1 Financial statements C

H
Section overview A
P
• In Bangladesh, all companies must comply with the provisions of the Companies Act. T
• In Bangladesh, financial statements must be prepared in accordance with IFRS
E
Standards. They must also give a true and fair view. R

1.1 Entity 1
Most accounting requirements are written with a view to use by any type of accounting
entity, including companies and other forms of organisation, such as a partnership. In this
Workbook, the term ‘company’ is usually used, because the main focus of the Financial
Accounting and Reporting syllabus is on the accounts of companies and groups of
companies.

1.2 Financial statements

The principal means of providing financial information to external users is the annual financial
statements. Financial statements provide a summary of the performance of an entity over a
particular period and of its position at the end of that period.
A complete set of financial statements prepared under IFRS Standards comprises:
• the statement of financial position;
• the statement of profit or loss and other comprehensive income or two separate statements
being the statement of profit or loss and the statement of other comprehensive income
(statements of financial performance);
• the statement of changes in equity (another statement of financial performance);
• the statement of cash flows; and
• notes to the financial statements.
The notes to the financial statements include:
• accounting policies ie, the specific principles, conventions, rules and practices applied in
order to reflect the effects of transactions and other events in the financial statements;
• detailed financial and narrative information supporting the information in the primary
financial statements; and
• other information not reflected in the financial statements, but which is important to
users in making their assessments.
The individual elements that are included in the financial statements are covered in detail later
in this chapter.

1.3 Requirement to produce financial statements

Limited liability companies are required by law to prepare and publish financial statements
annually. The form and content may be regulated primarily by national legislation, and in most
cases must also comply with Financial Reporting Standards.
In Bangladesh, all companies must comply with the provisions of the Companies Act 1994 (CA
1994). The key impact of this is as follows:
• Every Bangladeshi registered company is required to prepare financial statements for
each financial year which give a true and fair view.

ICAB 2024 Reporting framework and ethics 7

 • The individual (and some group) financial statements may be prepared:
– in accordance with the CA 1994 (as regards format and additional information
provided by way of notes); and
– in accordance with international accounting standards.
1.4 Filing deadlines
Legal regulations concerning the financial statements of an entity are of course specific to
the country of incorporation. Bangladeshi companies come under the Companies Act
1994.
The Companies Act establishes deadlines for the filing of financial statements:
• Non-listed companies: nine months after the financial year end
Listed companies are required by the Bangladesh Security and Exchange Commission
(BSEC) Rules to file their financial statements within four months of the financial year end.

1.5 Financial reporting standards

Company financial statements must comply with relevant Financial Reporting Standards and
other professional guidance and although these learning materials assume the preparation of
financial statements in accordance with IFRS Standards.
• International Financial Reporting Standards (IFRS Standards)
These are issued by the International Accounting Standards Board (IASB). Bangladeshi
companies whose securities are traded in a regulated public market eg, the Dhaka Stock
Exchange, must prepare their accounts in accordance with IFRS Standards.

1.6 Fair presentation

IAS 1, Presentation of Financial Statements requires financial statements to ‘present fairly’ the
financial position and performance of an entity.
‘Present fairly‘ is explained as representing faithfully the effects of transactions. In general terms
this will be the case if IFRS Standards are adhered to. IAS 1 states that departures from IFRS
Standards, known as the ‘true and fair override’, are only allowed:
• in extremely rare cases; and
• where compliance with IFRS Standards 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.

1.7 True and fair view

In Bangladesh, there is an overriding Companies Act requirement that financial statements should
present
‘a true and fair view’. This term is not defined in the Companies Act or Accounting Standards.
Truth is usually seen as an objective concept reflecting factual accuracy within the
bounds of materiality.
Fairness is usually seen as meaning that the view given is objective and unbiased.

Notes
1 What constitutes a true and fair view can then be restricted by stating that where a
choice of treatments or methods is permitted, the one selected should be the most
appropriate to the company’s circumstances. This restriction is likely to ensure
compliance with the spirit and underlying intentions of requirements, not just with the
letter of them.

8 Financial Accounting and Reporting - IFRS Standards ICAB 2024

 2 A further restriction is that financial statements should reflect the economic position of
the company, thereby reflecting the substance of transactions (ie, commercial reality), C
not merely their legal form. In most cases this will be achieved by adhering to IFRS. H
A
1.8 Fair presentation and the ‘true and fair override’ P
The CA 1994 requires that the financial statements show a true and fair view. IAS 1 has a T
similar requirement for ‘fair presentation’. IAS 1 permits an entity to depart from IFRS E
Standards if such a departure is required to satisfy the requirement for fair presentation. R
This departure is commonly known as the ‘true and fair override’.
Where the true and fair override is invoked, IAS 1 requires disclosure of the particulars of
the departure, the reason for it, and the financial effect. 1

1.9 Judgements and financial statements

Although IFRS Standards narrow down the range of acceptable alternative accounting
treatments, there are still many areas which are left to the discretion of the directors of the
company. On the whole, the concept of faithful representation should result in transactions
being ‘presented fairly’. However, commercial and financial considerations may result in
pressure being brought to bear to account for and report transactions in accordance with
their strict legal form. This can raise ethical questions for a professional accountant.

