trading activities, including using financial
instruments known as derivatives. Derivatives are a type of financial instrument that derives its value
from the underlying asset.
Issues of Corporate Governance and Ethics
There was a lack of transparency between the company’s management and shareholders. Enron’s
financial statements showed an incomplete picture of the company’s affairs.
There was a lack of integrity as business arrangements were made to deceive investors and others
about the actual happenings at Enron. Directors were more concerned with protecting their position
than what was best for the company, showing a lack of objectivity in decision-making.
Rules-based framework not sufficient?
What happened at Enron showed the weakness of relying on accounting standards based on specific
rules rather than guiding principles. What Enron did may not have breached the rules, but it seriously
misled investors and the stock market. Good ethical practices need to be adopted by the people
running the company, who are the directors.
Enron encouraged employees to buy its shares. As a result, many employees suffered substantial
financial losses. However, several senior managers sold their shares when the company was about to
collapse.
All staff have a responsibility to act ethically, whatever their role. Enron set stringent performance
targets, and employees who failed to meet them were sacked. This encouraged staff to focus on
reporting that they met targets even if they had not met them.
 Independence in Financial Reporting
Independence is emphasised because a company’s affairs and management must be effectively
scrutinised. Some directors, known as non-executive directors, are not involved with the company full-
time but monitor the behaviour of the executive directors who run the company daily.
The non-executive directors at Enron were condemned for being ineffective and not challenging how
the executive directors ran the company. Some non-executive directors had personal interests, which
conflicted with their role of holding the executive directors to account.
Enron’s auditor, Arthur Andersen, was responsible for reporting problems with the financial statements.
Instead, they went along with the accounting treatments that Enron used as they did not want to risk
losing a large amount of fee income from Enron.

Exam advice

Whilst ethics and specific events, such as the Enron scandal, are not examinable, students must follow ACCA’s
Code of Ethics and Conduct throughout their professional work.

3.4.1 Introduction to the Conceptual Framework

4.1 Introduction to the Conceptual Framework
If the financial statements are to be useful to interested readers, the information contained in the financial
statements should be reliable and of high quality.
This means the information must have specific characteristics and be prepared using certain
assumptions. The conceptual framework guides these characteristics and assumptions.

4.1.1 Conceptual Framework Definition and Purpose

The conceptual framework is a statement of generally accepted assumptions and principles that provides
a frame of reference for developing new practices and evaluating existing ones.
The purpose of the Conceptual Framework for Financial Reporting (Conceptual Framework) is to assist:
• the IASB (Board) in developing IFRS standards
• the preparers of financial statements in developing consistent accounting policies
• all parties to understand and interpret the standards.
The Conceptual Framework is not a standard. Therefore, nothing in the Conceptual Framework can
override a specific IFRS.

3.4.2 Qualitative Characteristics of Financial Information

4.2 Qualitative Characteristics of Financial Information
The Conceptual Framework for Financial Reporting identifies two fundamental qualitative characteristics
and four enhancing qualitative characteristics relating to useful financial information.
The fundamental qualitative characteristics of useful financial information are:
• Relevance
• Faithful Representation
The Conceptual Framework also provides four enhancing qualitative characteristics of useful financial
information are:
• Comparability
• Verifiability
 • Timeliness
• Understandability

4.2.1 Relevance
Relevant information is information that is capable of influencing the decisions of users. For financial
information to be relevant, one or both things must apply:
• The information needs to help the user form a view about what will happen to the business in the future
• the information confirms what has happened in the past.
Relevant information can be affected by its:
• Nature
Some items may be relevant to users simply because of their nature. For example, if a
director has borrowed money from the company, the transaction must always be disclosed,
even if the amount is small.
• Materiality
Information is material if its omission or misstatement could influence primary users’
decisions based on the financial information about the specific reporting entity.

