Chapter 3 The Regulatory Framework

Qualification ACCA
Paper F7 INT
Chapter 3 Fill in these boxes
Template ID CD1
Source 2.5 INT text ch 2 and 7
2.5 INt Study notes session 4
Fill in this box with where the
information came from

Chapter Learning Objectives Common to this chapter

Explain
Upon why a regulatory
completion framework
of this chapter is be
you will necessary
able to: Common to this chapter
 Explain why accounting standards on their own are not a
complete regulatory framework
 Distinguish between principles based and rules based
framework
Bullet point text
 Discuss whether a principles based framework and a rules No limit to number of
based framework can be complementary bullets here as the
number of bullets
 Describe the structure and objectives of the IASC Foundation, depends purely on
the International Accounting Standards Board, the Standards the number of
Advisory Council and the International Financial Reporting content objectives
Interpretations Committee covered in this
chapter
 Describe the IASB’s standard setting process including revisions
to and interpretations of standards
 Explain the relationship between national standard setters and
the International Accounting Standards Board in respect of the
standard setting process
 Describe the structure (format) and content of financial Draw diagram here
statements presented under IFRS Either draw in word
or insert a picture
 Prepare an entity’s financial statements in accordance with
prescribed structure and content
 Distinguish between the primary aims of not-for-profit and public
sector entities and those of profit orientated entities
 Discuss the extent to which International Financial Reporting
Standards are relevant to specialised, not-for- profit and public
sector entities

REPORTINGCH3ACCAF7INTJCV1 -1-
 REGULATORY
FRAMEWORK

STRUCTURE OF
REGULATORY
SYSTEM

STANDARD SETTING
PROCESS

BALANCE SHEET
FORMAT

INCOME
STATEMENT
FORMAT

NOT-FOR-PROFIT
AND PUBLIC
SECTOR ENTITIES

REPORTINGCH3ACCAF7INTJCV1 -2-
 1 The Regulatory System

Qualification ACCA
Paper F7 INT
Chapter 3 Fill in these boxes
Content Objective Explain why a regulatory framework is
needed
Content, illustration and
TYU included? Fill in this box with where the
Source (esp. vital) information came from

Qualification ACCA
Paper F7 INT
Chapter 3 Fill in these boxes
Content Objective Explain why accounting standards on
their own are not a complete regulatory
framework
Content, illustration and Fill in this box with where the
TYU included? information came from
Source (esp. vital)

Qualification ACCA
Paper F7 INT
Chapter 3
Content Objective Distinguish between a principles based
and a rules based framework
Content, illustration and
TYU included?
Source (esp. vital)

Qualification ACCA
Paper F7 INT
Chapter 3
Content Objective Discuss whether a principles based
framework and a rules based
framework can be complementary
Content, illustration and
TYU included?
Source (esp. vital)

REPORTINGCH3ACCAF7INTJCV1 -3-
 Qualification ACCA
Paper F7 INT
Chapter 3 Fill in these boxes
Content Objective Describe the structure and objectives
of the IASC Foundation, the
International Accounting Standards
Board, the Standards Advisory Council Fill in this box with where the
and the International Reporting information came from
Interpretations Committee
Content, illustration and
TYU included?
Source (esp. vital) 2.5 Int text Ch 2

Qualification ACCA
Paper F7 INT
Chapter 3
Content Objective Describe the IASB’s standard setting
process including revisions to and
interpretation of standards
Content, illustration and TYU 2 – new
TYU included?

Qualification ACCA
Paper F7 INT
Chapter 3
Content Objective Explain the relationship between
national standard setters and the
International Accountings Standards
Board in respect of the standard
setting process
Content, illustration and TYU 1 – 2.5 GBR text Ch 5 Act 3
TYU included?

1.1 Structure of International regulatory system

The history of the current structure:

. 1973 International Accounting Standards Committee (IASC) first set up

. issued International Accounting Standards (IASs)
. from April 2001 a new constitution and new structure was adopted for the IASC

REPORTINGCH3ACCAF7INTJCV1 -4-
 Expandable text

The International Accounting Standards Committee (IASC) was first set up in 1973 with
the aim of harmonising accounting procedures across the world. From 1975 the IASC issued
International Accounting Standards (IASs) in furtherance of this aim. Individual countries were
free to choose the degree to which IASs had to be followed within their jurisdiction.
Economically developed countries (e.g. the USA and the UK) developed their own national
accounting standards, so IASs had no direct authority in these countries. However several
countries without their own domestic standard-setting bodies decided to adopt the IASs
wholesale.
The IASC grew in authority during the 1970s and 1980s, with more and more countries taking
KanE interest
Y P O IinN its
T activities. However two recent developments have propelled the IASC to the
forefront of international accounting:
The IASC has been growing in
authority since its establishment
in the 1970s.

 the International Organisation of Securities Commissions (IOSCO) endorsement of

IASs as the basis for preparing accounts to support cross-border listings
 the European Union (EU) regulation to require all listed European companies to
prepare their consolidated accounts in accordance with IASs with effect from
1 January 2005.

In 1999 the Board of the IASC approved a report ‘Recommendations on Shaping IASC for the
Future’ which recommended that a new structure for the IASC was required to reflect the
IASC’s increased importance. Therefore with effect from April 2001 the IASC has adopted a
new constitution and a new structure,

1.2 New structure

THE IASC
FOUNDATION

STANDARDS
INTERNATIONAL ADVISORY
ACCOUNTING COUNCIL (SAC)
STANDARDS
BOARD (IASB)

INTERNATIONAL
FINANCIAL REPORTING
INTERPRETATIONS
REPORTINGCH3ACCAF7INTJCV1 -5-
COMMITTEE (IFRIC)
1.3 IASC Foundation

The IASC Foundation:

. is the supervisory body for the new structure
. has 19 trustees
. is responsible for governance issues and ensuring each body is properly funded

The objectives of the IASC Foundation are stated to be:

 to develop, in the public interest, a single set of high quality, understandable and
enforceable global accounting standards that require high quality, transparent and
comparable information in financial statements and other financial reporting to help
participants in the world’s capital markets and other users make economic decisions
 to promote the use and rigorous application of those standards
 to bring about convergence of national accounting standards and International
Accounting Standards to high quality solutions.

International Accounting Standards Board (IASB)

The IASB:
. is solely responsible for issuing international accounting standards
. standards now called International Financial Reporting Standards
. made up of 14 members
. has the same objectives as the IASC Foundation

Expandable text

The IASB is solely responsible for issuing new international accounting standards. The IASB
has announced that its new standards will be called International Financial Reporting
Standards (IFRSs), but the existing standards will continue to be called International
Accounting Standards (IASs). In this textbook we use the term ‘IFRSs’ to refer both to the
existing IASs issued by the former IASC and to the IFRSs from the IASB. Note that now the
term ‘IASC Foundation’ is used to refer to the whole structure of the new organisations in the
above diagram, while the IASB is just the standard-setting body.

International Financial Reporting Interpretations Committee (IFRC)

The IFRIC:
. issues rapid guidance on accounting matters where divergent interpretations of
IFRSs have arisen
. issues interpretations called IFRIC 1, IFRIC 2 etc

REPORTINGCH3ACCAF7INTJCV1 -6-
 Expandable text

In 1997 the IASC formed the Standing Interpretations Committee (SIC) to ensure proper
compliance with IFRSs by considering points of contention where divergent interpretations
have emerged and issuing an authoritative view; 33 interpretations (entitled SIC 1, SIC 2, etc)
were issued by the SIC before its change of name (see below).
SICs are important because IAS 1 (revised) states that financial statements cannot be
described as complying with IFRSs unless they comply with each IAS/IFRS and each
interpretation from the SIC/IFRIC.
In 2002 the SIC changed its name to the International Financial Reporting Interpretations
Committee (IFRIC). Interpretations are now designated IFRIC 1, IFRIC 2, etc.