Professional skills focus: Applying judgement

Applying professional judgement when preparing financial statements will require you to
show that you can identify and recommend the appropriate accounting treatment for the key
issues in the scenarios provided in the exam. This may also apply in your practical experience
too, as you are tasked with providing information or data to support the preparation of the
financial statements. In the ‘Explain…’ questions in the exam, you will need to demonstrate
that you can appraise the ethical or regulatory issues, especially where there may be a choice
of presentation options available, or management are putting pressure on to report the
results in a more favourable manner.

2 Purpose and use of financial statements

Section overview

• Financial statements are used to make economic decisions by a range of users. All users
require information regarding:
– financial position;
– financial performance;
– cash flows of an entity;
– changes in financial position; and
– financial statements which show management’s stewardship of the resources of an entity.

2.1 Objective of general-purpose financial reporting

The Conceptual Framework states the objective of general-purpose financial statements is to
provide financial information about the reporting entity that is useful to existing and potential

ICAB 2024 Reporting framework and ethics 9

 investors, lenders and other creditors in making decisions relating to providing resources to the
entity.
Existing and potential investors, lenders and other creditors are identified as the primary users of
the financial statements.

2.2 Users and their information needs

General purpose financial statements are directed at satisfying the information needs of the
primary users. However, the Conceptual Framework acknowledges that other users (such as
regulators and members of the public) may also find general purpose financial statements useful,
even though they are not primarily directed to these other groups (Conceptual Framework: para.
1.10).
We can identify the following users of financial statements and their information needs.

Primary and other users Need information to

Existing and potential • Make decisions about buying, selling or holding equity and
investors debt instruments and how to exercise their right to vote,
therefore need information on:
– Risk and return on investment
– Ability of the entity to pay dividends
– How effectively management are using the resources of
the entity and how it may affect future cash flows
– Whether the company’s policies and practices, including
those relating to climate change and sustainability, are in
keeping with the investors’ expectations
Lenders • Assess how efficiently management use the entity’s resources
to service any existing or proposed debt and the related
interest.
• Assess security for amounts loaned to the entity.
Other creditors • Assess the likelihood of being paid when due; and
• Assess whether any claims against the entity may affect its
ability to service any credit extended to them.
Employees • Assess their employer’s stability and profitability.
• Assess their employer’s ability to provide remuneration,
employment opportunities and retirement and other
benefits.
• Assess their employer’s ability to manage the risks associated
with climate change.
Customers • Assess whether the entity will continue in existence – important
where customers have a long-term involvement with, or are
dependent on, the entity eg, where there are product
warranties or where continuity of supply of specialist parts may
be needed.
• Assess whether the entity’s operating practices, such as its
commitment to reducing its carbon footprint, are in line with
their expectations.

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 Primary and other users Need information to
C
Governments and their • Assess allocation of resources and, therefore, activities of entities. H
agencies • Assist in regulating activities. A
• Assess taxation and determine taxation policies. P
• Provide a basis for national statistics. T
E
The public • Assess trends and recent developments in the entity’s R
prosperity and its activities – important where the entity makes
a substantial contribution to a local economy eg, by providing
local employment and using local suppliers.
1
Analysts • Assess the performance and position of a company to
inform decisions, often relating to investments.
• Compare different companies to advise their clients which
to invest in.

In most cases the users will need to analyse the financial statements, and non-financial
information provided in the annual report, in order to obtain the information they need.
Analysis of the financial statements is likely to include the calculation of accounting ratios but
in order to be meaningful, will also involve the interpretation of non-financial information.
(The calculation of accounting ratios and the analysis of those ratios is covered in the
Advanced syllabus.)
The Conceptual Framework acknowledges that general purpose financial statements cannot
provide all of the information that users may want. Therefore users must also consider other
information, such as the current industrial trends for that business, political climate and issues
and general economic conditions.

2.3 Accountability of management

Management has a stewardship role, in that it is accountable for the safe-keeping of the
entity’s resources and for their proper, efficient and profitable use. Providers of risk capital are
interested in information that helps them to assess how effectively management has fulfilled
this role, but again this assessment is made only as the basis for economic decisions, such as
those about investments and the reappointment/replacement of management.
It is also the case that in a smaller entity the owner and manager can be the same individual.
Financial reporting helps management to meet its need to be accountable to shareholders,
and also to other stakeholders by providing information that is useful to the users in making
economic decisions.
However, financial statements cannot provide the complete set of information required for
assessing the stewardship of management (see section 7 ‘Inherent limitations of financial
statements’ later in this chapter).

2.4 Financial position, performance and changes in financial position

All economic decisions are based on an evaluation of an entity’s ability to generate cash and
of the timing and certainty of its generation. Information about the entity’s financial position,
performance and changes in financial position provides the foundation on which to base such
decisions.
2.4.1 Financial position
An entity’s financial position covers:
• the economic resources it controls;
• its financial structure (ie, debt and share finance);

ICAB 2024 Reporting framework and ethics 11

 • its liquidity and solvency; and
• its capacity to adapt to changes in the environment in which it operates.
The primary users require information on financial position because it helps in assessing:
• the entity’s ability to generate cash in the future;
• how future cash flows will be distributed among those with an interest in, or claims on, the
entity;
• requirements for future finance and ability to raise that finance; and
• the ability to meet financial commitments as they fall due.
Information about financial position is primarily provided in a statement of financial position.