4.2.2 Faithful Representation

Faithful representation means the financial statements describe financial events and conditions fairly in
words and numbers. The information given should be:
• Complete (within bounds of materiality and cost) – Information reported should be complete as an
omission can cause financial statements to be false or misleading and, therefore, unreliable.
• Neutral (free from bias)
• Free from error (no errors or omissions)
Faithful representation also means presenting the substance (the commercial effect) of an economic
phenomenon rather than its legal form.
Useful Advice

Suppose the validity and amount of a claim for damages under a legal action were disputed. In that
case, it may be inappropriate to recognise the total amount of the claim in the statement of financial
position as a liability.
To faithfully represent the situation, it may be appropriate to disclose the amount and circumstances of
the claim.

4.2.3 Comparability
Comparability means users should be able to make comparisons between information:
• about the same business in different periods
• between different businesses in the same period
Comparability requires consistent measurement and classification, and presentation of the financial
effects of similar transactions and events.
Comparability does not always mean using the same methods to prepare information. Comparability
implies that users must be informed (in the notes to the financial statements) of the principal accounting
policies used, any changes to them and the effects of such changes.
Accounting policies – the specific principles, bases, conventions, rules and practices adopted by an entity
in preparing and presenting financial statements.
Another implication of comparability is that financial statements must show corresponding information
for preceding periods. In the financial statements of a business, another column of figures is present to
show the financial information of the preceding year.

4.2.4 Verifiability
Verifiability means giving financial statements users confirmation that their financial information is
faithfully represented.
Verifiability means that knowledgeable, independent observers can reach a consensus that a particular
representation has the fundamental quality of faithfulness.

4.2.5 Timeliness
Timeliness links to relevance. For information to influence users’ decisions, it must be available when
users make their decisions. However, other aspects may be affected if the information is reported quickly.
For example, the information may not be complete and may have been prepared so fast that it is more
likely to contain errors.
Information needs to be available in time for users to make decisions. Older information is generally less
useful (but may still be useful in identifying and assessing trends).

4.2.6 Understandability
Understandability means showing information clearly and concisely. Some items in the financial
statements are complicated. However, if they are omitted, the statements will be incomplete.
Understandability also assumes that the users of the financial statements have some accounting
knowledge.
Financial information should be made understandable through clear and concise classification and
presentation.
• Users are assumed to have a reasonable knowledge of business and economic activities and
accounting and a willingness to study information with reasonable diligence.
• Information about complex matters should not be excluded because it may be too difficult for certain
users to understand.
Activity 3
Match the characteristics of good accounting information to the list of actions that preparers or
users of financial information would take to ensure it displays those characteristics.
Action Characteristic

Shareholders have been asked if there is anything in the annual financial statements
that confuses them, and they have said everything is clear. Relevance

The auditors have completed their audit work and have found that the accounting Faithful
records support the financial statements. Representation

Management checks information before publication to ensure it is all correct and does
not miss anything. Comparable

Financial advisers use financial information to see how the company is doing compared
to other companies and to advise their clients. Verifiable
 Investors use financial information to judge a company’s prospects and decide whether
to continue to invest in the company. Timeliness

The accounts department prepares financial information covering an accounting period

within two weeks of the end of the period. Understandable

3.5.1 Accounting Principles

5.1 Accounting Principles
Accounting principles are the fundamental concepts accountants use to prepare financial statements.
Standard-setting boards consider these principles when developing new frameworks and financial
standards.

5.1.1 Materiality
The item’s nature and size are evaluated when determining whether the information is material. If the
item’s non-disclosure could influence the economic decisions of users based on the financial statements,
it is material.
Each material item should be presented separately in the financial statements. At the same time,
immaterial amounts of a similar nature or function should be aggregated and need not be presented
separately.

5.1.2 Offsetting
An entity shall not offset assets and liabilities or income and expenses unless required or permitted by an
IFRS.
An organisation should report assets, liabilities, income and expenses separately. Offsetting between
these elements in the financial statements is not allowed unless the offsetting reflects the substance of
the transaction.

5.1.3 Consistency
Consistency is needed to achieve comparability. It means treating and consistently presenting similar
items in the financial statements over different periods unless there are appropriate reasons to make a
change.
Reasons for change in the treatment of similar items could be due to the following:
• a significant change in its operations or
• if another classification provides a more suitable presentation of its transaction.
• Required by a new IFRS standard
Changes in accounting policies need to be disclosed in the notes of financial statements.

