Fundamental bases of financial

reporting in management of
financial resources
LEARNING OUTCOME
 Explain the main characteristics of
alternative (historical replacement net
realizable and economic value
 Explain provision of IFRS governing
financial statements regarding changes in
accounting
 Identify the appropriate accounting
treatment if a company changes a material
accounting policy
Important terminology
Assets – resources controlled by the
enterprise from which future economic
benefits are expected to flow to the
enterprise.
Recognition – inclusion of items (e.g.,
assets, liabilities) into the financial
statements with the amount included in
statement totals.
Recognition and Measurement:

Measurement – choice of the attribute by which

to quantify a recognized item. The most commonly
used attributes:
◦ Historical cost
◦ Net realizable value
◦ Current (replacement) cost
◦ Current market value
◦ Present value of future cash flows
Recognition and Measurement
 Net realizable value – amount of cash (sometimes the
present value) minus collection and other costs
incurred.
 Current (replacement) cost – amount needed to
acquire an equivalent asset.
 Current market value – amount of cash received from
an immediate sale of the asset.
 Present value of future cash flows – amount of cash
to be received, discounted at the appropriate interest
rate.
Alternative measurement
bases
 1. Historical Cost:
 Under the historical cost method of valuation, transactions are recorded at
historical cost – that is, the actual amount of money or money's worth,
received or paid to complete the transaction. Therefore,
1. Assets are recorded at the cash or fair value of other consideration given to
acquire them.
◦ ICC Plc purchased a building (ICC House) for Tshs500 million on 1 January
20X0. It also incurred additional expenditure of Tshs40 million relating to
legal costs.
◦ In this case the historical cost of the building will be Tshs540 million
(Tshs500 million + Tshs40 million).
2. Liabilities are recorded at the amount of proceeds received or amount
of cash expected to be paid to satisfy the liability.
 The historical cost recorded remains constant for ever. There are no changes in
the historical cost unless an addition or deduction is made. In the case of the
building discussed earlier, the historical cost of the building will remain Tshs540
million, even after 50 years or until the building is sold.
 2. Fair value / Current cost
 According to the Framework, under fair value accounting;
 Assets are carried at the amount of cash or cash equivalents that
would have to be paid if the same or an equivalent asset was acquired
currently.
 Liabilities are carried at the undiscounted amount of cash or cash
equivalents that would be required to settle the obligation currently.
 Simply put this means that: current cost / fair value is the amount for
which an asset could be exchanged, or a liability settled, between
knowledgeable, willing parties in an arm’s length transaction.
 Assets are recorded at: The amount of cash or cash equivalents that
would have to be paid if the same or an equivalent asset was acquired
currently.
 3. Net realizable (settlement) value
 Under the net realisable (settlement) value basis:
 1. Assets are recorded at the estimated selling
price of the asset, less costs to make the sale.
 IAS 2 Inventories defines net realisable value
as: (Estimated selling price during the ordinary
course of business ( )- Estimated cost of
completion and the estimated costs necessary to
make the sale)
 2. Liabilities are recorded at the
estimated settlement price of the liability.
 4 Present Value
 According to the Conceptual Framework for Financial Reporting, under present
value accounting, assets are carried at the present discounted value of the
future net cash inflows that the item is expected to generate in the normal
course of business.
 Liabilities are carried at the present discounted value of the future net cash
outflows that are expected to be required to settle the liabilities in the normal
course of business.
 Simply put this means that the present value of a future cash flow is the
nominal amount of money which will change hands at some future date,
discounted to account for the time value of money.
 A given amount of money is always more valuable sooner than later since
this enables one to take advantage of investment opportunities.
 Hence, present values of future cash flows are lower than corresponding
future values. They are arrived at by applying the appropriate discount rate.
Present value tables which give us the present value of $1 at different rates of
interest (discounting rates) and over different periods of time are readily
available.
 Assets are recorded at the present discounted value of the future net
cash inflows that they are expected to generate in the normal course of
business.
 Liabilities are recorded at the present
discounted value of the future net
cash outflows that are expected to be
required to settle the liabilities in the
normal course of business.
 The provision of International Financial Reporting Standards
governing financial
statements regarding changes in accounting policies.

