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In order to reflect Fair Presentation of Financial statement, it is imperative for us to understand what exactly FAIR PRESENTATION of Financial Statement represents. It is mandatory in accordance with good corporate governance that the financial statements must "Fairly present":
The Financial Position,
The Financial Performance &
Cash flows of an entity.
What is Fair Presentation?
According to IAS 1 - "Disclosure of Accounting Policies", Fair Presentation signifies, that the financial statement of a firm must "present fairly" the Financial position, financial performance and cash flow of the entity. In accordance of IAS 1.15 Fair Presentation requires the faithful representation of effects of transactions, other events, and conditions in accordance with the definitions & recognition criteria for assets, liabilities, income & expenses. The application of IFRSs, with additional disclosure when necessary, is presumed to result in financial statements that achieve the Fair Presentation.
Usefulness of Financial Statement:
Financial Statements prepared in accordance with IAS 1 - "Disclosure of Accounting Policies", has usefulness to many users of the financial statements of an enterprise. The objective is to provide information about financial position, performance & changes in financial position of an enterprise which is useful to wide range of Users in making Economic Decisions. Fairly presented financial statements may be used by users for different purposes which are enumerated below:
Promoters, owners & management require Fair Presentation of Financial Statement to make important business decisions which affects it Going Concern concept for its continued operations.
Employees are other users of these financial statements for making collective bargaining agreements in relation to discuss about their compensation & remunerations. For the purpose of increase in salaries and wages Labor union needs financial statements as from the financial statements they analyze the affordable limits in upcoming labor discussions.
Various existing lenders and investors for the purpose of monitoring their investments and to estimate the performance of organization or management.
Various Potential Lenders and Investors, In order to decide whether to invest in the entity or not.
Investments analyst, stock brokers and the Money managers for the purpose of various decisions for their clients such as to sell, buy, recommendations or to hold.
For the purpose of assigning credit ratings various rating agencies(like Bradstreet, Poor's, and Dun ) use financial statements
For the purpose of evaluating stability or the staying power and the financial strength of the entity or of the company many suppliers and customers use these financial statements as the entity is the responsible source for their business
To review Management's performance board of directors utilize these financial statements.
In order to access its own performance management utilizes these Financial Statements.
Business raiders, to inquire about unseen value in business with underpriced stock.
Competitors, to target their own economic outcome.
Many prospective competitors, to review how beneficial it might be to go into a business.
Government agencies accountable for inspecting, taxing, and regulating the company.
Many other parties such as environmentalists, Politicians, consumer advocates, media reporters, issue groups and lobbyists and many others who are either supporting or opposing any specific public issue.
Various potential or actual franchisees or franchisors, Partners for joint ventures and others has their self interest in knowing the company's overall financial health and situation
How can financial statements be fairly presented?
It is imperative to understand that how an enterprise can achieve the above mentioned objective of presenting the Financial Statements as Fairly Presented. Few important points which should be remembered so as to achieve and present the financial statement to be Fairly Presented are mentioned below:
Financials statement should be prepared in accordance with Financial Reporting Standards, i.e. IFRS.
Financial statements must present fairly the state of affairs & Business of the enterprise and explains the transactions and financial position of business of the corporation
Financial statements should not be false & misleading in any material respect.
Financial statements should not be incomplete in any Material Aspect.
These are main characteristics which should be kept in mind so as to how the Financial Statements be fairly presented.
What are IAS's/IFRS's?
International Financial Reporting Standards (IFRS) are issued by the International Accounting Standards Board (IASB) and are authoritative pronouncements on how transactions and events should be reflected in financial statements. The IASB is an independent private organization, consisting of representatives of national standard setters, regulators and representatives of the accounting profession. The name IFRS is used to designate both IAS (International Accounting Standards - issued by the Board of the International Accounting Standards Committee) & IFRS (International Financial Reporting Standards), issued by the IASB. IFRS also include interpretations issued by the Standing & those issued by the International Financial Reporting Interpretation Committee (IFRICs).
Some of the IFRS's are mentioned below for our immediate references:
Accounting for leases (IAS 17)
Accounting for borrowing costs (IAS 23)
Accounting for tangible fixed asset (IAS 16)
Accounting for provisions (IAS 37)
Accounting for impairment of assets (IAS 36)
Accounting for intangible assets (IAS 38)
Accounting for purchased goodwill (IFRS 3)
Let us try to understand different accounting treatments of above mentioned individual IASs/IFRSs and impact of their accounting treatment on the fair presentation of Financial Statements.