2.4.2 Financial performance

The profit earned in a period is used as the measure of financial performance, where profit is
calculated as income less expenses. Information about performance and variability of performance
is useful in:
• assessing potential changes in the entity’s economic resources in the future;
• predicting the entity’s capacity to generate cash from its existing resource base; and
• forming judgements about the effectiveness with which additional resources might be
employed.
Information on financial performance is provided by:
• the statement of profit or loss and other comprehensive income and/or statement of
profit or loss; and
• the statement of changes in equity.

2.4.3 Changes in financial position

Changes in financial position can be analysed under the headings of investing, financing and
operating activities and are presented in a statement of cash flows.
Cash flow information is largely free from the more judgemental allocation and measurement
issues (ie, in which period to include things and at what amount) that arise when items are included
in the statement of financial position or performance statements. For example, depreciation of
non-current assets involves judgement and estimation as to the period over which to charge
depreciation. Cash flow information excludes non-cash items such as depreciation.
Cash flow information is therefore seen as being factual in nature, and hence more reliable and
more readily understood than other sources of information.
Information on the generation and use of cash is useful in evaluating the entity’s ability to
generate cash and its need to use what is generated.

2.4.4 Notes and supplementary schedules

Notes and schedules attached to financial statements can provide additional information
relevant to users, for example the non-current assets note (see Chapter 4).

3 Bases of accounting
Section overview

• You will have covered the accrual basis and the cash basis of financial reporting in your
Accounting studies. In this section, we briefly revise these and introduce the ‘break-up
basis’. You will need to familiar with the following:

12 Financial Accounting and Reporting - IFRS Standards ICAB 2024

 – accrual basis
– cash basis C
H
– break-up basis
A
• The going concern basis is referred to by the Conceptual Framework as the P
‘underlying assumption’. T
E
R
3.1 Accrual basis
Under this basis of accounting, transactions are recognised when they occur, not when the
related cash flows into or out of the entity. You will be familiar with this basis from your 1
Accounting studies. The Conceptual Framework states that:
Accrual accounting depicts the effects of transactions and other events and circumstances on
a reporting entity’s economic resources and claims in the periods in which those effects occur,
even if the resulting cash receipts and payments occur in a different period (Conceptual
Framework: para 1.17).
Application of accrual accounting means that:
• Sales are recorded in the period in which the performance obligations associated with a
contract are satisfied, which is normally when control of an asset passes from seller to
buyer, not when the seller receives full payment. While this basis has no effect on the
timing of the recognition of cash sales, it does mean that credit sales are recorded earlier
than if the cash basis of accounting was used. When credit sales are recognised, a
receivable is created in the seller’s accounts.
• Expenses are recognised in the period when the goods or services are consumed, not
when they are paid for. An amount payable will be set up in the entity’s books for credit
purchases, again leading to earlier recognition than if the cash basis was used.
• The consumption of non-current assets, such as plant and machinery, is recognised over
the period during which they are used by the entity (ie, the asset is depreciated), not in
the year of purchase as they would be under the cash basis of accounting.
The Conceptual Framework makes it clear that information in an entity’s financial statements
should be prepared on the accrual accounting basis.

3.2 Going concern basis

The accrual basis of accounting assumes that an entity is a going concern. Under this basis,
financial statements are prepared on the assumption that the entity will continue in
operation for the foreseeable future, in that management has neither the intention nor the
need to liquidate the entity by selling all its assets, paying off all its liabilities and distributing
any surplus to the owners.
Going concern is referred to by the Conceptual Framework as an ‘underlying assumption’.

3.3 Cash basis

The cash basis of accounting is not used in the preparation of a company statement of
financial position and performance statements as it is not allowed by IFRS Standards,
although the cash effect of transactions is presented in the form of a statement of cash flows.
(We will look at the statement of cash flows in Chapter 2.) The cash basis may be used,
however, for small unincorporated entities, for example clubs and societies.
In many ways the cash basis of accounting is very simple. Only the cash impact of a transaction is
recorded.

ICAB 2024 Reporting framework and ethics 13

 3.4 Break-up basis
As we saw in section 3.1, one of the key assumptions made under the accrual basis is that the
business will continue as a going concern. However, this will not necessarily always be the case.
There may be an intention or need to sell off the assets of the business. Such a sale typically
arises where the business is in financial difficulties and needs the cash to pay its creditors. Where
this is the case an alternative method of accounting must be used (in accordance with IAS 1,
Presentation of Financial Statements). In these circumstances the financial statements will be
prepared on a basis other than going concern, which is commonly referred to as the ‘break-up’
basis. The break-up basis values assets and liabilities today as if the entity was about to cease
trading and had to dispose of all its assets and liabilities.
The effect of this is seen primarily in the statement of financial position as follows:
• Classification of assets and liabilities
All assets and liabilities would be classified as current rather than non-current.
• Valuation of assets
Assets would be valued on the basis of the recoverable amount on sale. This is likely to be
substantially lower than the carrying amount of assets held under historical cost accounting.

