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Monday, November 12, 2012

Framework for the Preparation and Presentation of Financial Statements

Background


The Framework for the Preparation and Presentation of Financial Statements describe the basic concepts by which financial statements are prepared. The Framework serves as a guide to the Board in developing accounting standards and as a guide to resolving accounting issues that are not addressed in an International Accounting Standard or Interpretation. In the absence of a Standard or an interpretation that specifically applies to a transaction, management must use its judgment in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgment, IAS 8 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income and expenses in the Framework.

The Framework addresses general-purpose financial statements that a business enterprise (including a state-owned business enterprise) prepares and presents at least annually to meet the common information needs of a wide range of users external to the enterprise. Therefore, the Framework does not necessary apply to special purpose financial reports such as reports to tax  authorities, reports to governmental regulatory authorities, prospectus prepared in connection with securities offerings, and reports prepared in connection with business combinations.

Scope


This Framework sets out the concepts that underline the preparation and presentation of financial statements for external users.

The Framework deals with:

§  The objective of financial statements
§  The qualitative characteristics that determine that usefulness of information in financial statements
§  The definition, recognition and measurement of the elements from which financial statements are constructed
§  Concepts of capital and capital maintenance

The Framework addresses the general purpose financial statements that a business enterprise (including a state-owned business enterprise) prepares and presents at least annually to meet the common information needs of a wide range of users external to the enterprise. Therefore, the Framework does not necessarily apply to special purpose financial reports such as reports to tax authorities, reports to governmental regulatory authorities, prospectuses prepared in connection with securities offerings and reports prepared in connection with business combinations.

Users and their information needs


The principal classes of users of financial statements are present and potential investors, employees, lenders, suppliers and other trade creditors, customers, government and their agencies and the general public. All of these categories of users rely on financial statements to help them in decision making.

The Framework also concludes that because investors are providers of risk capital to the enterprise, financial statements that meet their needs will also meet most of the general financial information needs of other users. Common to all of these user groups is their interest in the ability of an enterprise to generate cash and cash equivalents and of the timing and certainty of those future cash flows.

Responsibility for financial statements


The management of an enterprise has the primary responsibility for preparing and presenting the enterprise’s financial statements.

Objective of financial statements


The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions.

The financial statements cannot provide all the information that users may need to make economic decisions. For one thing, financial statements show the financial effects of past events and transactions, whereas the decisions that most users of financial statements have to make relate to the future. Further, financial statements provide only limited amount of the non-financial information needed by users of financial statements. It should be understood that all of the information needs of these user groups cannot be met by financial statements, however general purpose financial statements focus on information needs that are common to all users.

§  Financial position
§  Performance
§  Changes in financial position
§  Changes in equity position
§  Notes and supplementary schedules
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Underlying assumptions


The Framework sets out the underlying assumptions of financial statements:


Accrual Basis


The effects of transactions and other events are recognized when they occur, rather than when cash or its equivalents is received or paid, and they are reported in the financial statements of the periods to which they relate.

 Going concern


The financial statements presume that an enterprise will continue in operations indefinitely or, if that presumption is not valid, disclosure and a different basis of reporting required.

Qualitative characteristics of financial statements


These characteristics are the attributes that make the information in financial statements useful to investors, creditors and others. The Framework identifies four principal qualitative characteristics:

§  Understandability
§  Relevance
§  Comparability
§  Reliability
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The elements of financial statements


Financial statements portray the financial effects of transactions and other events by grouping them into broad classes according to their economic characteristics. These broad classes are termed the elements of financial statements.

The elements directly related to financial position (balance sheet) are:

§  Assets
§  Liabilities
§  Equity

The elements directly related to performance (income statement) are:

§  Income
§  Expenses

The cash flow statement reflects both income statement elements and changes in balance sheet elements.



Capital maintenance


The concept of capital maintenance is concerned with how an entity defines the capital that it seeks to maintain. It provides the linkage between the concepts of capital and the concepts of profit because it provides the point of reference by which profit is measured; it is a prerequisite for distinguishing between an entity’s return on capital and its return on capital.

Only inflows of assets in excess of amounts needed to maintain capital. It may be regarded as profit and therefore as a return on capital. Hence, profit is the residual amount that remains after expenses (including capital maintenance adjustments, where appropriate) have been deducted from income. If expenses exceed income the residual amount is a lost.

There are two concepts of capital maintenance;


Financial capital maintenance


Under this concept the profit is earned only if the monetary value of net assets at the end of the period exceeds the monetary value of net assets at the beginning of the period after excluding any distributions and capital contributions.


 Physical capital maintenance

Under this concept the profit is earned only if the physical productive capacity of the entity at the end of the period exceeds the operating capacity at the beginning of the period after excluding any distributions from owners of the entity.



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