CHAPTER - 3

THE FINANCIAL REPORTING

FRAMEWORK

• IFRS, which stands for International Financial Reporting Standards, is a

globally recognized accounting framework developed and maintained by the
International Accounting Standards Board (IASB). It provides a set of principles
and guidelines for the preparation and presentation of financial statements.
• IFRS is designed to ensure consistency, transparency, and comparability in
financial reporting across different countries and industries.

The Purpose of the Conceptual Framework

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

Going Concern Assumption

• Going concern assumes that the entity will continue in operation for the
foreseeable future. This basis is presumed to apply unless users of financial
statements are told otherwise (in the notes to the financial statements).
• Therefore, there is neither the intention nor the need to enter liquidation or
cease trading.
• If going concern is in doubt, a capital reconstruction may be necessary.
Elements of Financial Statements
Assets
Asset – a present economic resource controlled by the entity as a result of past
events.
Economic resource – a right that has the potential to produce economic benefits.
The three key elements of an asset are therefore a right, potential to produce economic
benefits and control.

Rights
A right may:
• Correspond to an obligation of another party (e.g. a right to receive cash, goods
or services); or
• Not correspond to another party’s obligation (e.g. a right to use or sell PPE or
inventories)

Not all rights are assets – they must meet the other criteria of potential economic
benefits and control in order to be an asset. Therefore, for example, a right to use a
public right of way or a right to use know how that is in the public domain are not assets
because they are not controlled.

Economic Benefits
Economic benefits may take the form of future cash inflows or an avoidance of cash
outflows. They may also be represented by a future exchange of resources on
favourable terms.
A right that has the potential to produce economic benefits is often acquired in
exchange for a payment (e.g. buying an item of inventory).
However, payment does not necessarily result in an asset; it may result in an expense
(e.g. repairs and maintenance on a property). Equally, a payment is not always made
to acquire an asset (e.g. an asset granted by a government).
Control
An entity controls an economic resource if it has the present ability to direct the use of
the economic resource and obtain benefits flowing from it. Control also includes the
present ability to prevent other parties from directing the use of the resource and
obtaining economic benefits associated with it.

Liabilities
The three key elements of a liability are an obligation, the transfer of an economic
resource and past events.

Obligation
An obligation is a duty or responsibility that an entity has "no practical ability to avoid".
It is always owed to another party (who may be a person, another entity or society at
large); however, it is not necessary to know the identity of that party. There is no
requirement for the other party to recognise an asset.
Obligations may be legal or constructive (i.e. arise from an entity’s customary
practices, published policies or specific statements). This corresponds to the
requirements of IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

Transfer of Economic Resources

There is no “probable criterion” for the transfer of economic resources:
• There must simply be the potential for a transfer;
• A low likelihood of transfer may affect the recognition and measurement of a
liability.

Past Event
A present obligation only exists as a result of a past event if:
• The entity has already obtained economic benefits or taken an action; and
• As a consequence, the entity will or may have to transfer an economic resource
that it otherwise would not have had to transfer.
Other Elements
Equity – the residual interest in the assets of the entity after deducting all its
liabilities.
Income – increases in assets or decreases of 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
Recognition – the process of capturing for inclusion in the statement of financial
position or statement of financial performance an item that meets the definition of an
element.
Recognition involves:
• The depiction of the item in words and by a monetary amount; and
• The inclusion of that amount in one or more totals in that statement.
Only items that meet the definition of an element may be recognised. However not
all items that do meet these definitions are recognised.
An asset/liability is recognised only if recognising it (and any resulting income/expense
or changes in equity) provides information that is useful – i.e. it must be relevant and
a faithful representation.

Recognition Criteria
Recognition may not always provide relevant information. For example:
● If it is uncertain whether an asset/liability exists (existence uncertainty); or
● It exists, but the probability of an inflow or outflow of economic benefits is low.

In order to be recognised, an item must be measured. Faithful representation requires

consideration of measurement uncertainty:
● Measurement uncertainty arises when monetary amounts in the financial
statements must be estimated (e.g. future cash flows).
 ● A high level of measurement uncertainty does not necessarily mean that
recognition does not result in useful information.
● In some cases, a compromise solution is to use a slightly less relevant
measurement basis that is subject to lower measurement uncertainty.
● However, if measurement uncertainty is so high that no measurement basis
would provide useful information, an item should not be recognised. This is the
case for most internally generated intangible assets.

Derecognition
Derecognition is the removal of all (or part) of a recognised asset/liability from the
statement of financial position. It normally occurs when an item no longer meets the
definition of an asset/liability when the entity:
• Loses control of an asset;
• No longer has a present obligation for a liability.

Fair value (IFRS 13) – the price which would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at the
measurement date.
IFRS 13 does not prescribe when an entity should use fair value but how fair value
should be used. (For example, IAS 40 Investment Property allows fair value
measurement of investment property, but IFRS 13 specifies how that is measured.)

Active market – a market in which transactions for the asset/liability take place with
sufficient frequency and volume to provide pricing information on an ongoing basis.

Highest and best use – the use of a non-financial asset by market participants which
would maximise the value of the asset or the group of assets and liabilities within which
the asset would be used.

Principal market – the market with the greatest volume and level of activity for the
asset/liability.
Most advantageous market – the market that maximises the amount that would be
received to sell the asset or minimises the amount that would be paid to transfer the
liability, after taking transaction and transport costs into account.

Price
Fair value is an exit price rather than an entry price. It is the amount that would be
received for an asset or paid for a liability in the principal market (or most
advantageous market where there is no principal market).
• Fair value can be a price that is directly observable or a price that is estimated
using a valuation technique.
• Fair value includes transport costs but does not include transaction costs.
• Fair value is not adjusted for transaction costs as these costs are not
characteristics of the specific asset/liability. Any transaction costs are treated in
accordance with other standards and are generally expensed as incurred.
Transport costs are reflected in the fair value of an asset/liability because they change
the characteristics of the item (i.e. the location of the asset/liability is changed).

Highest and Best Use

For non-financial assets (e.g. investment property), fair value measurement must
reflect the highest and best use of that asset. This takes into account the use of the
asset that is:
• Physically possible
• Legally allowed; and
• Financially feasible
Taking account of the highest and best use may require assumptions that the asset
will be combined with other assets (i.e. in a group of assets) or with other assets and
liabilities (i.e. in a business) available to market participants.
Hierarchy of Inputs
Valuation techniques require the use of inputs. For example, an income approach
requires the use of estimated cash flows and interest rates. These inputs are
categorised as level 1, 2 or 3 inputs.

Level 1 Inputs
Level 1 inputs are quoted prices in active markets for identical assets/liabilities that the
entity can access at the measurement date.

Level 2 Inputs
Level 2 inputs are inputs other than quoted prices that are observable for the
asset/liability, either directly or indirectly.
These would include prices for similar, but not identical, assets/liabilities that were then
adjusted to reflect the factors specific to the measured asset/liability.

Level 3 Inputs
Level 3 inputs are unobservable inputs for the asset/liability. The use of Level 3 inputs
should be kept to a minimum.