Accounting for Leases (IAS 17)
The objective of this Standard is to prescribe, for lessees and lessors, the appropriate accounting policies and disclosure to apply in relation to leases. The classification of leases adopted in this Standard is based on the extent to which risks and rewards incidental to ownership of a leased asset lie with the lessor or the lessee.
Types of Leases:
Lease payments under an operating lease shall be recognised as an expense on a straight-line basis over the lease term unless another systematic basis is more representative of the time pattern of the user's benefit.
At the commencement of the lease term, lessees shall recognise finance leases as assets and liabilities in their statements of financial position at amounts equal to the fair value of the leased property or, if lower, the present value of the minimum lease payments, each determined at the inception of the lease. The discount rate to be used in calculating the present value of the minimum lease payments is the interest rate implicit in the lease, if this is practicable to determine; if not, the lessee's incremental borrowing rate shall be used. Any initial direct costs of the lessee are added to the amount recognized as an asset. Minimum lease payments shall be apportioned between the finance charge and the reduction of the outstanding liability. The finance charge shall be allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability. Contingent rents shall be charged as expenses in the periods in which they are incurred. A finance lease gives rise to depreciation expense for depreciable assets as well as finance expense for each accounting period.
Accounting Treatment for leases in financial statement:
Lessors shall present assets subject to operating leases in their statements of financial position according to the nature of the asset. The depreciation policy for depreciable leased assets shall be consistent with the lessor's normal depreciation policy for similar assets, and depreciation shall be calculated in accordance with IAS 16 and IAS 38. Lease income from operating leases shall be recognized in income on a straight-line basis over the lease term, unless another systematic basis is more representative of the time pattern in which use benefit derived from the leased asset is diminished.
Lessors shall recognize assets held under a finance lease in their statements of financial position and present them as a receivable at an amount equal to the net investment in the lease. The recognition of finance income shall be based on a pattern reflecting a constant periodic rate of return on the lessors net investment in the finance lease.
Manufacturer or dealer lessors shall recognize selling profit or loss in the period, in accordance with the policy followed by the entity for outright sales. If artificially low rates of interest are quoted, selling profit shall be restricted to that which would apply if a market rate of interest were charged. Costs incurred by manufacturer or dealer lessors in connection with negotiating and arranging a lease shall be recognized as an expense when the selling profit is recognized.
Accounting for borrowing costs (IAS 23)
The objective of IAS 23, borrowing costs is that the borrowing costs are directly attributable to the acquisition, construction or production of a qualifying asset form part of the cost of that asset. Other borrowing costs are recognized as an expense. Borrowing costs are interest and other costs that an entity incurs in connection with the borrowing of funds.
Accounting treatment of Borrowing Costs as per IAS - 23
An entity shall capitalize borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. An entity shall recognize other borrowing costs as an expense in the period in which it incurs them.
A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.
To the extent that an entity borrows funds specifically for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalization as the actual borrowing costs incurred on that borrowing during the period less any investment income on the temporary investment of those borrowings.
To the extent that an entity borrows funds generally and uses them for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalization by applying a capitalization rate to the expenditures on that asset. The capitalization rate shall be the weighted average of the borrowing costs applicable to the borrowings of the entity that are outstanding during the period, other than borrowings made specifically for the purpose of obtaining a qualifying asset. The amount of borrowing costs that an entity capitalizes during a period shall not exceed the amount of borrowing costs it incurred during that period.
Accounting for tangible fixed asset (IAS 16)
The objective of this Standard is to prescribe the accounting treatment for property, plant and equipment so that users of the financial statements can discern information about an entity's investment in its property, plant and equipment and the changes in such investment. The principal issues in accounting for property, plant and equipment are the recognition of the assets, the determination of their carrying amounts and the depreciation charges and impairment losses to be recognized in relation to them.
Property, plant and equipment are tangible items that:
are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and
(b) Are expected to be used during more than one period.
The cost of an item of property, plant and equipment shall be recognized as an asset if, and only if:
It is probable that future economic benefits associated with the item will flow to the entity; and
The cost of the item can be measured reliably.