4 The Conceptual Framework

Section overview

The Conceptual Framework is organised into chapters, and the key chapters for the purposes of
Financial Accounting and Reporting are:
• The qualitative characteristics of financial information
• The definitions of elements in the financial statements
• Guidance on recognition and derecognition
• Guidance on measurement bases
• Principles for disclosure and presentation in the financial statements

4.1 Conceptual Framework

The Conceptual Framework is organised into the following eight chapters:

Chapter 1: The objective of general purpose financial reporting

Chapter 2: Qualitative characteristics of useful financial information
Chapter 3: Financial statements and the reporting entity
Chapter 4: The elements of financial statements
Chapter 5: Recognition and derecognition
Chapter 6: Measurement
Chapter 7: Presentation and disclosure
Chapter 8: Concepts of capital and capital maintenance (this is outside of the Financial Accounting
and Reporting syllabus)
In this chapter we have already introduced some of the concepts dealt with by the Conceptual
Framework.

14 Financial Accounting and Reporting - IFRS Standards ICAB 2024

4.2 Status and purpose of the Conceptual Framework
The Conceptual Framework initially states its purposes:
(a) to assist the International Accounting Standards Board (Board) to develop IFRS
Standards that are based on consistent concepts;
(b) to assist to develop consistent accounting policies when no IFRS Standard applies to a
particular transaction or other event, or when an IFRS Standard allows a choice of
accounting policy; and
(c) to assist all parties to understand and interpret IFRS Standards.
The Conceptual Framework is not an IFRS Standard and so does not overrule any individual IFRS
Standard. In the (rare) case of conflict between an IFRS Standard and the Conceptual Framework,
the IFRS Standard will prevail.

4.3 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 (Conceptual Framework: para 1.2).
Those include decisions about:
• buying, selling or holding equity and debt instruments;
• providing or settling loans and other forms of credit; or
• exercising rights to vote on, or otherwise influence, management’s actions that affect the use of
the entity’s economic resources.
These users need information about:
• the economic resources of the entity, claims against the entity and changes in those resources
and claims; and
• how efficiently and effectively the entity’s management have discharged their responsibilities to
use the entity’s resources.
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.
4.4 Chapter 2: Qualitative characteristics of useful financial information
4.4.1 Overview
Qualitative characteristics are the attributes that make the information provided in
financial statements useful to users.
The two fundamental qualitative characteristics are relevance and faithful representation.
There are then four enhancing qualitative characteristics which enhance the usefulness of
information that is relevant and faithfully represented. These are: comparability,
verifiability, timeliness and understandability.

ICAB 2024 Reporting framework and ethics 15

 4.4.2 Relevance
Relevant financial information can be of predictive value, confirmatory value or both. These roles
are interrelated.

Definition
Relevance: Relevant financial information is capable of making a difference in the decisions made
by users.

Information on financial position and performance is often used to predict future position and
performance and other things of interest to the user eg, likely dividend, wage rises. The
manner of presentation will enhance the ability to make predictions eg, by highlighting
unusual items.
The relevance of information is affected by its nature and its materiality.

Definition
Materiality: Information is material if omitting, misstating or obscuring it could reasonably be
expected to influence decisions that primary users of general purpose financial reports make on
the basis of financial information about a specific reporting entity.

Information may be judged as material either by its value (eg, large transactions that influence
the amount of the financial transactions recorded) or because of its nature (eg, remuneration of
management), or both. Materiality is not a qualitative characteristic itself (like relevance or faithful
representation), because it is merely a threshold or cut-off point. It should be noted that
materiality is an entity specific assessment and that this will vary between companies, and that
there is no designated threshold for the definition of materiality.

4.4.3 Faithful representation

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
substance of the phenomena that it purports to represent. The user must be able to depend on it
being a faithful representation.

Definition
Faithful representation: A perfectly faithful representation should be complete, neutral and free
from error.

A complete depiction includes all information necessary for a user to understand the
information 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. Neutrality is supported by the exercise of prudence.
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.

Definitions
Prudence: The exercise of caution when making judgements under conditions of uncertainty

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 (Conceptual Framework: para. 2.16). Prudence supports the concept of neutrality.
Substance over form: Substance over form is the principle that transactions and other events
are accounted for and presented in accordance with their substance and economic reality and
not merely their legal form.

Substance over form is not a separate qualitative characteristic under the Conceptual
Framework. The IASB says that 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.
Most transactions are reasonably straightforward and their substance ie, their commercial effect,
is the same as their strict legal form. However, in some instances this is not the case as can be
seen in the following example.