1.6 The Standards Advisory Council (SAC)

The SAC provides a forum for a range of experts from different countries and different
business sectors to offer advice to the IASB when drawing up new standards.

1.7 The development of an IFRS

The procedure for the development of an IFRS is as follows:
 the IASB identifies a subject and appoints an Advisory Committee to advise on the
issues
 the IASB publishes an Exposure Draft for public comment, being a draft version of the
intended standard
 following the consideration of comments received on the Draft, the IASB publishes
the final text of the standard,IFRS.
 At any stage the IASB may issue a Discussion Paper to encourage comment
 The publication of an IFRS, Exposure Draft or IFRIC Interpretation requires the votes
of at least 8 of the 14 IASB members

Expandable text

Neither the IASC Foundation, the IASB nor the accountancy profession has the power to
enforce compliance with IFRSs. Nevertheless, some countries adopt IFRSs as their local
standards, and others ensure that there is minimum difference between their standards and
IFRSs. In recent years, the status of the IASB and its standards has increased, so IFRSs
carry considerable persuasive force throughout the world.

1.8 Benchmark treatment and allowed alternative treatment

Some older IASs have two choices of treatment of items in the financial statements:
. the bench mark treatment, and
. the allowed alternative treatment

REPORTINGCH3ACCAF7INTJCV1 -7-
In future IFRSs:
. if there is a choice of allowable treatments a straight choice will be given
, no treatment will be designated as the benchmark treatment

Expandable text

Some IFRSs in the past have permitted two alternative accounting treatments for the same
type of transaction or event. These are known as the benchmark treatment and the
allowed
K E Y P alternative
OINT treatment.
For example, IAS 23 permits borrowing costs either to be written off as incurred (the
Some IASs permit
benchmark two
treatment) or capitalised into the cost of qualifying assets (the allowed alternative
alternative treatments: the
treatment).
benchmark treatment and
Although the IASC wished to allow a choice of accounting treatment in some cases, this
the allowed alternative
meant
treatment. that financial statements might not be comparable. It was suggested that enterprises
reporting under IFRSs should be required to reconcile their financial statements to the
benchmark treatment.
This idea received
Both treatments little support and was never implemented. In practice, both the benchmark
have equal
and
status,the
but allowed alternative treatment have equal status. However, the treatment adopted
the treatment
must
adoptedbe mustapplied consistently.
be applied
consistently.
The IASB has stated that future standards (IFRSs) will not contain benchmark treatments and
allowed
both thealternatives. Where a choice of treatment is appropriate, a straight choice will be
given
benchmark withoutand designating
the one treatment as the benchmark treatment.
allowed alternative

1.9 The IASB, IOSCO and the European Union

IOSCO is:
. the International Organisation of Securities Commissions,
. an influential organisation of the world’s stock market regulators

IOSCO has:
. endorsed the IASC’s core standards in 2000
. recommended that its members should permit multinational issuers to use IFRS to
prepare their financial statements for cross-border listings.

The EU issued a Regulation in June 2005. This requires:

. all EU listed companies
. to prepare their consolidated financial statements in compliance with IFRS
. with effect from 1 January 2005

Expandable text

IOSCO, the International Organisation of Securities Commissions, is an influential

organisation of the world’s stock market regulators, in which the US Securities and
Exchange Commission (SEC) is a key member.

REPORTINGCH3ACCAF7INTJCV1 -8-
In 1995 the IASC agreed with IOSCO that the IASC would develop a set of core standards. If
IOSCO were satisfied with these standards, IOSCO would then endorse IFRSs as an
acceptable basis of accounting for cross-border capital raising and listing purposes in all
global markets (including the US).
The IASC completed its core standards with the issue of IAS 39 in December 1998 and
submitted them for endorsement by IOSCO. In May 2000 this endorsement was finally given.
IOSCO has now recommended that its members (including the SEC) should permit
multinational issuers to use IFRSs to prepare their financial statements for cross-border
offerings and listings.

IFRS 1 First-time Adoption of International Financial Reporting

Standards
Introduction
From 2005, International Financial Reporting Standards dominate national financial reporting.
EU Regulations require listed companies to apply international standards in the preparation of
their consolidated accounts for periods beginning on or after January 2005. These companies
were therefore first time adopters that year.

IFRS 1 sets out the procedures for making the transition from national accounting standards
to international standards, and applies to all first time adopters for accounting periods
beginning on or after 1 January 2005.

Date of transition: comparative figures

IFRS should be applied from the date of transition, which is the beginning of the earliest
period for which the 'first IFRS financial statements' present comparative information. The
balance sheet at that date is called the 'opening IFRS balance sheet'. The date of transition,
and therefore the date of the opening IFRS balance sheet, for an entity adopting IFRSs for
the first time in its 31 December 2005 financial statements and presenting comparative
information for one year will be 1 January 2004. This is the first day of the comparative
period. The opening IFRS balance sheet itself need not be published, but it will provide the
opening balances for the comparative period.

At the date of transition all companies adopting IFRS must prepare a balance sheet which
complies with IFRS in force at the first reporting date (which is 31 December 2005 in the
above situation). This opening IFRS balance sheet must comply with international standards.
(a) It must recognise all assets and liabilities required by international standards and
must not recognise any assets or liabilities not permitted by the standards.
(b) All assets, liabilities and components of equity must be re-classified and valued in
accordance with international standards.

Any gains or losses arising on the adoption of IFRSs (with the exception of those relating to
certain acquired intangible assets) should be recognised directly in retained earnings as at
the date of the transition.

Explanations to be disclosed
Entities must explain how the transition to IFRSs affects their reported financial performance,
financial position, and cash flows. The two main disclosures required here reconcile reported
equity and profits.
The entity’s equity (i.e. shareholders’ funds) as reported under previous GAAP must be
reconciled to the equity reported under IFRS at two dates:
(1) The date of transition. This is the opening balance sheet date. In our example it is 1
January 2004.

REPORTINGCH3ACCAF7INTJCV1 -9-
(2) The last balance sheet prepared under previous GAAP. In our example this is 31
December 2004.
The last annual profit reported under previous GAAP must be reconciled to the same year’s
profit prepared under IFRS. In our example this will be the profit for 2004.
Any material differences in the previous GAAP and IFRS cash flow must also be explained.
For UK companies the main difference will be in the definition of cash. The IFRS definition
includes cash plus items classified as liquid resources under UK GAAP.
When preparing its first IFRS statements, an entity may identify errors made in previous
years, or make or reverse impairments of assets. These adjustments must be disclosed
separately.

Exemptions
IFRS 1 grants limited exemptions in situations where the cost of compliance would outweigh
the benefits to the user. For example:
 Previous business combinations do not have to be restated in accordance with IFRSs.
This relates to classifying combinations as mergers or acquisitions, fair valuing assets
and liabilities, and the treatment of goodwill.
 If it is not possible to establish the cost of an asset, then fair value at the date of
transition can be used as deemed cost.
 If a subsidiary adopts IFRSs later than its parent, then the subsidiary may value its
assets and liabilities either at its own transition date or its parent’s transition date (which
would normally be easier).