Accounting treatment for Tangible Fixed Assets IAS - 16
An item of property, plant and equipment that qualifies for recognition as an asset shall be measured at its cost. The cost of an item of property, plant and equipment is the cash price equivalent at the recognition date. If payment is deferred beyond normal credit terms, the difference between the cash price equivalent and the total payment is recognized as interest over the period of credit unless such interest is capitalized in accordance with IAS 23.
The cost of an item of property, plant and equipment comprises:
(a) Its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates.
(b) Any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management.
(c) The initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period.
An entity shall choose either the cost model or the revaluation model as its accounting policy and shall apply that policy to an entire class of property, plant and equipment.
Cost model: After recognition as an asset, an item of property, plant and equipment shall be carried at its cost less any accumulated depreciation and any accumulated impairment losses.
Revaluation model: After recognition as an asset, an item of property, plant and equipment whose fair value can be measured reliably shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the end of the reporting period.
If an asset's carrying amount is increased as a result of a revaluation, the increase shall be recognized in other comprehensive income and accumulated in equity under the heading of revaluation surplus. However, the increase shall be recognized in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognized in profit or loss. If an asset's carrying amount is decreased as a result of a revaluation, the decrease shall be recognized in profit or loss. However, the decrease shall be recognized in other comprehensive income to the extent of any credit balance existing in the revaluation surplus in respect of that asset.
Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. Depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value. Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately. The depreciation charge for each period shall be recognized in profit or loss unless it is included in the carrying amount of another asset. The depreciation method used shall reflect the pattern in which the asset's future economic benefits are expected to be consumed by the entity.
The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful
Accounting for provisions (IAS 37)
The objective of this Standard is to ensure that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to enable users to understand their nature, timing and amount.
IAS 37 prescribes the accounting and disclosure for all provisions, contingent liabilities and contingent assets, except:
(a) Those resulting from financial instruments that are carried at fair value;
(b) Those resulting from Executory contracts, except where the contract is onerous. Executory contracts are contracts under which neither party has performed any of its obligations nor both parties have partially performed their obligations to an equal extent;
(c) Those arising in insurance entities from contracts with policyholders; or
(d) Those covered by another Standard.
A provision is a liability of uncertain timing or amount.
Accounting treatment for Provisions IAS - 37
A provision should be recognized when:
(a) An entity has a present obligation (legal or constructive) as a result of a past event;
(b) It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
(c) A reliable estimate can be made of the amount of the obligation.
If these conditions are not met, no provision shall be recognized. In rare cases it is not clear whether there is a present obligation. In these cases, a past event is deemed to give rise to a present obligation if, taking account of all available evidence, it is more likely than not that a present obligation exists at the end of the reporting period.
The amount recognized as a provision shall be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. The best estimate of the expenditure required to settle the present obligation is the amount that an entity would rationally pay to settle the obligation at the end of the reporting period or to transfer it to a third party at that time.
Where the provision being measured involves a large population of items, the obligation is estimated by weighting all possible outcomes by their associated probabilities. Where a single obligation is being measured, the individual most likely outcome may be the best estimate of the liability. However, even in such a case, the entity considers other possible outcomes.
A contingent liability is:
(a) A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or
(b) A present obligation that arises from past events but is not recognized because:
(i) It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
(ii) The amount of the obligation cannot be measured with sufficient reliability.
An entity should not recognize a contingent liability. An entity should disclose a contingent liability, unless the possibility of an outflow of resources embodying economic benefits is remote.
A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.
An entity shall not recognize a contingent asset. However, when the realization of income is virtually certain, then the related asset is not a contingent asset and its recognition is appropriate.
Accounting for impairment of assets (IAS 36)
The objective of this Standard is to prescribe the procedures that an entity applies to ensure that its assets are carried at no more than their recoverable amount. An asset is carried at more than its recoverable amount if its carrying amount exceeds the amount to be recovered through use or sale of the asset. If this is the case, the asset is described as impaired and the Standard requires the entity to recognize an impairment loss. The Standard also specifies when an entity should reverse an impairment loss and prescribes disclosures.
Accounting treatment of an asset that may be impaired
An entity shall assess at the end of each reporting period whether there is any indication that an asset may be impaired. If any such indication exists, the entity shall estimate the recoverable amount of the asset.
Irrespective of whether there is any indication of impairment, an entity shall also:
Test an intangible asset with an indefinite useful life or an intangible asset not yet available for use for impairment annually by comparing its carrying amount with its recoverable amount. This impairment test may be performed at any time during an annual period, provided it is performed at the same time every year. Different intangible assets may be tested for impairment at different times. However, if such an intangible asset was initially recognized during the current annual period, that intangible asset shall be tested for impairment before the end of the current annual period.