Context example: Sale and repurchase agreement

A Ltd sells goods to B Ltd for CU10,000 but is contractually obliged to repurchase the goods
from B Ltd in 12 months’ time for CU11,000, regardless of their condition or value at that date.
The legal form of the transaction is that A has sold goods to B. To reflect the legal form, A Ltd
would record a sale and show the resulting profit, if any, in profit or loss for the period. In 12
months’ time, when the goods are repurchased, A Ltd would record a purchase.
The above treatment does not provide a faithful representation because it does not reflect the
economic substance of the transaction. A Ltd is under an obligation to repurchase the goods and
A Ltd bears the risk that those goods will be damaged, obsolete or unsaleable in a year’s time.
The substance is that B Ltd has made a secured loan to A Ltd of CU10,000 plus interest of
CU1,000. To reflect substance, A Ltd should continue to show the goods as an asset in
inventories (at the lower of cost and net realisable value) and should include a liability to B Ltd
of CU10,000 as a current liability. A Ltd should accrue for the interest over the duration of the
loan.
When A Ltd pays CU11,000 to repurchase the goods, this should be treated as a repayment of
the loan plus accrued interest.

Other examples of accounting for substance over form:

• Leases
Accounting for leases under IFRS 16, Leases (which is covered in Chapter 7) is an example
of the application of substance as the lessee recognises an asset in its statement of financial
position even though the legal form of a lease is that of renting the asset, not buying it.
• Group financial statements
Group financial statements are covered in detail in Chapters 10 to 15. The central
principle underlying group accounts is that a group of companies is treated as though it
were a single entity, even though each company within the group is itself a separate
legal entity.

4.4.4 Enhancing qualitative characteristics

The Conceptual Framework has additional characteristics which enhance the fundamental
characteristics of relevance and faithful representation. The following definitions are provided
by the Conceptual Framework:

Definitions
Comparability: This enables users to identify and understand similarities in, and differences
among, items.

ICAB 2024 Reporting framework and ethics 17

 Verifiability: This 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 that a particular depiction is a faithful
representation.
Timeliness: This means having information available to decision-makers in time to be capable of
influencing their decisions. Generally, the older the information is, the less useful it is.
Understandability: Classifying, characterising and presenting information clearly and
concisely makes it understandable.

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.
Corresponding information for preceding periods should be shown to enable comparison over
time.
Verifiability
Information may be verified by a number of different methods, such as observing an inventory
count and physically reviewing assets, maybe with the assistance of a specialist valuation
expert. There may be a number of different tests or financial models which can assist in
verifying data, such as the recalculation of depreciation using the entity’s rates.
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 information
may be inherently complex and cannot be made easy to understand. Excluding this information
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 advisor to understand information about complex economic information.

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4.5 Chapter 4: The elements of financial statements

4.5.1 Overview
Transactions and other events are grouped together in broad classes and in this way their financial
effects are shown in the financial statements. The five elements of financial statements are assets,
liabilities, equity, income and expenses.

4.5.2 Definitions of elements

The key definitions of ‘asset’ and ‘liability’ will be referred to again and again in these learning
materials, because they form the foundation on which so many accounting standards are based. It
is very important that you can reproduce these definitions accurately and quickly and apply them
to a given scenario.

Definitions
Asset: A present economic resource controlled by the entity as a result of past events. An
economic resource is a right that has the potential to produce economic benefits.
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.

4.5.3 Assets
We can look in more detail at the components of the definitions given above.
Assets must have the potential to produce future economic benefits either alone or in
conjunction with other items.

Definition
Potential to produce economic benefits: An economic resource is a right that has the potential to
produce economic benefits. For that potential to exist, it does not need to be certain, or even
likely, that the right will produce economic benefits.

In simple terms, an item is an asset if:

• it is cash or the right to receive cash in the future eg, a trade receivable, or a right to
services that may be used to generate cash eg, a prepayment; or
• it can be used to generate benefits (which can include making cost savings) or meet
liabilities eg, a tangible or intangible non-current asset.
The existence of an asset, particularly in terms of control, is not reliant on:
• physical form (hence intangible assets such as patents and copyrights may meet the
definition of an asset and appear in the statement of financial position – even though they
have no physical substance); or
• legal ownership (hence some leased assets, even though not legally owned by the
company, may be included as assets in the statement of financial position. See Chapter 7.

ICAB 2024 Reporting framework and ethics 19

 4.5.4 Liabilities
The Conceptual Framework sets out the definition of a liability, as stated above, that
fundamentally the liability can only exist when all three of the following criteria have been
satisfied:
• the entity has an obligation
• the obligation is to transfer an economic resource
• the obligation is a present obligation that exists as a result of past events

Definition
Obligation: A duty or responsibility that the entity has no practical ability to avoid.

As seen above, obligations may be:

• legally enforceable as a consequence of a binding contract or statutory requirement.
This is normally the case with amounts payable for goods and services received; or
• the result of business practice. For example, even though a company has no legal
obligation to do so, it may have a policy of rectifying faults in its products even after a
standard warranty period has expired.
A management decision (to acquire an asset, for example) does not in itself create an obligation,
because it can be reversed. But a management decision implemented in a way which creates
expectations in the minds of customers, suppliers or employees, becomes an obligation. This is
sometimes described as a constructive obligation. This issue is covered more fully in Chapter 9
in the context of the recognition of provisions.
Liabilities must arise from past transactions or events. For example, the sale of goods is the past
transaction which allows the recognition of repair warranty provisions.
Settlement of a present obligation will involve the entity giving up resources embodying
economic benefits in order to satisfy the claim of the other party. In practice, most liabilities
will be met in cash but this is not essential.