Summary of IFRS 1
 In the first IFRS financial statements, all IFRSs in force at the reporting date should be
applied to the whole period under review.
 The date of transition to IFRS is the opening balance sheet for the comparative period.
 Any gains or losses arising on transition shall be recognised directly in retained
earnings at the date of transition.
 The effects of the transition on equity and profits shall be disclosed.
 There are a few limited and specific exemptions where the cost of compliance would
exceed the benefits to the users.

1.10 The IASB and national standard setters

The intentions of the IASB are:

. to develop a single set of understandable and enforceable high quality global
accounting standards, however
. the IASB cannot enforce compliance with its standards, therefore
. it needs the co-operation of national standard setters

In order to achieve this the IASB works in partnership with the major national standard setting
bodies:
. all the most important national standard setters are represented on the IASB and their
views are taken into account so that a consensus can be reached
. all national standard setters can issue IASB Discussion Papers and Exposure Drafts
for comment in their own countries, so that the views of all preparers and users of
financial statements can be represented
. each major national standard setter ‘leads’ certain international standard setting
projects.
.

REPORTINGCH3ACCAF7INTJCV1 - 10 -
 Expandable text

The IASB intends to develop a single set of understandable and enforceable high quality
global accounting standards.
As far as possible, future international standards will be more rigorous than previously and will
no longer allow alternative treatments. The Chairman of the IASB, Sir David Tweedie has
already stated that there will not be ‘convergence for the sake of convergence by the issue of
a set of ‘lowest common denominator’ accounting standards’.
Because the IASB on its own cannot enforce compliance with its standards, it needs the co-
operation of national standard setters. Without their support, rigorous new international
standards are unlikely to be adopted by everybody. Therefore, the IASB works in partnership
with the major national standard setting bodies, including the UK ASB and the US Financial
Accounting Standards Board (FASB).
 All the most important national standard setters are represented on the IASB and their
views are taken into account so that a consensus can be reached. All national standard
setters can issue IASB Discussion Papers and Exposure Drafts for comment in their own
countries, so that the views of all preparers and users of financial statements can be
represented.
 Each major national standard setter ‘leads’ certain international standard setting projects.
For example, the UK ASB is carrying out much of the work to develop a new international
standard on leasing.
All the major national standard setters are now committed to international convergence.

Test your understanding 1

What would be the advantages of international harmonisation of accounting standards for

investors and potential investors?

Solution

Investors increasingly make investment decisions on a world-wide basis, because businesses

increasingly operate across national boundaries. Therefore investors need to compare the
financial statements of companies operating in different countries.

At present most non-domestic investments are made by public investment companies and
unit trusts which employ analysts skilled in the examination of financial statements from
different countries. An individual investor would have difficulty making an informed
investment decision with the present differences in international financial reporting.

REPORTINGCH3ACCAF7INTJCV1 - 11 -
1.11 The regulatory framework
The regulatory framework of accounting in each country which uses IFRS is affected by a
number of legislative and quasi-legislative influences as well as IFRS:
 national company law
 EC Directives
 Stock Exchange rules.

1.12 Why a regulatory framework is necessary

A regulatory framework for the preparation of financial statements is necessary for the
following reasons:

. financial statements are used by a wide range of users – investors, lenders,

customers etc

. they need to be useful to these users

. they need to be comparable

. they need to provide at the least some basic information

. increase users’ understanding of and confidence in financial statements

. regulate the behaviour of companies towards their investors

Accounting standards on their own would not be complete regulatory framework. In order to
fully regulate the preparation of financial statements and the obligations of companies and
directors, legal and market regulations are required as well.

1.13 Principles based and rules based framework

Principles based framework:

. based upon a conceptual framework such as the IASBs Framework

. accounting standards set on the basis of the conceptual framework

Rules based framework:

. “cookbook” approach

. accounting standards are a set of rules which companies must follow

In the UK there is a principles based framework in terms of the Statement of Principles and
accounting standards and a rules based framework in terms of the Companies Acts, EC
directives and Stock Exchange rulings.

REPORTINGCH3ACCAF7INTJCV1 - 12 -
 Test your understanding 2

What are the objectives of the IASC Foundation?

Solution
The objectives of the IASC Foundation are stated to be:
 to develop, in the public interest, a single set of high quality, understandable and
enforceable global accounting standards that require high quality, transparent and
comparable information in financial statements and other financial reporting to help
participants in the world’s capital markets and other users make economic decisions
 to promote the use and rigorous application of those standards
 to bring about convergence of national accounting standards and International
Accounting Standards to high quality solutions.

REPORTINGCH3ACCAF7INTJCV1 - 13 -
 2 Preparation of financial statements for companies

Qualification ACCA
Paper F7 INT
Chapter 3 Fill in these boxes
Content Objective Describe the structure (format) and
content of financial statements
presented under
IFRS
Content, illustration and
TYU included?
Source 2.5 INT text Ch 7 and 2,5 INT study
notes session 4

Qualification ACCA
Paper F7 INT
Chapter 3
Content Objective Prepare an entity’s financial
statements in accordance with the
prescribed structure and content
Content, illustration and Ill 1 – 2.5 INT text – Ch 7 Act 1
TYU included? Ill 2 – 2.5 INT text – Ch 7 Act 2
TYU 3 – 2.5 GBR text Ch 7 Q1
TYU 4 – 2.5 study notes session 4 Q1
Source 2.5 INT text Ch 7 and 2,5 INT study
notes session 4

2.1 IAS 1 Presentation of financial statements

In most jurisdictions the structure and content of financial statements is defined by local law.
In the UK this is Companies Act 1985. International accounting standards are however
designed to work in any jurisdiction and therefore require their own set of requirements for
presentation of financial statements. This is given by IAS 1.
A complete set of financial statements comprises:
 balance sheet
 income statement
 a statement showing changes in equity
 cash flow statement
 accounting policies and explanatory notes.

REPORTINGCH3ACCAF7INTJCV1 - 14 -
The formats for the balance sheet and income statement used in this section are:
. in the Implementation Guidance that accompanies IAS 1
. they are not obligatory, but are obviously of vital examination importance
. they should be used unless a question clearly calls for some other method of
presentation – which is unlikely.

Expandable text

Background to IAS 1
The idea of publishing financial statements, at least to members, is a consequence of the
development of the concept of limited liability and the spread worldwide of the company with a
share capital as the main form of organisation for larger enterprises.

Each country has its own legislation governing the operation of limited companies, often
laying down detailed accounting requirements with obligatory formats for financial statements
like those applied to all countries in the European Community.

For the purpose of this International syllabus, we do not consider individual countries’ local
requirements, but those of the IASB.

The stated purpose of IAS 1 Presentation of financial statements is to prescribe the basis for
presentation of general-purpose financial statements, in order to ensure comparability. The
standard itself is in two parts. The first part, entitled ‘Overall Considerations’, and dealing with
basic accounting concepts, was covered in an earlier chapter. The second part ‘Structure and
Content’ contains a large number of disclosure requirements for financial statements. It
includes, in accompanying implementation guidance, illustrations of formats for financial
statements. Although their use is not obligatory, they are the recommended formats for
examination purposes in the ACCA’s International syllabus.

Miscellaneous requirements of IAS 1

Identification of financial statements
 Financial statements should be clearly identified and distinguished from other information
in the same published document.
 Each component of the financial statements should be clearly identified. In addition, the
following information should be prominently displayed, and repeated when it is necessary
for a proper understanding of the information presented:
– the name of the reporting enterprise or other means of identification
– whether the financial statements cover an individual enterprise or a group of
enterprises
– the balance sheet date or the period covered by the financial statements, whichever is
appropriate to that component of the financial statements
– the reporting currency
– the level of precision used in the presentation of figures in the financial statements
(e.g. $000 or millions of $).