Test goodwill acquired in a business combination for impairment annually.
If there is any indication that an asset may be impaired, recoverable amount shall be estimated for the individual asset. If it is not possible to estimate the recoverable amount of the individual asset, an entity shall determine the recoverable amount of the cash-generating unit to which the asset belongs (the asset's cash-generating unit).
Accounting for intangible assets (IAS 38)
The objective of this Standard is to prescribe the accounting treatment for intangible assets that are not dealt with specifically in another Standard. This Standard requires an entity to recognize an intangible asset if, and only if, specified criteria are met. The Standard also specifies how to measure the carrying amount of intangible assets and requires specified disclosures about intangible assets.
An intangible asset is an identifiable non-monetary asset without physical substance.
The recognition of an item as an intangible asset requires an entity to demonstrate that the item meets:
(a) The definition of an intangible asset; and
(b) The recognition criteria.
This requirement applies to costs incurred initially to acquire or internally generate an intangible asset and those incurred subsequently to add to, replace part of, or service it.
An asset is identifiable if it either:
(a) is separable, i.e. is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability, regardless of whether the entity intends to do so; or
(b) Arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.
An intangible asset shall be recognized if, and only if:
(a) It is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and
(b) The cost of the asset can be measured reliably.
The probability recognition criterion is always considered to be satisfied for intangible assets that are acquired separately or in a business combination.
An intangible asset shall be measured initially at cost.
The cost of a separately acquired intangible asset comprises:
(a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates; and
(b) Any directly attributable cost of preparing the asset for its intended use.
Accounting for purchased goodwill (IFRS 3)
The objective of the IFRS is to enhance the relevance, reliability and comparability of the information that a reporting entity provides in its financial statements about a business combination and its effects. It does that by establishing principles and requirements for how an acquirer:
(a) Recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree;
(b) Recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and
(c) Determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination.
Disclosure for Purchased Goodwill as per IFRS 3
The IFRS requires the acquirer to disclose information that enables users of its financial statements to evaluate the nature and financial effect of business combinations that occurred during the current reporting period or after the reporting date but before the financial statements are authorized for issue. After a business combination, the acquirer must disclose any adjustments recognized in the current reporting period that relate to business combinations that occurred in the current or previous reporting periods.
How do different accounting treatments in individual IAS's/IFRS's impact on the fair presentation? - A critical Evaluation:
Critical Evaluation: It should be noticed that if financial statements are to be presented fairly, the above enumerated Accounting treatment for different IAS & IFRS should be critically implemented.
Let us try to understand the implication of not implementing the above mentioned Accounting Statements. Let us presume Enterprise Alpha & Beta who are in similar lines of business and are listed on recognized Stock Exchange of the respective Country. Now, since both Enterprise Alpha & Beta are in operations of Business they must be undergoing different business transaction of similar nature. Now, considering the fact if IFRS are not followed in booking these transactions then it might result in recording of transactions in different ways which might influence the decision making of Users to Financial statements. Thus, following accounting treatment as per IFRS/ IAS, it gives the opportunity to record financial transactions in uniformity to all the user of financial statement. Further, it also brings robust corporate governance while preparing & presenting the financial statement fairly.
Further, we can consider another example where Enterprise Alpha & Beta undergo for an asset on Lease and given the nature of transaction it is difficult to classify in Operating or Finance Lease. IAS 17, Accounting for Leases will help to understand the nature of Lease undergone by both the Enterprise. Not only it will provide the guidance in classification, also it will help to maintain the uniformity in recording the lease transaction in financial statements. This will help the users of the financial statement to take a prudent & most informed decision on the basis of uniform & truly presentation of financial statement.
So it is evident from the above mentioned points that many people, organizations, institutions and business utilize these financial statements for the various businesses and from the above discussion its very much clear and evident that how necessary is to understand and to analyze financial statements if an organization or a business entity is seeking achievement or success in the business world. Financial statements might be drawn up for many players such as for service industries, non-profit organizations, private individuals and many more The kind of the entity involved severely influence the kind of data accessible in the financial statements. The purposes and the importance of financial statements to the user are noticeably affects the data he or she will seek.