 International Accounting Standard (IAS-8)-Accounting

Policies, Changes in Accounting Estimates and Errors
 Example

 If a company is valuing its inventory according to the FIFO

method, then the same method should be followed year after
year. Also, all items of inventory in that category should be valued
under the FIFO method.
 Definitions
 Accounting policies: The specific principles, bases, conventions,
rules and practices applied by an entity in preparing and presenting
financial statements.
 Change in accounting estimate: An adjustment of the carrying
amount of an asset or a liability, or the amount of the periodic
consumption of an asset, that results from the assessment of the
present status of, and expected future benefits and obligations
associated with, assets and liabilities.
Changes in accounting estimates result from new information or
new developments and, accordingly, are not corrections of errors.
 Impracticable: Applying a requirement is impracticable when the
entity cannot apply it after making every reasonable effort to do
so.
Cont. ……………….
 Prior period errors: Omissions from, and misstatements in, the
entity’s financial statements for one or more prior periods arising
from a failure to use, or misuse of, reliable information that was
available at the time and could reasonably be expected to have been
obtained and taken into account in the preparation and
presentation of FS.
 Retrospective application: Applying a new accounting policy to
transactions, other events and conditions as if that policy had always
been applied.
 Retrospective restatement: Correcting the recognition,
measurement and disclosure of amounts of elements of financial
statements as if a prior period error had never occurred.
 Cont.………….
 Prospective application: of a change in
accounting policy and of recognizing the effect
of a change in an accounting estimate,
respectively, are:
 applying the new accounting policy to transactions,
other events and conditions occurring after the date
as at which the policy is changed; and
 recognizing the effect of the change in the
accounting estimate in the current and future
periods affected by the change.
Objective Of IAS 8
 it prescribes the criteria for:
 selection of accounting policies;
 changes in accounting policies;
 accounting treatment;
 disclosure of changes in accounting policies;
 changes in accounting estimates;And
 correction of errors;
The achievement of the objective
would result in:
 enhancement of:
 relevance and reliability of financial
statements;
 comparability of financial statements with
the financial statements of other entities;
 Change in accounting policy
 A change in accounting policy means changing the method
used for preparing and presenting a part of the financial
statement from the one which was adopted previously.
 An entity can change its accounting policy from the previously
adopted policies, only under the following situations:
1. The change is required by a standard.
2. The change is required by law.
3. The change will result in greater accuracy of the
financial statements, and therefore increases the
understanding of the financial statements.
The following items are not treated as a change in accounting policy:
1. Change in accounting policy for the same transaction when its substance has
changed.
2. Adoption of new policies for new transactions or transactions which were
not material in earlier periods.
 An intangible asset is an identifiable non-monetary asset without physical
substance e.g. goodwill, patents, copyrights etc.

Question: Are these a change in accounting policy?

 At the end of its first year of acquisition of investment property, Top-Inv decided to
adopt the cost model after initial recognition in line with IAS 40, after the CFO has
made a case for the revaluation model.
 Adopting the revaluation model of IAS 16 where the cost model was previously in
use
 After reassessing the useful life of its property, Sheraton Towers decides that
depreciation should now be over 55 years instead of the previous 50 years it was
being depreciated.
 Applying changes in accounting policies
 The timing or effective date for a change in the accounting policy is
as follows:
1. If the change is prescribed by an accounting standard and the
effective date is given, then the accounting policy is to be
changed from that effective date.
If the effective date is not given or if the change is voluntary,
then retrospective changes are required in the financial
statements.
This means that the figures in last year’s financial statements
must be adjusted.
2. If retrospective changes are not possible then the prospective
effect is given for the changes in accounting policy.
 While applying the change in accounting policy retrospectively, the prior
period figures of equity that is affected should also be changed and
disclosed, as if the new policy had always been applied. This is discussed in
detail in the next Learning Outcome, below.
Disclosure of changes in
accounting policies
 If the accounting policies have changed, the following disclosures
need to be made in the notes that are attached to the financial
statements.
1. Changes due to requirements of standards
(a) The date of application of the standard or interpretation, and its
description.
(b) The nature of the change in the accounting policy.
(c) The transitional provisions that might have an effect on future
periods.
(d) The changes in earnings per share during the current period and
prior periods.
(e) The amount of the adjustment relating to periods before those
presented.
(f) If retrospective application is impracticable, the reasons for same.
 On voluntary changes in
accounting policies
(a) The nature of the changes in accounting policy.
(b) The reasons for a change in accounting policy
(c) The changes in earnings per share during the
current period and prior periods.
(d) The amount of the adjustment relating to
periods before those presented.
(e) If retrospective application is impracticable, the
reasons for the same.
 WHAT IS A CHANGE IN ACCOUNTING
ESTIMATE?

 An adjustment of carrying amount of an asset or liability;

 An adjustment of the amount of periodic consumption of an
asset; that results from:
◦ The assessment of the present status of assets and
liabilities
◦ Expected future benefits of assets
◦ Obligations associated with liabilities
 Change in accounting estimates result from:
◦ New information; or
◦ New developments
 Are NOT corrections of
REASON FOR ESTIMATION
 When an item of financial statements
cannot be measured precisely, it can only
be estimated. This is because of:
Uncertainties inherent in the business;
Where judgments are involved;
Where estimation is required?
 Bad debts
 Inventory obsolescence;
 Fair value of financial assets or financial
liabilities;
 The useful lives of, or expected pattern of
consumption of the future economic
benefits embodied in, depreciable assets;
and
 Warranty obligation etc
 ACCOUNTING FOR CHANGES IN
ACCOUNTING POLICIES
 Retrospective application
 The paramount rule is that the change in
accounting policy is applied
retrospectively.
 defines retrospective application as
‘applying a new policy to transactions,
other events and conditions as if the
policy had always been applied
 Retrospective Adjustment
 Adjust the opening balance of each affected component of equity
for the earliest prior period presented, and
 The other comparative amounts disclosed for each prior period
presented as if the new accounting policy had always been
applied.
 When retrospective application of a change in accounting policy is
not possible, the change in accounting policy can be applied
prospectively.
 At times the retrospective application of a change in accounting
policy may not be possible as it is impracticable to determine
either:
◦ The period specific effects of the change, or
◦ The cumulative effect of the change.