REPORTINGCH3ACCAF7INTJCV1 - 15 -
The reporting period
Financial statements should be presented at least annually. When, in exceptional
circumstances, an enterprise’s balance sheet date changes and annual financial statements
are presented for a period longer or shorter than one year, an enterprise should disclose, in
addition to the period covered by the financial statements:
 the reason for a period other than one year being used
 the fact that comparative amounts for the income statement, changes in
equity, cash flows and related notes are not entirely comparable.

Timeliness
The usefulness of financial statements is impaired if they are not made available to users
within a reasonable period after the balance sheet date. An enterprise should issue its
financial statements as soon as practicable after the balance sheet date. Ongoing factors
such as the complexity of an enterprise’s operations are not sufficient reason for failing to
report on a timely basis. Specific deadlines are dealt with by legislation and market regulation
in many jurisdictions.

REPORTINGCH3ACCAF7INTJCV1 - 16 -
2.2 The balance sheet

The IAS 1 recommended format for the balance sheet is as follows:

XYZ Group
Balance sheet as at 31 December 20X2

ASSETS $ $
Non-current assets
Property, plant and equipment X
Goodwill X
Other intangible assets X
Investments in associates X
Available-for-sale investments X
––
X
Current assets
Inventories X
Trade receivables X
Other current assets X
Cash and cash equivalents X
––
X
––
Total assets X
––

EQUITY AND LIABILITIES

Capital and reserves
Share capital X
Other reserves X
Retained earnings X
––
X
––
Total equity X

Non-current liabilities
Long-term borrowings X
Deferred tax X
Long-term provision X
––
X

Current liabilities
Trade and other payables X
Short-term borrowings X
Current portion of long
term borrowings X
Current tax payable X
Short-term provisions X
––
X
––
Total equity and liabilities X
––

REPORTINGCH3ACCAF7INTJCV1 - 17 -
2.3 Classification of assets as current or non-current

An asset should be classified as a current asset when it:

 is expected to be realised in the normal course of the enterprise’s operating cycle; or
 is held primarily for trading purposes or for the short-term and expected to be realised
within 12 months of the balance sheet date; or
. is cash or a cash equivalent asset which is not restricted in its use.

All other assets should be classified as non-current assets.

IAS 1 uses the term ‘non-current’ to include tangible, intangible and financial assets of a long-
term nature. It does not prohibit the use of alternative descriptions as long as the meaning is
clear.

2.4 Classification of liabilities as current or non-current

A liability should be classified as a current liability when it:

 is expected to be settled in the normal course of the enterprise’s operating cycle; or
 is held primarily for trading purposes; or
 is due to be settled within 12 months of the balance sheet date.

All other liabilities should be classified as non-current liabilities.

An enterprise should continue to classify its financial liabilities as non-current, even when they
are due to be settled within 12 months of the balance sheet date if:
 the original term was for a period of more than 12 months
 the enterprise intends to refinance the obligation on a long-term basis
 that intention is supported by an agreement to refinance, or to reschedule
payments, which is completed before the financial statements are approved.

The amount of any liability that has been excluded from current liabilities in accordance with
this paragraph, together with information in support of this presentation, should be disclosed
in the notes to the balance sheet.

REPORTINGCH3ACCAF7INTJCV1 - 18 -
2.5 Information to appear on the face of the balance sheet

As a minimum, the face of the balance sheet should include line items which present the
following amounts:
1 property, plant and equipment
2 investment property
3 intangible assets
4 financial assets (excluding amounts shown under 5, 8 and 9)
5 investments accounted for using the equity method
6 biological assets (i.e. living animals or plants)
7 inventories
8 trade and other receivables
9 cash and cash equivalents
10 trade and other payables
11 tax liabilities and assets as required by IAS 12 Income taxes
12 provisions
13 financial liabilities
14 minority interest, presented within equity
15 issued capital and reserves attributable to the equity holders of the parent company.

IFRS 5 (see later chapter) additionally requires that assets classified as held for sale must
also be disclosed separately on the face of the balance sheet.

Additional line items, headings and subtotals should be presented on the face of the balance
sheet:
. when an IFRS requires it, or
. when such presentation is necessary to present fairly the enterprise’s financial position.

2.6 Information to be presented either on the face of the balance

sheet or in the notes
There should also be disclosure:
. either on the face of the balance sheet or in the notes to the balance sheet,
. further sub classifications of the line items presented
. classified in a manner appropriate to the enterprise’s operations.
. of amounts payable to and receivable from the parent enterprise, fellow subsidiaries and
associates and other related parties

REPORTINGCH3ACCAF7INTJCV1 - 19 -
 Expandable text

Examples of items which could require further analysis are:

 tangible assets classified by class as required by IAS 16 Property, plant and
equipment
 receivables analysed between amounts receivable from trade customers, receivables
from related parties, prepayments and other amounts
 inventories subclassified, in accordance with IAS 2 Inventories, into classifications
such as merchandise, production supplies, materials, work in progress and finished goods
 provisions analysed between provisions for employee benefit costs and any other
items classified in a manner appropriate to the enterprise’s operations
 equity capital and reserves analysed between the various classes of paid-in capital,
share premium and reserves.

2.7 Share capital disclosure

Disclose the following, either on the face of the balance sheet or in the notes:
 for each class of share capital:
– the number of shares authorised
– the number of shares issued and fully paid, and issued but not fully paid
– par value per share, or that the shares have no par value
– a reconciliation of the number of shares outstanding at the beginning and at the end of
the period
– the rights, preferences and restrictions attaching to that class including restrictions on
the distribution of dividends and the repayment of capital
– shares in the enterprise held by the enterprise itself or by subsidiaries or associates of
the enterprise
– shares reserved for issue under options and sales contracts, including the terms and
amounts
 a description of the nature and purpose of each reserve within equity.

The following should be disclosed in the notes:

 the amount of equity dividends declared after the balance sheet date but before the
financial statements were authorised for issue, and the related amounts per share
 the amount of any cumulative preference dividends not recognised.

For an enterprise without share capital, such as a partnership:

. disclose information equivalent to that required above
. showing movements during the period in each category of equity interest and
. the rights, preferences and restrictions attaching to each category of equity interest.

REPORTINGCH3ACCAF7INTJCV1 - 20 -
2.8 Preparing a balance sheet

When preparing a balance sheet follow these rules:

. allow a page for the balance sheet, a page for notes and a page for workings
. few workings will be required as much can be done in notes to the accounts
 write out a heading in full.
 use the same narrative as in the IAS 1 format.
 leave some space between the various parts and allow for the later insertion of figures
that you may have forgotten to include

Illustration 1
Small Limited is a quoted company with an authorised share capital of $250,000, consisting
of ordinary shares of $1 each. The company prepares its accounts as on 31 March in each
year and the trial balance, before final adjustments, extracted on 31 March 20X5 showed:
$ $
Equity share capital, issued and fully paid 200,000
Retained earnings as on 1 April 20X4 61,000
6% Loan notes (secured on leasehold factory) 60,000
Leasehold factory:
Cost at beginning of year 200,000
Accumulated depreciation at beginning of year 76,000
Plant and machinery:
Cost at beginning of year 80,000
Accumulated depreciation at beginning of year 30,000
Additions to plant in year 10,000
Payables and accrued expenses 170,000
Inventory as on 31 March 20X5 160,000
Receivables 100,000
Prepayments 80,000
Balance at bank 90,000
Profit for the year (subject to any items
in the following notes) 111,000
Sale proceeds of plant ______ ______
12,000
720,000 720,000
You ascertain that:
(1) The loan notes are repayable at par by six equal annual drawings starting on
31 December 20X5.
(2) Annual depreciation is calculated as to:
Leasehold factory – 2% on cost
Plant and machinery – 20% reducing balance on NBV as at 31 March 20X4 plus
additions less disposals in the year
(3) Plant disposed of: cost $16,000, accumulated depreciation is $3,200.
(4) Inventory has been valued at the lower of cost and net realisable value.
(5) A dividend of 20% was declared in May 20X5.

