Ethics, related parties and accounting policies

Ethics are a code of moral principles that people follow with respect to what is right or wrong. Ethical principles are not
necessarily enforced by law, although the law incorporates moral judgements. (Murder is wrong ethically and is also
punishable legally.)

Fundamental ethical principles:

- Integrity - To be straightforward and honest in all professional and business relationships

- Objectivity - Not to allow bias, conflict of interest or undue influence of others to override professional or business
judgements
- Professional Competence and Due Care - To maintain professional knowledge and skill at the level required to
ensure that a client or employer receives competent professional service based on current developments in
practice, legislation and techniques and act diligently and in accordance with applicable technical and professional
standards
- Confidentiality - To respect the confidentiality of information acquired as a result of professional and business
relationships and therefore, not disclose any such information to third parties without proper and specific
authority, unless there is a legal or professional right or duty to disclose, nor use the information for the personal
advantage of the professional accountant or third parties
- Professional behaviour - To comply with relevant laws and regulations and avoid any action that discredits the
profession

Threats to fundamental principles

- Self-interest - The threat that a financial or other interest will inappropriately influence a professional accountant’s
judgement or behaviour.
- Self-review - The threat that a professional accountant will not appropriately evaluate the results of a previous
judgment made; or an activity performed by the accountant, or by another individual within the accountant’s firm
or employing organisation, on which the accountant will rely when forming a judgment as part of performing a
current activity.
- Advocacy - The threat that a professional accountant will promote a client’s or employing organisation’s position
to the point that the accountant’s objectivity is compromised
- Familiarity - The threat that due to a long or close relationship with a client or employing organisation, a
professional accountant will be too sympathetic to their interests or too accepting of their work
- Intimidation - The threat that a professional accountant will be deterred from acting objectively because of actual
or perceived pressures, including attempts to exercise undue influence over the accountant

Where the above threats exist, appropriate safeguards must be put in place to eliminate or reduce them to an
acceptable level. Safeguards against breach of compliance with the ACCA Code include:

(a) Safeguards created by the profession, legislation or regulation (eg corporate governance)
(b) Safeguards within the client/the accountancy firm’s own systems and procedures
(c) Educational training and experience requirements for entry into the profession, together with continuing
professional development
IAS 1 and Fair Presentation

- ACCA’s Code of Ethics and Conduct forbids members from being associated with ‘misleading’ information, but IAS
1 Presentation of Financial Statements goes further, and requires that an entity must ‘present fairly’ its financial
position, financial performance, and cash flows.
- ‘Present fairly’ is explained as representing faithfully the effects of transactions. In general terms this will be the
case if IFRS is adhered to. IAS 1 states that departures from international standards are only allowed:
 In extremely rare cases;
 Where compliance with IFRS would be so misleading as to conflict with the objectives of financial statements as
set out in the Conceptual Framework, that is, to provide information about financial position, performance and
changes in financial position that is useful to a wide range of users.
- IAS 1 expands on this principle as follows:
 Compliance with IFRS should be disclosed.
 Financial statements can only be described as complying with IFRS if they comply with all the requirements of
IFRS.
 Use of inappropriate accounting policies cannot be rectified either by disclosure or explanatory material.

‘Compliance’ is necessary, but not sufficient for fair presentation. ‘Fairness’ is an ethical concept, directed at giving the
users of financial statements the opportunity to see the full picture of an entity’s position and performance.

Related Parties (IAS 24)

- A person or entity that is related to the entity that is preparing its financial statements (the ‘reporting entity’).
- A person or a close member of that person’s family is related to a reporting entity if that person:
 Has control or joint control over the reporting entity;
 Has significant influence over the reporting entity; or
 Is a member of the key management personnel of the reporting entity or of a parent of the reporting entity.
- An entity is related to a reporting entity if any of the following conditions apply:
 The entity and the reporting entity are members of the same group (which means that each parent, subsidiary
and fellow subsidiary is related to the others).
 One entity is an associate* or joint venture* of the other entity (or an associate or joint venture of a member of
a group of which the other entity is a member).
 Both entities are joint ventures* of the same third party.
 One entity is a joint venture* of a third entity and the other entity is an associate of the third entity.
 The entity is a post-employment benefit plan for the benefit of employees of either the reporting entity or an
entity related to the reporting entity.
 The entity is controlled or jointly controlled by a person identified in (a).
 A person identified in the 1st bullet point of (a) has significant influence over the entity or is a member of the
key management personnel of the entity (or of a parent of the entity).
 The entity, or any member of a group of which it is a part, provides key management personnel services to the
reporting entity or the parent of the reporting entity.
 * Including subsidiaries of the associate or joint venture

Close members of the family of a person are defined (IAS 24: para. 9) as “those family members who may be expected to
influence, or be influenced by, that person in their dealings with the entity and include:

- That person’s children and spouse or domestic partner;

- Children of that person’s spouse or domestic partner; and
- Dependants of that person or that person’s spouse or domestic partner.”

