CHAPTER THREE

1) Concept of Accounting Standards:

We know that Generally Accepted Accounting Principles (GAAP) aims at bringing uniformity and
comparability in the financial statements. It can be seen that at many places, GAAP permits a variety
of alternative accounting treatments for the same item. For example, different methods for valuation
of stock give different results in financial statements.
Such practices sometimes can misguide intended users in taking decision relating to their field.
Keeping in view the problems faced by many users of accounting, a need for the development of
common accounting standards was aroused. For this purpose, the Institute of Chartered Accountants
of India (ICAI), which is also a member of International Accounting Standards Committee (IASC),
had constituted Accounting Standard Board (ASB) in the year 1977. ASB identified the areas in
which uniformity in accounting was required. After detailed research and discussions, it prepared
and submitted a draft to the ICAI. After proper examination, ICAI finalized them and notified for its
use in financial statements.

2) International Financial Reporting Standard (IFRS).

Role of Accounting Standards

Accounting standards are necessary because without them, users of financial statements would have
to learn the basis of accounting for each company, making comparisons to other companies’
financial statements difficult.
Accounting rules tend to vary in different jurisdictions. Until recently, one of the major challenges in
conducting global business has been the fact that different countries have adopted different
accounting standards for business transactions. Developed countries like the United States, the
United Kingdom, Japan, Germany, Australia, etc., follow their own professional frameworks for
measurement and disclosure of financial information, usually called generally accepted accounting
principles (GAAP). As investors seek to compare financial results across entities from different
countries, they have had to restate and convert accounting data from one country to the next in order
to make them comparable. This takes time and can be expensive, especially in a globalized world
with multinationals operating across many countries.
The potential solution to this problem lies with the International Accounting Standards
Board (IASB) and its International Financial Reporting Standards (IFRS). The IASB was
formed in 2001 to replace the International Accounting Standards Committee (IASC) with the
objective of developing a single set of high-quality, understandable, and enforceable accounting
standards to help participants in the world’s capital markets and other users make economic
decisions.
The advantages of adopting one common set of standards are clear. Companies in jurisdictions that
have mandated or allowed the use of IFRS, such as Australia, Hong Kong, the United Arab
Emirates, Europe, Japan, and the United States, will have financial statements that are more
comparable with each other. It will be far easier for investors and other financial statement users to
evaluate the information of various companies across the globe, and companies will only have to
prepare one set of financial statements, instead of multiple versions. Thus, in the long run, the global
use of IFRS should reduce the costs of doing business globally.

3) THE IFRS CONCEPTUAL FRAMEWORK

The Conceptual Framework lays the foundation for resolving the big issues in accounting. You can
think of it as the “Why, Who, What, How” of financial reporting.

Objective: The Conceptual Framework is focus on general purpose financial statements, which
are prepared and presented annually and are directed toward the common information needs of a
wide range of financial statement users. Many of these users rely on the financial statements as their
major source of financial information. Special purpose financial reports, such as computations for
taxation purposes or other regulatory reporting requirements, are outside the scope of the
Conceptual Framework.

4) Characteristics of financial information

The Conceptual Framework uses the term qualitative characteristics to describe the attributes that
will most likely make the information provided in financial statements useful to users. The
Conceptual Framework suggests Fundamental and Enhancing Characteristic.

Fundamental Characteristic: Relevance

To be relevant, information must be capable of making a difference to the decision maker. Typically,
this happens when financial information is used to help users in making their own predictions of
future outcomes (predictive value) or in assessing previous evaluations (confirmatory value).
Information that has predictive value often also has confirmatory value.
The degree of relevance may be influenced by the materiality of the information. Materiality means
that the information must be important enough to the user to make a difference to his or her decision
if it were omitted or erroneously declared. Only the information that is material needs to be
separately disclosed, listed, or discussed in financial statements. An item may be material due to its
nature or magnitude, or both. For example, all entities are required to disclose financial expenses
(borrowing costs, interest expenses) regardless of their magnitude. Immaterial items are not required
to be disclosed separately and may be combined with other information.
Thus, materiality depends on the size of the item or the scale and impact of the error in the particular
circumstances of its omission or misstatement. The Conceptual Framework did not prescribe a fixed
level of materiality since it is entity-specific—what is material for one entity may not be material for
another.