REPORTINGCH3ACCAF7INTJCV1 - 21 -
You are required to prepare in a form suitable for publication and in conformity with the
provisions of IAS 1, the balance sheet as on 31 March 20X5 together with accompanying
notes.

Solution

Small Limited
Balance sheet as at 31 March 20X5
Reference to notes $ $
Assets
Non-current assets
Property, plant and equipment 2 157,760
Current assets
Inventories 160,000
Trade receivables 100,000
Prepayments 80,000
Cash at bank 90,000
______
430,000
______
Total assets 587,760
______
Equity and liabilities
Capital and reserves
Share capital 3 200,000
Retained earnings 157,760
_______
357,760
Non-current liabilities 4
6% loan notes 50,000
Current liabilities
Trade and other payables 170,000
Current portion of 6% loan notes 10,000
_______ 180,000
_______
Total equity and liabilities 587,760

Notes to the balance sheet

1 Statement of accounting policies
(a) The financial statements have been prepared in accordance with International
Financial Reporting Standards.
(b) Depreciation
(i) Leasehold factory – 2% on cost.
(ii) Plant and machinery – depreciation is calculated on the reducing balance
method at a rate of 20% pa. Assets acquired during the year are charged with
a full year’s depreciation.
(c) Inventory – Inventory has been valued at the lower of cost and net realisable value.

REPORTINGCH3ACCAF7INTJCV1 - 22 -
2 Tangible assets
Leasehold Plant and
property machinery Total
$ $ $
Cost:
At 1 April 20X4 200,000 80,000 280,000
Additions – 10,000 10,000
Disposals –
______ (16,000)
______ (16,000)
_______
At 31 March 20X5 200,000
______ 74,000
______ 274,000
_______
Accumulated depreciation:
At 1 April 20X4 76,000 30,000 106,000
Eliminated on disposals (3,200) (3,200)
Charged for the year (W1) 4,000
_____ 9,440
_____ 13,440
______
At 31 March 20X5 80,000
_____ 36,240
_____ 116,240
______

Net book value:

at 31 March 20X5 120,000
______ 37,760
______ 157,760
_______
at 31 March 20X4 124,000 50,000 174,000
_______ ______ _______
3 Share capital
The authorised share capital consists of 250,000 equity shares of $1 each, of which
200,000 are issued and fully paid.
The company proposes a dividend of 20% ($40,000) for the year.
4 Loan notes
The 6% loan notes are secured on the leasehold factory.

Workings
(W1) Depreciation $ $
Leasehold factory 2% of $200,000 4,000
Plant and machinery
NBV b/d 50,000
Additions 10,000
Disposals at NBV (12,800)
_____
Depreciation 20%  47,200 =_____
9,440

13,440
_____
(W2) Disposal of plant
Proceeds 12,000
Cost 16,000
Less: Depreciation 3,200
12,800
______
Loss on disposal 800
______
(W3) Profit for year per list of balances 111,000
Less: Depreciation 13,440
Loss on sale (W2) 800

REPORTINGCH3ACCAF7INTJCV1 - 23 -
 14,240
______
96,760
______
Note: The proposed dividend is disclosed by note only.

REPORTINGCH3ACCAF7INTJCV1 - 24 -
2.9 Statement of changes in equity
The statement of changes in equity provides a comprehensive summary of all movements in
the share capital and reserves during the year.

XYZ Group
Statement of changes in equity for the year ended 31 December 20X2

Share Share Revaluatio Retained Total

capital premiu n reserve earnings
m
$ $ $ $ $
Balance at 31 December 20X1 X X X X X
Changes in accounting policy (X) (X)
–– –– –– –– ––
Restated balance X X X X X
Surplus on revaluation of properties X X
Deficit on revaluation of investments (X) (X)
–– –– –– –– ––
Net gains and losses not
recognised in the income X X
statement
Net profit for the period X X
Dividends (X) (X)
Issue of share capital X X X
–– –– –– –– ––
Balance at 31 December 20X2 X X X X X

Expandable text

This statement is usually presented in columnar form and shows the movements during the
period in all the capital and reserve headings which in total make up the equity of the
enterprise.
The detailed requirements in IAS 1 are that an enterprise should present, as a separate
component of its financial statements, a statement showing:
 the net profit or loss for the period
 each item of income and expense which, as required by other Standards, is recognised
directly in equity, and the total of these items
 the cumulative effect of changes in accounting policy and the correction of errors
recognised directly in equity in accordance with IAS 8 (see earlier chapter).

In addition, an enterprise should present, either within this statement or in the notes:
 capital transactions with owners and distributions to owners
 the balance of accumulated profit or loss at the beginning of the period and at the
balance sheet date, and the movements for the period
 a reconciliation between the carrying amount of each class of equity capital, share
premium and each reserve at the beginning and the end of the period, separately
disclosing each movement.

REPORTINGCH3ACCAF7INTJCV1 - 25 -
2.10 Income statement
Two formats of income statement are provided, one using the classification of expenses by
function and the other using classification by nature. The one shown below is classification of
expenses by function.
Classification of expenses by function
XYZ Group
Income statement for the year ended 31 December 20X2
20X2
$
Revenue X
Cost of sales (X)
––
Gross profit X

Distribution costs (X)

Administrative expenses (X)
––
Profit from operations X
Finance costs (X)
––
Profit before tax X
Income tax expense (X)
––
Net profit for the period X
––

Notes:
 The concluding figure is net profit for the period. Dividends and the balance of
accumulated profit brought forward appear in the statement of changes in equity,
though it may be convenient to include dividends in the income statement as a
deduction from net profit, especially in questions on consolidated financial statements.
 Exceptional items (i.e. large unusual items deriving from the ordinary activities of the
business) could be included in cost of sales, distribution costs or administrative
expenses, or shown separately on the face of the income statement, in all cases
explained by a supporting note.
 IFRS 5 requires additional presentation of the results of discontinued operations, where
operations have been discontinued in the year (see later chapter).

REPORTINGCH3ACCAF7INTJCV1 - 26 -
2.11 Information to be presented on the face of the income statement
As a minimum, the face of the income statement should include line items which present the
following amounts:
 revenue
 finance costs
 share of profits and losses of associates and joint ventures accounted for using the
equity method
 tax expense
 a single amount (see IFRS 5) comprising the post-tax profit or loss on discontinued
operations (see later chapter)
 profit or loss for the period.

Final profit or loss then split between:

 the equity holders of the parent company
 the minority interest (see sections on group accounts)

Additional line items, headings and subtotals should be presented on the face of the income
statement:
. when required by an IFRS or
. when such presentation is necessary to present fairly the enterprise’s financial
performance.

No items may be presented as extraordinary items.