In considering each possible related party relationship, attention is directed to the substance of the relationship, and not
merely the legal form.
Not Related Parties (IAS 24)

- Two entities simply because they have a director or other member of key management personnel in common, or
because a member of key management personnel of one entity has significant influence over the other entity.
- Two venturers simply because they share joint control over a joint venture.
- Providers of finance, Trade unions, public utilities, and Departments and agencies of a government simply by virtue
of their normal dealings with an entity (even though they may affect the freedom of action of an entity or
participate in its decision-making process); and
- A customer, supplier, franchisor, distributor, or general agent with whom an entity transacts a significant volume
of business, simply by virtue of the resulting economic dependence.

Disclosure

- IAS 24 Related Party Disclosures requires an entity to disclose the following:

 The name of its parent and, if different, the ultimate controlling party irrespective of whether there have been
any transactions.
 Total key management personnel compensation (broken down by category)
 If the entity has had related party transactions:
o Nature of the related party relationship
o Information about the transactions and outstanding balances, including commitments and bad and
doubtful debts necessary for users to understand the potential effect of the relationship on the financial
statements
- No disclosure is required of intragroup related party transactions in the consolidated financial statements. Items of
a similar nature may be disclosed in aggregate except where separate disclosure is necessary for understanding
purposes.

Government-related entities

- If the reporting entity is a government-related entity, an exemption is available from full disclosure of transactions,
outstanding balances, and commitments with the government or with other entities related to the same
government. However, if the exemption is applied, disclosure is required of:
 The name of the government and nature of the relationship
 The nature and amount of each individually significant transaction (plus a qualitative or quantitative indication
of the extent of other transactions which are collectively, but not individually, significant)

Accounting policies

- The specific principles, bases, conventions, rules, and practices applied by an entity in preparing and presenting
financial statements. An entity should select its accounting policies by applying the relevant IFRS. Some standards
permit a choice of accounting policies (e.g., cost and revaluation models)
- If there is no IFRS Standard covering a specific transaction or condition, management should use judgement to
develop an accounting policy, giving consideration to:
(a) IFRS Standards dealing with similar and related issue
(b) The Conceptual Framework definitions of elements of the financial statements and recognition criteria
(c) The most recent pronouncements of other national GAAPs based on a similar conceptual framework and
accepted industry practice (providing the treatment does not conflict with extant IFRS Standards or the
Conceptual Framework)
- A change in accounting policy is only permitted if the change Is required by an IFRS; or results in financial
statements providing reliable and more relevant information.
- A change in accounting policy should be accounted for retrospectively (unless the transitional provisions of an IFRS
Standard specify otherwise): Adjust the opening balance of each affected component of equity, restate
comparatives
Accounting estimates

- Estimation involves judgements based on the latest reliable information

- E.g., warranty obligations, useful lives of depreciable assets and fair values of financial assets
- A change in an accounting estimate may be necessary if new information arises or if circumstances change. That
change should be applied prospectively

Prior period errors

- Omissions from, and misstatements in, the entity’s financial statements for one or more prior periods arising from
a failure to use, or misuse of, reliable information that:
(a) Was available when the financial statements for those periods were authorised for issue.
(b) Could reasonably be expected to have been obtained and taken into account in the preparation and
presentation of those financial statements
- Material prior period errors should be correctly retrospectively in the first set of financial statements authorised
for issue after their discovery by:
(a) Restating comparative amounts for each prior period presented in which the error occurred.
(b) (If the error occurred before the earliest prior period presented) restating the opening balances of assets,
liabilities and equity for the earliest prior period presented; and
(c) Including any adjustment to opening equity as the second line of the statement of changes in equity.
- Where it is impracticable to determine the period-specific effects or the cumulative effect of the error, the entity
should correct the error from the earliest period/date practicable

Creative accounting

- Timing of transactions may be delayed/speeded up to improve results

- Profit smoothing through choice of accounting policy e.g., inventory valuation
- Classification of items e.g., expenses versus non-current assets
- Revenue recognition policies e.g., through adopting an aggressive accounting policy of early recognition
The Financial Reporting Framework
IAS 1 Presentation of Financial Statements

- In order to achieve fair presentation, an entity must comply with IFRS & Conceptual Framework

The Conceptual Framework for Financial Reporting

- A conceptual framework 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 IASB’s 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

The purpose of the Conceptual Framework is to (para. SP1.1):

- Assist the IASB to develop IFRS Standards that are based on consistent concepts;
- Assist preparers of accounts to develop accounting policies in cases where there is no IFRS applicable to a
particular transaction, or where a choice of accounting policy exists; and
- Assist all parties to understand and interpret IFRS Standards.