Fundamental Characteristic: Faithful Representation

Financial statements represent economic phenomena, i.e., resources, claims to resources, and
changes in resources and claims, in words and numbers. Such depiction should reflect the substance
of an economic phenomenon rather than its legal form. Information that faithfully represents the
underlying economic phenomenon should be complete, neutral, and free from error.
Completeness means that the financial reports should include all necessary information for a user to
understand the economic phenomenon being depicted, including all necessary descriptions and
explanations. Neutrality means that the information must be depicted without bias. It is supported by
the concept of prudence, i.e., the exercise of caution when making judgments under conditions of
uncertainty. Freedom from error means that there are neither erroneous depictions of economic
phenomenon nor any omission.
Enhancing Characteristic: Comparability
Users usually compare financial statements of an entity over a period to identify trends in its
financial position and performance. Thus, it is important that the basis of preparation and
presentation remains comparable over time. For example, the comparison between sales in 2016
and 2015 only makes sense if you know that there has been no material change in the way sales are
recognized in the financial statements. Similarly, you may want to compare performance to another
retailer. To be comparable, “like things must look alike, and different things must look different.”
Comparability does not force an entity to continue using the same accounting principles, policies, or
estimates when more relevant and newer information surfaces.
Enhancing Characteristic: Verifiability
Verifiability helps assure users that information faithfully represents the economic phenomenon it
purports to represent. It means that given the same economic phenomenon and its depiction, two
different knowledgeable and independent parties can come to a consensus that the depiction is a
faithful representation of the economic phenomenon.
Enhancing Characteristic: Timeliness
Timeliness means that the information must be made available to users early enough to help them
make decisions, thus, making the information more relevant to their needs. By providing information
about its financial position and performance to the users of the financial statement in a timely
manner,
Enhancing Characteristic: Understandability
Understandability means that financial information must be classified, characterized, and presented
clearly and concisely. The framework assumes that users have a reasonable knowledge of business,
economic activities and accounting, and a willingness to study the information with reasonable
diligence
Constraints in Providing Useful Information
In providing information that can be useful to our users, a pervasive constraint we face is cost.
Financial information is not produced without costs; for example, cost of data collection, cost of data
processing, and cost of verifying and disseminating the information. Naturally, higher costs result in
lower returns to shareholders. Businesses will need to assess whether the benefits of reporting
particular information are likely to outweigh the costs incurred in providing or using the information.
Assumptions in Financial Reporting
The Conceptual Framework states that in order to meet the objectives of financial reporting, there
are assumptions accrual basis. In short, this means that transactions and other events are recognized
when they occur and not when cash is received or paid. In measuring and reporting financial
information, we also assume that the entity will continue to operate long enough to use existing
assets like land, buildings, equipment, and supplies for its intended purposes. In other words, the
business has neither the intention nor the need to liquidate or curtail the scale of its operations. This
is called the going concern assumption that would normally apply to most entities.
The Time-Period Concept
The only way for a business to know for certain how well it has performed is to shut down, sell the
assets, pay the liabilities, and return any leftover cash to the owners. The time-period concept
ensures that accounting information is reported at regular intervals.
The Revenue Recognition Principle
When should you recognize, i.e., record, revenue? In short, when you “earn” revenue.
In general, for the sale of goods, revenue is recognized when:
■ the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;
■ the entity retains neither continuing managerial involvement to the degree usually associated with
ownership nor effective control over the goods sold;
■ the amount of revenue can be measured reliably;
■ It is probable that the economic benefits associated with the transaction will flow to the entity; and
■ The costs incurred or to be incurred in respect of the transaction can be measured reliably.

The expense recognition principle is the basis for recording expenses. Expenses are the costs of
assets used up or liabilities incurred in earning income. Expenses have no future benefit to the
business. Once you have identified and measured all the expenses, we match the expenses incurred
to the associated revenue earned during the same period in order to obtain profit or loss.
The Matching Concept
The matching concept is used to explain the relationship between expenses and revenues. The
Conceptual Framework states that expenses are recognized in the Income Statement on the basis of a
direct association between the costs incurred and the earning of specific items of income.
Measurement principle: IFRS generally states two Measurement principles historical cost
principle and fair value principle.

Historical cost principle: dictates that a company record assets at their cost. This is applicable not
only when the asset is purchased but also over time the asset is held. For example ABC company
purchase land for birr 500,000 the company initially record it at birr 500,000 but what does ABC
company do if by end of next year the fair value fair value of the land birr 600,000 under
historical cost principle it continues to report the land at bir 500,000.

Fair value principle: states that assets and liabilitie s should be repot at fair value (estimated sale
value minus estimated cost to sale or use) it use to revalue plant, property and equipment.