Professional skills focus: Structuring problems and solutions

It is important that you thoroughly understand the Conceptual Framework, as you will be
referring to it throughout your studies. Your exam may ask you to comment on the impact of
the Conceptual Framework on other IFRS Standards, such as how the recognition of a liability
is important in assessing provisions and liabilities in IAS 37, Provisions, Contingent Liabilities
and Contingent Assets.

Interactive question 1: Asset or liability?

Explain in each of the following scenarios whether the items in question may be classified as
assets or liabilities.

Question Answer

Oak plc has purchased a licence for CU25,000. The

licence gives the company the use of robotic delivery
drones which will save CU60,000 a year for the next five
years. Should Oak plc classify the licence as an asset?

20 Financial Accounting and Reporting - IFRS Standards ICAB 2024

 Question Answer

Pear Ltd acts as a trustee for shares held by Piper Ltd. Piper
Ltd retains the voting rights as well as receiving the
dividends from the shares. Pear Ltd receives a fee for the
trustee services they provide to Piper Ltd. Can Pear Ltd
classify these shares as assets?

Sycamore Ltd provides a standard warranty with the

purchase of every laptop it sells. These standard
warranties are not paid for by the purchaser and are valid
for a period of 24 months from the date of sale. Does
Sycamore Ltd have to recognise these warranties as
liabilities?

See Answer at the end of this chapter.

4.5.5 Equity
Equity is the residual interest in the assets of an entity after deducting its liabilities, so the amount
at which it is shown is dependent on the measurement of assets and liabilities. It has nothing to do
with the market value of the entity’s shares.
Equity may be sub-classified in the statement of financial position providing information which is
relevant to the decision-making needs of the users. This will indicate legal or other restrictions on
the ability of the entity to distribute or otherwise apply its equity.
In practical terms, the important distinction between liabilities and equity is that creditors have the
right to insist that the transfer of economic resources is made to them regardless of the entity’s
financial position, but owners do not. All decisions about payments to owners (such as dividends
or share capital buy-back) are at the discretion of management.

4.5.6 Performance
Profit is used as a measure of performance, or as a basis for other measures (eg, earnings per
share (EPS)). It depends directly on the measurement of income and expenses, which in turn
depend (in part) on the concepts of capital and capital maintenance adopted.
Income and expenses can be presented in different ways in profit or loss and in other
comprehensive income, to provide information relevant for economic decision-making. For
example, a statement of profit or loss could distinguish between income and expenses which
relate to continuing operations and those which do not.
Items of income and expense can be distinguished from each other or combined with each other.
Income:
• Both revenue and gains are included in the definition of income.
• Revenue arises in the course of ordinary activities of an entity. (We will look at revenue in
more detail in Chapter 6.).
• Gains include those arising on the disposal of non-current assets. The definition of
income also includes unrealised gains eg, on revaluation of non-current assets.
• A revaluation gives rise to an increase or decrease in equity.
• Gains on revaluation, which are recognised in a revaluation surplus (which is covered in
Chapter 4.)
Expenses:

ICAB 2024 Reporting framework and ethics 21

 • Both expenses and losses are included in the definition of expense.
• Losses will include those arising on the disposal and impairment of property,
plant and machinery, as well as intangible non-current assets.

4.6 Chapter 5: Recognition and derecognition

Definition
Recognition: The process of capturing for inclusion in the statement of financial position or
statement(s) of financial position an item that meets the definition of one of the elements of
the financial statements an asset, a liability, equity, income or expenses. The amount at
which an asset, liability or equity is recognised in the statement of financial position is
referred to as its ‘carrying amount’.

4.6.1 Recognition criteria

Recognition is the point at which an element is included in the financial statements.
According to the Conceptual Framework, 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 ie, it provides:
– relevant information about the element
– a faithful representation of the element.
However, the benefits of providing that information should justify the costs of recognising
it. Recognition is subject to cost constraints.

Definition
Cost constraint: Reporting financial information imposes costs, and it is important that those costs
are justified by the benefits of reporting that information.

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; and 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.

4.6.2 Derecognition

Definition
Derecognition: Derecognition is the removal of all or part of a recognised asset or liability
from an entity’s statement of financial position.

Derecognition normally occurs when the element no longer meets the definition of an
element. For an asset, this is usually when control is lost. For a liability, this is usually when
there is no longer a present obligation. It is possible to derecognise part of an asset or
liability.

22 Financial Accounting and Reporting - IFRS Standards ICAB 2024

 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.

4.7 Chapter 6: Measurement

For an item or transaction to be recognised in an entity’s financial statements it needs to be
measured as a monetary amount. IFRS Standards use several different measurement bases but
the Conceptual Framework refers to two main measurement bases:
• historical cost
• current value

4.7.1 Historical cost

Definition
Historical cost: These measures provide monetary information about assets, liabilities and related
income and expenses, using information derived, at least in part, from the price of the transaction
or other event that gave rise to them.