The objective of general-purpose financial reporting

- To provide financial 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
- Existing and potential investors, lenders and other creditors are referred to as the primary users of financial
statements
- To make decisions, primary users need information about:
 The economic resources of the entity, claims against the entity and changes in those resources and claims
 Management's stewardship: how efficiently and effectively the entity's management and governing board
have discharged their responsibilities to use the entity's economic resources
- Three aspects are relevant to users of financial statements
 Financial performance reflected by accrual accounting
 Financial performance reflected by past cash flows
 Changes in economic resources and claims not resulting from financial performance, e.g., a share issue
Qualitative characteristics of useful financial information

- Information is useful if it is relevant and faithfully represents what it purports to represent

- Relevance: Relevant information is capable of making a difference in the decisions made by users. […] Financial
information is capable of making a difference in decisions if it has predictive value, confirmatory value, or both.
- When assessing relevance, consideration should be given to materiality
- Materiality: Information is material if omitting, misstating, or obscuring it could reasonably be expected to
influence decisions that the primary users of general-purpose financial statements make on the basis of those
financial statements
- Sometimes the most relevant information may have such a high level of measurement uncertainty that, instead,
the most useful information is that which is slightly less relevant but is subject to lower measurement uncertainty.
- Faithful representation: A faithful representation reflects economic substance rather than legal form, and is
complete, neutral, and free from error
- Prudence is the exercise of caution when making judgements under conditions of uncertainty
- The enhancing qualitative characteristics are:
(a) Comparability: The qualitative characteristic that enables users to identify and understand similarities in, and
differences among, items
(b) Verifiability: Helps assure users that information faithfully represents the economic phenomena it purports to
represent. Verifiability means that different knowledgeable and independent observers could reach consensus,
although not necessarily complete agreement, that a particular depiction is a faithful representation
(c) Timeliness: Having information available to decision-makers in time to be capable of influencing their
decisions. Generally, the older information is the less useful it is
(d) Understandability: Classifying, characterising, and presenting information clearly and concisely makes it
understandable

Financial statements and the reporting entity

- Objective of financial statements

 To provide financial information about the reporting entity's assets, liabilities, equity, income and expenses
that is useful to users of financial statements in assessing the prospects for future net cash inflows to the
reporting entity and in assessing management's stewardship of the entity's economic resources

- Reporting entity: An entity that is required, or chooses, to prepare financial statements. A reporting entity can be a
single entity or a portion of an entity or can comprise more than one entity. A reporting entity is not necessarily a
legal entity
The elements of financial statements

- Asset: A present economic resource controlled by the entity as a result of past events
- Liability: A present obligation of the entity to transfer an economic resource as a result of past events
- Equity: The residual interest in the assets of the entity after deducting all its liabilities
- Income: Increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to
contributions from holders of equity claims
- Expenses: Decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating
to distributions to holders of equity claims

Recognition and derecognition

- Recognition: The process of capturing for inclusion in the statement of financial position or the statement(s) of
financial performance an item that meets the definition of one of the elements of financial statements—an asset, a
liability, equity, income, or expenses
- Recognition is the point at which an item is included in the financial statements. Recognising one item other items
- An item is recognised in the financial statements if the item meets the definition of an element and recognition of
that element provides users of the financial statements with information that is useful
- Recognition is subject to cost constraints
- Derecognition normally occurs when the element no longer meets the definition of an element
 For an asset – when control is lost
 For a liability – when there is no longer a present obligation
- Accounting requirements for derecognition aim to faithfully represent both
 Any assets and liabilities retained after the transaction or event that led to the derecognition; and
 The change in the entity’s assets and liabilities as a result of that transaction or event

Measurement

- IFRS Standards use a mixed measurement approach, which means that different measurement bases are used for
different classes of elements
- There are two main measurement bases: Historical cost; and Current value (which includes fair value, value in use,
fulfilment value and current cost)
- Fair value: The price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction
between market participants at the measurement date
- Value in use: The present value of the cash flows, or other economic benefits, that an entity expects to derive from
the use of an asset and from its ultimate disposal
- Fulfilment value: The present value of the cash, or other economic resources, that an entity expects to be obliged
to transfer as it fulfils a liability
- Current cost of an asset: The cost of an equivalent asset at the measurement date, comprising the consideration
that would be paid at the measurement date plus the transaction costs that would be incurred at that date
- Current cost of a liability: The consideration that would be received for an equivalent liability at the measurement
date minus the transaction costs that would be incurred at that date
- Current cost and historical cost are both entry values, they ‘reflect prices in the market in which the entity would
acquire the asset or would incur the liability
- Fair value, value in use and fulfilment value are exit values.
- Fair value reflects the perspective of market participants, whereas value in use and fulfilment value reflect entity-
specific assumptions
- Factors to consider in selecting a measurement basis:
 Nature of information provided
 Usefulness of information provided
 Other factors (Cost constraint, Enhancing qualitative characteristics)
Presentation and Disclosure

- SOPL is the primary source of information about an entity’s performance

- In developing Standards, the IASB will, in principle, require all income and expenses to be included in the
statement of profit of loss, but may decide that income or expenses arising from a change in the current value of
an asset or liability should be classified as other comprehensive income (OCI). This should be the exception and
only where it provides more relevant information or a more faithful representation.
- Similarly, in principle, OCI is reclassified to profit or loss in a future period when doing so results in the provision of
more relevant information or a more faithful representation

Concepts of capital and capital maintenance

- There are two concepts relating to capital:

(a) Financial concept of capital where capital refers to the net assets or equity of an entity
(b) Physical concept of capital where capital is regarded as the productive capacity of the entity, for example units
of output per day