5.1.4 Prudence
Prudence is the exercise of caution when making judgements under conditions of uncertainty. In
preparing a business’s financial statements, assets and income should not be overstated, while liabilities
and expenses should not be understated.
The main problem with exercising prudence is that it may result in the understatement of assets (and
income) and the overstatement of liabilities (and expenses).
However, this is not allowed as this would conflict with the qualitative characteristic of faithful
representation. Such misstatements would also lead to misstatements in future periods.
5.1.5 Duality (dual aspect)
Also known as the dual effect or dual aspect, the double entry concept explains that every transaction has
at least two impacts on a business, a debit and credit entry.

5.1.6 Historical Cost and Current Value

The historical cost concept states that all transactions are initially recorded at historical cost, which is
the cost at the time of the transaction. The historical cost system of accounting is particularly relevant to
Assets.
Current value measures provide monetary information about assets, liabilities and related income and
expenses, using information updated to reflect conditions at the measurement date.
Some bases of current value include:
• Fair value (price on an active market, or present value of future cashflows)
• Value-in-use (value derived from use of the asset)
• Current cost (value of an equivalent asset on measurement date)

5.1.7 Substance over Form

Substance over form is part of faithful representation. It means that the treatment of items in a company’s
financial statements should be determined by their commercial reality and not by how they could be
treated for legal purposes.
The concept is particularly relevant to assess:
• whether the definition of an element is met
• management’s assertions that elements of financial statements are complete, valid and accurate.
In most circumstances, substance and legal form are the same. If they are not, information about the
legal form alone would not faithfully represent the economic substance. For example:
• A legal sale of an item of equipment may, in substance, be a lease.
• Sales to a customer may be paid for using the proceeds of a loan to the customer. When the
transactions are considered together, the sale may be without substance.
• A sale of goods or services to a customer is made in exchange for purchasing a similar value of goods
or services from the customer.
Whether the substance of a transaction should prevail over its legal form is a complex deliberation and
depends on each transaction's circumstances.

3.5.2 Basis of Financial Statements Preparation

5.2 Basis of Financial Statements Preparation
The financial statements are prepared by the management (directors) of a company with these three
basic assumptions:
• The business is a going concern.
Going concern assumes that an entity will continue operating for the foreseeable future (the
next 12 months). During that time, the company directors do not intend or will not be forced to
liquidate the business or cease trading.
Going concern underlies the basis of the preparation of all published financial statements. It
is so fundamental that users are entitled to assume that this basis has been applied unless
an alternative basis is stated (in the notes to the financial statements).
• Accruals basis – The financial statements cover all transactions and events in the stated accounting
period.
Transactions and events are recognised in a company’s accounting records when they
happen and are not based on cash settlement.
 The transactions or events will be included in the financial statements for the period they
apply to. This may result in year-end accruals that are included within current liabilities in the
financial statements.
The accruals basis links to the matching concept that expenses are recognised in the same
accounting period as the revenues they relate to.
• Business Entity – The contents of the financial statement relate to the business.
The business is a separate entity from its owners/shareholders. The financial statements
should only include transactions that relate to the business and not transactions that relate to
the shareholders' personal interests.
The business entity concept is an accounting concept, not a legal concept. Therefore, it
applies to sole traders and partnerships even though the business and the owners are not
legally distinct.
Activity 4
For each statement below, comment if it is true or false.
1. The materiality concept states that omitting or misstating information may influence the decisions of
users of financial statements.
2. The accruals basis states that transactions should be accounted for when they are settled by cash.
3. Sarah is a sole trader. She has recently bought a car, which she does not use when on business. She
has paid for the car through her business's bank account and included the car as an asset in the
business's financial statements. This is a violation of the business entity concept.
4. The going concern concept implies that the business will continue operation for the longer term, at least
the next five years.
5. Substance over form means that an accountant will account for a transaction according to its legal
substance.
6. Consistency means that the same items must always be treated in the same way in the financial
statements over different periods.
7. The application of prudence means expenses should consistently be recognised if there is any
likelihood of them occurring, but accountants should be more cautious about recognising income.