The historical cost is the consideration paid to acquire or create an asset, plus any relevant
transaction costs. Equally, the historical cost of a liability is the value of the consideration received
in order to take on the liability, less any relevant transaction costs.
Historical cost is the most commonly adopted measurement basis, but this is usually combined
with other bases eg, an historical cost basis may be modified by the revaluation of land and
buildings.

Advantages Disadvantages

Actual costs are more difficult to manipulate, and Costs may be out of date and so this may
so they can be verified (invoices, etc) so the result in an overstatement of profit
measurements are reliable. (revenues at current values, whereas
expenses associated with them at historical
costs).
The statement of financial position and the Valuation of assets may be out of date as
statement of cash flows are consistent with each they are based on their historical costs.
other.

Cost is easy to understand. It is not affected, nor representative of,

movements due to inflation. This can lead
to misleading results as comparative figures
for previous years are not adjusted for
inflation.

4.7.2 Current value

Definition
Current value: These measures provide monetary information about assets, liabilities and
related income and expenses, using information updated to reflect conditions at the
measurement date. Because of the updating, current values of assets and liabilities reflect
changes since the previous measurement date in estimates of cash flows and other factors
reflected in those current values.

ICAB 2024 Reporting framework and ethics 23

 Current value seeks to correct some of the problems associated with historical cost, by providing
a number of alternative measurement bases:
• fair value
• value in use (for assets) / fulfilment value (for liabilities)
• current cost

Definition
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.

Fair value is measured in accordance with IFRS 13, Fair Value Measurement. This
measurement method has implications across much of the IFRS Standards in this module,
notably in the measurement of the values of property, plant and equipment (Chapter 4),
contingent liabilities (Chapter 10-14), business combinations and the assets and liabilities
purchased (Chapters 10-14) and non-current assets identified for sale or disposal (Chapter
4).
Fair value is calculated by taking the open market value, and where there is no active market for
that element, the following would be used:
• estimates of future cash flows; and
• time value of money (discounting the future cash flows).

Definition
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.

Value in use considers the specific factors relevant to that entity regarding the likely future
value of the asset within that entity eg, revenue generation or cost savings.

Definition
Fulfilment value: The present value of the cash, or other economic resources, that an entity
expects to be obliged to transfer as it fulfils its liabilities.

Fulfilment value provides information about the present value of the estimated cash flows
needed to fulfil a liability. This can be used when the liability amount is known, as opposed to
being subject to a negotiation.

Definition
Current cost: The current cost of an asset is the cost an equivalent asset at the measurement
date comprising the consideration that would be paid at the measurement, plus transaction
costs that would be incurred at that date. The current cost of a liability is the consideration
would be received for an equivalent liability at the measurement date, minus the transaction
costs that would be incurred at that date.

Although this is similar in nature to historical costs, in that it takes actual costs, it is
representative of the current cost of replacing that asset or liability. The Conceptual
Framework refers to this as an ‘entry cost’, whereas historical costs is an ‘exit cost’.
Occasionally, it may be difficult to obtain a current cost of an element from information

24 Financial Accounting and Reporting - IFRS Standards ICAB 2024

 currently available (eg, if only newer models are available); instead, it is possible for the
entity to adjust for the condition and age in order to buy a similar model or asset.

4.8 Chapter 7: Presentation and disclosure

It is essential that an entity ensures that the information presented in the financial statements is
effectively communicated. Relevant disclosures giving a fair representation of the position and the
performance of the entity at the reporting date are required.
Effective communication also requires the entity to make available information that is relevant
to their entity and industry, instead of just producing the very minimum or basic information.
This is often referred to as ‘boilerplate’ whereby the standard descriptions are provided,
rather than giving an entity-specific and relevant explanation of the position and performance
of the business.
Offsetting (netting off assets and liabilities of a similar nature) is discouraged.

5 The regulatory framework

Section overview

• Financial reporting is the provision of financial information to those outside the entity.
• The organisation responsible for setting IFRS Standards comprises the International
Financial Reporting Standards Foundation (IFRS Foundation), the Monitoring Board, the
International Accounting Standards Board (IASB), the IFRS Advisory Council (Advisory
Council) and the IFRS Interpretations Committee (Interpretations Committee).
• The process of setting IFRS Standards is an open dialogue involving co-operation
between national and international standard setters.
• The IFRS Foundation formed the International Sustainability Standards Board (ISSB) in
2021 to develop IFRS Sustainability Disclosure Standards which will compliment IFRS
Standards.

5.1 The IFRS Foundation

The IFRS Foundation and its independent standard-setting body, the IASB, provide public
accountability through the transparency of their work, the consultation with the full range of
interested parties in the standard-setting process, and their formal accountability links to the
public. The leaders of the major economies, through the G20, have confirmed the importance of
an independent standard-setter accountable to the public interest.
Public accountability, ensured by the organisation’s constitution and governance arrangements,
is vital to the organisation’s success. The Trustees of the IFRS Foundation are responsible for
ensuring that appropriate governance arrangements are in place and observed by all parts of
the organisation.
The Trustees’ effectiveness in exercising their functions is assessed annually by the Trustees’ Due
Process Oversight Committee.
The IFRS Foundation oversees the work of the IFRS Interpretations Committee and the IFRS
Advisory Council.

