CkBooks Online – Free Online Books

IASB stands for International Accounting Standard Board; it is an independent, privately funded accounting standard setter organization. IASB develops Accounting Standards that harmonize the accounting practices globally.

Objective:

Main objective of the framework is to provide a rational and sensible guide for preparing accounting standards and applying them accordingly. This framework is used preparation and preparation of financial statements.

Purpose of IASB’s Framework:

It provides assistance in:

• Development of new IFRS (International Financial Reporting Standards)
• Review of existing IAS (International Accounting Standards)
• Promoting Harmonization
• Developing National Standards

Components of Financial Statements and their objectives

The framework is concerned with “general purpose financial statements”. Components of financial statements include:

1. Balance Sheet

• Balance sheet is prepared to know the financial position

2. Income Statement

• Income statement shows financial performance/profitability

3. Statement of Changes in Equity

• This statement is prepared to show the movement in different heads of owners’ equity

4. Cash Flow Statement

• It is prepared to know the cash inflows and outflows during the year divided into operating, investing and financing activities

5. Notes

• Notes are prepared to disclose significant accounting policies selected and applied in preparing the financial statement. It also contains some imperative disclosures to make financial statements understandable.

Users of the financial statements

Communication of the financial information flows towards the users of the financial statements.

• Shareholders (assess the ability of enterprise to pay the dividend)
• Lenders (determine the ability of enterprise to pay their loan and interest)
• Employees (concerned about their pay, retirement benefits etc.)
• Govt. agencies (determine tax, regulate the activities )
• Public (enterprises make substantial contribution to the local economy)
• Suppliers (evaluate whether the entity will be fine as a customer and pay its dues)
• Customers (decide whether the company will be able to continue producing and supplying goods with the same quality)

Underlying Assumptions

1) Accrual Basis

Accrual concept is used to measure the incomes and expenses of the entity. According to the accrual concept incomes and expenses are not measured at the amount of cash received or paid during the year but for incomes the measurement basis are earnings and for expenses measurement basis are incurrence.

2) Going Concern

Going concern means that the entity will continue its operations for the foreseeable future and there is no intention to liquidate it or to significantly curtail its operations.

Qualitative Characteristics of Financial Statements

Qualitative characteristics are the attributes that make the information provided in financial statements useful to the users.

Qualitative characteristics that make the financial information useful

Materiality

It is threshold quality which must be checked before studying the further qualitative characteristics. Information is material if its omission/misstatement could influence the economic decisions of users taken on the basis of financial statements.

1) Relevance

Information must be relevant to the decision making needs of users. It helps users to evaluate past, present or future events. It also helps users to confirm or correct past evaluations.

What makes financial information relevant?

Predictive role

Current level/structure of asset holding issued to predict the ability of the entity to take advantages of opportunities and its ability to react to adverse situation.

Confirmative role

Some information plays confirmatory role as outcome of the planned operations. Information about financial position and past financial performance is used as predicting future financial position and performance.

2) Reliability

Information may be relevant but so unreliable in nature that its recognition may be potentially misleading.

What makes financial information reliable?

Faithful representation

Information must represent faithfully the transactions it purport to represent in order to be reliable.

Substance over form

It is the principle that transactions and other events are accounted for and presented in accordance with their economic substance (economic reality) and not merely their legal form.

Neutrality

Information must be free from bias and should not be focused on predetermined results.

Prudence

Financial information presented in the financial statements relating to the assets and incomes should not be overstated and relating to the liabilities and expenses should not be understated.

Completeness

Financial information must be complete in terms of cost measurement and documentation. Omission may cause information to be misleading.

Qualitative characteristics that make the presentation useful

1) Comparability

Users should be able to compare an entity’s performance over time and to compare one entity’s performance with other.

Consistency

To make the financial statements comparable accounting policies and classification should be consistent over the years. Requirements of the applicable accounting standards should also be applied consistently.

Disclosure of accounting policies

Significant accounting policies should be disclosed in the notes this makes the financial statements comparable with financial statements of other entities.

2) Understandability

Financial statements should be presented in such a way that these are understood by a user having average knowledge of commerce and business.

Readily understandable by users

Users are assumed to have basic knowledge of accounting to understand the published financial statements.

Aggregation and classification

Presentation of financial information in the financial statements should be aggregated if these are not material. Information relating to the same class should be classified in one group.

Constraints to relevancy and reliability of financial information

Quality of relevancy and reliability depends upon three constrains:

1) Balance between qualitative characteristics Relevance and reliability are often in conflict. For example; market values of fixed tangible assets more relevant than historical cost, but these are less reliable.

2) Timeliness If there is unjustified delay in the reporting of information it may lose its relevancy. Information may be reported on a timely basis when all aspects of the transaction are not known, thus compromising reliability.

3) Balance between cost and benefit

When information is provided, its benefits must exceed the costs of obtaining and presenting it.