2.12 Information to be presented either on the face of the income

statement or in the notes

An enterprise should present:

. either on the face of the income statement or in the notes to the income statement,
. an analysis of expenses using a classification based on
. either the nature of expenses or their function within the enterprise.

IAS 1 encourages the inclusion of this analysis on the face of the income statement.

REPORTINGCH3ACCAF7INTJCV1 - 27 -
2.13 The nature of expense method
$ $
Revenue X
Other income X
Changes in inventories of finished goods
and work in progress* X
Raw materials and consumables used* X
Employee benefits expense (= staff costs) X
Depreciation and amortisation expense X
Other expenses X
__
Total expenses (X)
__
Profit X
__

Such an approach might be appropriate for a small manufacturing concern.

It is important to understand the two items marked with an asterisk (*) in the example above.
 Changes in inventories of finished goods and work in progress – This is computed as:
Closing inventories Opening
of finished goods MINUS inventories of
and work in progress finished goods and
work in progress

. If closing inventory exceeds opening inventory, the item is a credit in the income
statement,
. if closing inventory is less than opening inventory, it is a debit
. note that inventories of raw materials and consumables are not included here as they
are included in the next item.

 Raw materials and consumables used – this is computed as:

Opening PLUS Purchases MINU Closing
inventories S inventories
of raw of raw
materials materials

Expandable text
Nature of expense method
Under the nature of expense method expenses are aggregated in the income statement
according to their nature (for example depreciation, purchases of materials, transport costs,
wages and salaries, advertising costs) and are not reallocated amongst various functions
within the enterprise. This method is simple to apply in many smaller enterprises because no
allocation of operating expenses between functional classifications is necessary. An example
of a classification using the nature of expense method is as follows:

REPORTINGCH3ACCAF7INTJCV1 - 28 -
2.14 The function of expense or cost of sales method
Revenue X
Cost of sales (X)
__
Gross profit X
Other income X
Distribution costs (X)
Administrative expenses (X)
Other expenses (X)
__
Profit X
__

If the function of expense method is adopted, the following expenses, disclosed on the face of
the income statement in the nature of expense method, must be disclosed in a note:
 depreciation and amortisation expense
 employee benefits expense.

The amount of equity dividends recognised in the period should be disclosed:

. either on the face of the income statement or
. the statement of changes in equity, or
. in the notes
. the related amount per share should also be disclosed.

Expandable text

Function of expense method

The second analysis is referred to as the function of expense or ‘cost of sales’ method and
classifies expenses according to their function as part of cost of sales, distribution or
administrative activities. This presentation often provides more relevant information to
users than the classification of expenses by nature, but the allocation of costs to functions
can be arbitrary and involves considerable judgement.

REPORTINGCH3ACCAF7INTJCV1 - 29 -
Illustration 2

An extract from the list of balances of Production Limited as at 30 September 20X3 is given
below:
$ $
Sales revenue 900,000
Inventories:
Raw materials 40,000
Work-in-progress 70,000
Finished goods 60,000
Purchase of raw materials 300,000
Production salaries 200,000
Production overheads 80,000
Administration salaries 100,000
Office rent 20,000

Closing inventories are:

Raw materials 30,000
Work-in-progress 62,000
Finished goods 80,000
Prepare the company’s income statement for the year ended 30 September 20X3:
(a) classifying expenses by function
(b) classifying expenses by nature

Solution

a) Classifying expenses by function

Income statement for the year ended 30 September 20X3
$
Revenue 900,000
Cost of sales (working) 578,000
_______
Gross profit 322,000
Administrative expenses (working) 120,000
_______
Profit 202,000
_______

REPORTINGCH3ACCAF7INTJCV1 - 30 -
 Working
Allocation of costs Cost of sales Administrative
$ $
Opening inventories: Raw materials 40,000
Work-in-progress 70,000
Finished goods 60,000
Raw materials 300,000
Production salaries 200,000
Production overheads 80,000
Administrative salaries 100,000
Office rent 20,000
Closing inventories: Raw materials (30,000)
Work-in-progress (62,000)
Finished goods (80,000) _______
_______
578,000
_______ 120,000
_______
This form of working is very useful for all questions requiring the use of this format – with
an extra column if required for distribution costs, of course.

(b) Classifying expenses by nature

Income statement for the year ended 30 September 20X3
$ $
Revenue 900,000
Change in inventories of finished goods and
work-in-progress (W1) 12,000
Raw materials and consumables (W2) 310,000
Production overheads 80,000
Employee benefits expense (200 + 100) 300,000
Office rent 20,000
_______
(710,000)
_______
Profit 202,000
_______

Workings
(W1) Change in inventories $
Closing inventory:
Finished goods 80,000
Work-in-progress 62,000
Opening inventory:
Finished goods (60,000)
Work-in-progress (70,000)
______
Increase 12,000
______

(W2) Raw materials

Opening inventory 40,000
Purchases 300,000
Closing inventory (30,000)
_______
310,000
_______

REPORTINGCH3ACCAF7INTJCV1 - 31 -
 Test your understanding 3

Slamometer Limited, which has traded for many years, has an authorised and issued capital
of 60,000 5.6% irredeemable preference shares of $1 and 140,000 ordinary shares of $1,
all of which are fully paid and qualify as equity shares. It also has in issue $20,000 9% loan
notes redeemable on 31 December 20X9.
The income statement for the year ended 31 March 20X4 has been drafted:
$ $
Profit on trading 71,570
Interest received 910
_____
72,480
Less: Interest on loan notes 1,800
Income taxes under-provided for previous year____
870
2,670
_____
69,810
_____
The following further information is relevant:
(1) Total sales revenue for the year was $1,013,000.
(2) Profit on trading is calculated after charging:
$
Distribution costs 152,571
Raw materials 366,238
Manufacturing overheads 159,302
Wages of production employees 98,789
Salaries of sales staff 56,400
Depreciation of factory 4,000
Depreciation on plant and machinery 7,300
Office rent 2,300
Management remuneration 91,100
Auditors’ remuneration 1,500
Legal and accounting charges 620
Interest on bank overdraft 1,310
(3) The loan note interest was paid on 31 March 20X4.

(4) Income tax on the profits of the year ended 31 March 20X4 is estimated at $32,000,
based on a rate of 25%.
(5) The $3,360 dividend for the year on the irredeemable preference shares has been paid.
(6) The balances on the company’s reserves on 31 March 20X3 were:
$
Share premium account 6,100
Plant replacement reserve 40,000
Retained earnings 51,700
(7) The ordinary share capital of $140,000 includes 15,000 shares issued in June 20X3 at a
premium of 30c each.
(8) The directors have transferred $10,000 to plant replacement reserve and propose an
ordinary dividend of 15% for the year. An ordinary dividend of 12% in respect of the year
ended 31 March 20X3 was paid on 15 May 20X3.
(9) The company has three directors, with the following salaries:

REPORTINGCH3ACCAF7INTJCV1 - 32 -
 $
Mr X, chairman 63,500
Mrs Y, sales director 15,300
Mrs Z, production director 12,300

You are required to prepare the income statement and statement of changes in equity of
Slamometer Limited for the year ended 31 March 20X4 in a form which complies with IAS 1
and other relevant IASs. Ignore the requirement to show accounting policies.