5.2 Membership
Membership of the IFRS Foundation has been designed so that it represents an international
group of preparers and users, who become IFRS Foundation trustees. The selection process of

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 the trustees takes into account geographical factors and professional background. IFRS
Foundation trustees appoint the IASB members.

5.3 The IASB

The IASB is responsible for setting accounting standards. It is made up of an independent group of
experts with an appropriate mix of recent practical experience in setting accounting standards, in
preparing, auditing, or using financial reports and in accounting education. There is no particular
geographical dominance, although geographical diversity is required. Members have a variety of
backgrounds and include:
• auditors
• preparers and users of financial statements
• academics

5.4 Objectives of the IASB

The Preface to IFRS Standards states that the objectives of the IASB are as follows:
• To develop, in the public interest, a single set of high-quality, understandable,
enforceable and globally accepted financial reporting standards based on clearly
articulated principles. These standards should require high quality, transparent and
comparable information in financial statements and other financial reporting to help
investors, other participants in the various capital markets of the world and other users of
the information to make economic decisions;
• To promote the use and rigorous application of those standards;
• In fulfilling the above objectives to take account of, as appropriate, the needs of a range
of sizes and types of entities in diverse economic settings; and
• To promote and facilitate the adoption of IFRS Standards through the convergence of
national accounting standards and IFRS Standards.

5.5 The purpose of accounting standards

The overall purpose of accounting standards is to identify accounting practices for the
preparation of financial statements.
Accounting standards create a common understanding between users and preparers on
how particular items, for example the valuation of property, are treated. Financial
statements should therefore comply with all applicable accounting standards.

5.6 Application of IFRS Standards

Within each individual country local regulations govern, to a greater or lesser degree, the
issue of financial statements. These local regulations include accounting standards issued
by the national regulatory bodies or professional accountancy bodies in the country
concerned.
Over the last 25 years however, the influence of IFRS Standards on national
accounting requirements and practices has been growing. For example:
• Since accounting periods commencing on or after 1 January 2005, all EU companies
whose securities are traded on a regulated public market must prepare their
consolidated financial statements in accordance with EU-endorsed IFRS Standards.

5.7 Setting of IFRS Standards

The overall agenda of the IASB is initially set by discussion with the IFRS Advisory Council.
The process for developing an individual standard involves the following steps.

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 Step 1 During the early stages of a project, IASB may establish an Advisory Committee or
working group to give advice on issues arising in the project. Consultation with the
Advisory Committee and the Advisory Council occurs throughout the project.
Step 2 IASB may develop and publish a Discussion Paper for public comment.
Step 3 Following the receipt and review of comments, IASB would develop and publish an
Exposure Draft for public comment.
Step 4 Following the receipt and review of comments, the IASB would issue a final
International Financial Reporting Standard.
The period of exposure for public comment is normally 120 days. However, in some
circumstances, proposals may be issued with a comment period of not less than 30 days. Draft
IFRS Interpretations are exposed for a 60-day comment period.

5.8 Scope and authority of IFRS Standards

The Preface to IFRS Standards makes the following points:
• IFRS Standards apply to all general purpose financial statements ie, those directed towards
the common information needs of a wide range of users.
• The IASB’s objective is to require like transactions and events to be accounted for and
reported in a like way. The IASB intends not to permit choices in accounting treatment. The
IASB is reconsidering those transactions and events for which IFRS Standards permit a
choice of accounting treatment with the objective of reducing the number of those choices.
• Standards include paragraphs in bold and plain type. Bold type paragraphs indicate the
main principles, but both types have equal authority.
• Any limitation of the applicability of a specific IFRS Standard is made clear in that standard.

5.9 The ISSB

The ISSB was formed in 2021 with responsibility for developing a set of sustainability
disclosure standards (IFRS Sustainability Disclosure Standards) which will complement the
existing IFRS Standards.
Similar to the IASB, the ISSB will comprise members from a range of professional backgrounds and
geographical areas. The members of the ISSB should have experience and expertise relevant to
sustainability.

5.10 Objectives of the ISSB

The aim of the IFRS Sustainability Disclosure Standards is to provide high-quality, transparent and
comparable information relating to sustainability in the financial statements and in sustainability
disclosures which are focused on the needs of investors and the financial markets.
Sustainability reporting is important to the users of financial statements who are increasingly
interested in information relating to the sustainability of an entity’s operations. The users are
interested both in the social aspects of sustainability, such as the impact an entity has on its local
environment, and on how sustainability impacts on company value. Other organisations have
developed guidance around the disclosure of sustainability information; however, the lack of
formal standards and the range of guidance has led to inconsistency in what type of information
is disclosed, how it is disclosed and how it links to ‘traditional’ accounting and measures of
corporate value.
The intention is for the ISSB to cover a range of environmental, social and governance (ESG)
sustainability topics on which investors want information. It will initially focus on climate-related
reporting due to the urgent need for information on climate-related matters.

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