Solution

Slamometer Limited
Income statement for the year ended 31 March 20X4
Notes $ $
Sales revenue 1,013,000
Cost of sales (W) 647,929
_______
Gross profit 365,071
Distribution costs (W) 224,271
Administrative expenses (W) 67,920
______
292,191
______
Profit from operations 72,880
Interest receivable 910
Finance cost (1,800 + 1,310) (3,110)
____
(2,200)
_____
(1) Profit before tax 70,680
(2) Income tax expense 32,870
_____
Profit for the year 37,810
_____

Notes to the income statement

(1) The profit before tax is after charging:
$
Depreciation 11,300
Staff costs (including $91,100 total salaries paid 246,289
to the company’s directors)

(2) Taxation
$
Income tax at 25% 32,000
Tax under-provided in previous year 870
_____
32,870
_____
(3) Proposed dividend
The company proposes to pay an ordinary dividend of
15% for the year ended 31 March 20X4.

REPORTINGCH3ACCAF7INTJCV1 - 33 -
 Slamometer Limited
Statement of changes in equity for the year ended 31 March
20X4
Plant
Share Share replacement Retained
capital premium reserve earnings Total
$ $ $ $ $
Balance at 31 March 20X3 185,00 6,100 40,000 51,700 282,800
0
Net profit for year 37,810 37,810
Dividends paid in year:
Preference (3,360) (3,360)
Ordinary ((140 – 15)  12%) (15,000) (15,000
)
Transfer 10,000 (10,000) –
Issue of share capital 15,000 4,500 19,500
______ _____ _____ _____ ______
200,00 10,600 50,000 61,150 321,750
0
______ _____ _____ _____ ______

Working
Classification of expenses
Cost of Distribution
Administrative
salescosts
expenses
$ $ $
Expenses per note 2
Distribution costs 152,571
Raw materials 366,238
Manufacturing overheads 159,302
Staff costs 98,789 56,400
Directors 12,300 15,300 63,500
Depreciation (4,000 + 7,300) 11,300
Office rent 2,300
Audit 1,500
Legal and accountancy 620
______ ______ _____
647,929 224,271 67,920
______ ______ _____
Tutorial notes:
1 The irredeemable preference shares qualify as equity, so the
dividend must be included in the statement of changes in
equity, rather than as an expense in the income statement.
2 IAS 1 requires the total employee benefits expense to be
disclosed. IAS 24 additionally requires separate disclosure
of the benefits paid to key management personnel.

REPORTINGCH3ACCAF7INTJCV1 - 34 -
2.15 Statement of recognised income and expense

An alternative to the conventional statement of changes in equity is a statement of recognised

income and expense (SORIE)

XYZ Group
Statement of recognised income and expense for the year
ended 31 December 20X2
20X2 20X1
$ $
Surplus/(deficit) on revaluation of properties (X) X
Surplus/(deficit) on revaluation of investments X
__ (X)
__

Net income recognised directly in

equity X X
Profit for the period X
__ X
__

Total recognised income and expense X

__ X
__
Effect of changes in accounting policy (X)
__

Statement of recognised income and expense

This statement shows all gains and losses, whether they appear in the income statement or
not. The statement is confined to the current year’s gains and losses. It opens with the gains
not recognised in the income statement (revaluation surpluses and deficits) and then shows
the net profit or loss for the period. If this statement is presented, it remains necessary to
disclose by note the movements on share capital and reserves required in the statement of
changes in equity.
The statement of recognised income and expense is helpful to users because it focuses on
the overall performance of the period, regardless of whether the gains and losses appear in
the income statement.

REPORTINGCH3ACCAF7INTJCV1 - 35 -
 Test your understanding 4

The following trial balance has been extracted from the books of Arran as at 31 March 19X7:
$000 $000
Accounts office rent 98
Audit fee 22
Salaries 150
Bad debts 27
General administration 125
General distribution 23
Distribution centre storage costs 110
Advertising 40
Share capital (all ordinary shares of $1 each) 270
Share premium 80
Revaluation reserve 20
Dividend 27
Cash at bank and in hand 3
Debtors 233
Fixed asset investments 280
Interest paid 25
Dividends received 15
Interest received 1
Land and buildings at cost (land 100, buildings 100) 200
Land and buildings: accumulated depreciation 30
Plant and machinery at cost 400
Plant and machinery: accumulated depreciation 170
Profits reserve account (at 1 April 19X6) 235
Purchases 1,210
Sales 2,165
Stocks at 1 April 19X6 140
Trade creditors 27
Bank loan 100
––––– –––––
3,113 3,113
––––– –––––

REPORTINGCH3ACCAF7INTJCV1 - 36 -
Additional information
(1) Stocks at 31 March 19X7 had a cost of $85,000.
(2) Depreciation for the year to 31 March 19X7 is to be charged against cost of sales as
follows:
Buildings 5% on cost (straight line)
Plant and machinery 30% on net book value (reducing balance)
(3) Corporation tax of $165,000 is to be provided for the year to 31 March 19X7. A
dividend of 10p per share was paid. The loan is repayable in five years.
(4) Fixed asset investments are to be revalued up by $100,000.
(5) Salaries are to be apportioned equally between cost of sales, administration expenses
and distribution costs.
Required:
Revenue statement, statement of changes in equity and balance sheet for year ended 31
March 19X7.
Note: Show all workings but notes are not required.

Solution

Arran plc (Financial statements)

Income statement for the year ended 31 March 19X7
$000
Revenue 2,165
Cost of sales (1,389)
–––––
Gross profit
Administration (295)
Distribution (250)
–––
Operating profit
Interest payable (25)
Interest receivable 1
Investment income 15
–––
Profit before tax 222
Tax (165)
–––
Profit after tax 57
–––

REPORTINGCH3ACCAF7INTJCV1 - 37 -
Statement of changes in equity

Share Share Revaluation Retained Total

capital Premium reserve earnings
Opening 270 80 20 235 605
Profit after tax 57
Dividends (27)
Revaluation 80

Closing 270 80 100 265 735

Balance sheet as at 31 March 19X7

$000 $000
Fixed assets
Tangible (working) 326
Investment (280 + 100) 380
Current assets
Stock 85
Debtors 233
Bank 3
–––
321
––––
1,027
––––
$’000
Share capital 270
Share premium 80
Revaluation reserve 120
Profit and loss reserve 265
––––
735
Non-current liabilities 100
Current liabilities (27 + 165) 192
––––
1,027
––––
Working – tangible fixed assets
Land and Plant and
buildings machinery Total
$000 $000 $000
Net book value 170 230
Depreciation charge (5) (69) (74)
––– ––– –––
Closing 165 161 326

REPORTINGCH3ACCAF7INTJCV1 - 38 -
2.16 Small company financial statements

There is a long standing debate about the relevance of IFRS to small companies:
. In general, IFRSs make no distinction between large and small companies
. A case can certainly be made for requiring a lower level of disclosure from small and
medium-sized entities (SMEs),
. The main users of small company financial statements are not normally external
investors
. the extensive disclosures required by accounting standards are often irrelevant to
small companies
. The recognition and measurement criteria used by large companies may not be
appropriate to small companies

The IASB is currently working on this area and intends to produce an Exposure Draft in 2006
followed by a Standard in 2007.

Expandable text
Small companies
In general, IFRSs make no distinction between large and small companies. The disclosure
requirements of IAS 1, for example, apply to all enterprises producing published financial
statements.
A case can certainly be made for requiring a lower level of disclosure from small and medium-
sized entities (SMEs), and in some countries this already happens. For example, in the
countries of the European Community limits are set, in terms of sales revenue, total assets
and average number of employees. Companies below these limits need only present a much
reduced balance sheet and no income statement at all. The European Community definition
of a ‘small company’ is based on size. However, many people would argue that the criterion
for allowing compliance with less onerous reporting requirements should be the lack of public
accountability, not size.

Large companies are often publicly quoted companies, owned by a large number of outside
investors. They are managed by directors who may not even own shares and who are
accountable to the shareholders. The overriding objective of a large company is to maximise
the return to the investors by maximising profit.

Small companies are almost always unquoted, and they are often owned and managed by
the same people. The objective of a small company is usually to make sufficient profit to
support the owners and their dependants. Beyond that it may seek to maximise profit, but
may equally well have an interest in minimising profits above a certain level, for tax reasons.

The requirements of accounting standards appear mainly designed to satisfy the information
needs of the owners of large companies, that is, external investors. Many recent accounting
standards have had the objective of protecting external investors from the consequences of
‘creative accounting’ by the directors.

The main users of small company financial statements are not normally external investors,
but the tax authorities, lenders and potential lenders (often banks) and the owner/managers
themselves. Increasingly, it is being argued that the extensive disclosures required by
accounting standards are irrelevant to small companies. The recognition and measurement
criteria used by large companies may not be appropriate and may even be positively
unhelpful to owner/managers of small companies, who often have little specialist accounting
knowledge.

REPORTINGCH3ACCAF7INTJCV1 - 39 -
The IASB’s approach to the small company debate

The IASB has been discussing this topic for some time, sympathetic to the argument that the
current suite of IFRSs is too complicated for many small companies, so that the costs of
complying with the IFRSs may be disproportionate to the benefits realised from such
compliance.
The IASB’s current proposal is as follows:
 all enterprises (including SMEs) should be free to choose to comply with full IFRSs.
In principle they are suitable for all enterprises
 there should be stand-alone IASB Standards for SMEs
 the definition of SMEs should be a matter for local jurisdictions, but the IASB will
indicate those entities for which IASB Standards for SMEs are not appropriate. The
IASB believes that the issue is not one of pure size; for example a small company
whose shares are dealt in on a public stock exchange has a public accountability and
should be required to produce financial statements using IFRSs
 the IASB Standards for SMEs should be built on the same IASB Framework as is
used for IFRSs
 the IASB standards for SMEs may well contain recognition and measurement
simplifications; they should certainly contain simplified presentation and disclosure
rules
 eligible entities should adopt IFRSs in their entirety or IASB Standards for SMEs in
their entirety; they may not cherry pick from the two sets of rules
 the IASB hopes to produce an exposure draft of IASB Standards for SMEs during
[Link] Standards in 2007.

3 Not-for-profit and public sector entities

Qualification ACCA
Paper F7 INT
Chapter 3 Fill in these boxes
Content Objective Distinguish between the primary aims
of not-form-profit and public sector
entities and those of profit orientated
entities Fill in this box with where the
Content, illustration and TYU 6 – new information came from
TYU included?
Source

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 Qualification ACCA
Paper F7 INT
Chapter 3
Content Objective Discuss the extent to which Financial
Reporting Standards are relevant to
specialised, not-for-profit and public
sector entities
Content, illustration and
TYU included?
Source

4.1 Comparison of aims

The main aims of not-for-profit and public sector entities are very different to those of profit
orientated entities:

Profit Not-for-profit/
orientated public sector

Financial aim is to make profit and Financial aim is to achieve value for
Increase shareholder wealth money/provide service

Directors are accountable to shareholders Managers are accountable to trustees/

government/public

External finance freely available – loans, Finance limited to donations/government

share capital subsidy

4.2 Value for money

Value for money is achieved by a combination of the three Es:

. Effectiveness – success in achieving its objectives/providing its service

. Efficiency – how well its resources are used
. Economy – keeping cost of inputs low

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 Expandable text

Effectiveness, Efficiency and Economy

Effectiveness means achieving the objectives (usually non-monetary) of the organisation. The
objectives of not-for-profit and public sector entities will differ depending upon the type of
entity. For example a school may have the objectives of teaching a certain number of children
and achieving certain academic standards. A hospital may have the objectives of treating out-
patients within a particular time scale or minimising the number of empty beds. Effectiveness
is therefore measured by identifiable measures of achievement in reaching those goals or
objectives.

Efficiency means using the resources available well. It is effectively the quantity of output
obtained for a given measure of input. Efficiency means getting more out of fewer inputs and
thereby reducing the cost of output. In a school it might be measured by the pupil to teacher
ratio and in a hospital by the number of patients seen by a consultant during a surgery.

Economy means keeping the cost of input resources as low as possible. This is achieved by
paying less for the inputs that are required to meet the objectives or provide the service. In a
school giving more teaching time to classroom assistants rather than higher paid teachers
would be a form of economy or in a hospital scheduling duties to a nurse rather than a doctor.

4.3 Accounting standards and not-for-profit and public sector entities

Accounting standards are designed to:

. measure financial performance accurately and consistently

. report the financial position accurately and consistently

. account for the stewardship of the directors of the resources and assets

Not-for-profit and public sector organisations:

. do not aim to achieve a profit but will have to account for their income and costs

. will have to account for their effectiveness, economy and efficiency

. do not have to produce financial statements for the public (but in many cases may do
so)

Some measurement accounting standards will be relevant such as those relating to inventory,
non-current assets, leasing etc. Others relating purely to reporting such as earnings per share
will not be so relevant.

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 Test your understanding 6

What is meant by value for money in the public sector?

Solution
Value for money is a combination of efficiency, effectiveness and economy.

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Chapter Summary
Qualification ACCA
Paper F7 INT
Chapter 3
Template ID CS1
Source 2.5 text INT chapters 2 and 7
2.5 study notes session 4

STRUCTURE OF
REGULATORY
SYSTEM

THE IASC
FOUNDATION

STANDARDS
INTERNATIONAL ADVISORY
ACCOUNTING COUNCIL (SAC)
STANDARDS
BOARD (IASB)

INTERNATIONAL
FINANCIAL REPORTING
INTERPRETATIONS
COMMITTEE (IFRIC)

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 STANDARD SETTING
PROCESS

BALANCE SHEET
FORMAT

INCOME
STATEMENT
FORMAT

Statement of changes Statement of recognised

in equity income and expense

NOT-FOR-PROFIT
AND PUBLIC
SECTOR ENTITIES

Value for money

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Checklist – submit with each
chapter
NGLM CHECKLIST Tick
1 Table completed per content objective Done
2 Icons Done
3 Followed blueprint Done
4 Read and followed the house style document Done
5 Content, illustrations, TYUs included Done
6 Legacy material used and referenced, although text Done
must be up to date with current standards.
7 Activities etc. taken from legacy material (please list):
Ill 1 – 2.5 INT text Ch 7Act 1
Ill 2- 2.5 INT text – Ch 7 Act 2
TYU 1 – 2.5 GBR text Ch 5 act 3
TYU 3 – 2.5 GBR text Ch 7 Q1
TYU 4 – 2.5 GBR study notes Q1

8 No bullet after heading – begin with some explanatory Done

text
9 Bullets used, max. 9 bullets per heading, 70 words per Done
bullet
10 Any exceptions to rule 9 as per the syllabus Done
11 Expandable text, 500 words max per paragraph Done
12 Main content Arial 10, headings bold 14, subheadings Done
bold 12, correctly numbered with 1, 1.1, 1.2, etc.
13 Diagrams/tables used Done

14 Tables are 15 cm across and rules on text followed

(more info on balance sheets etc., layout in the house
style guide)
15 Varied style for illustrations Done
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18 Saved correctly Done

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