A Complete set of Financial Statements (as agree with IAS 1)

This Standard (IAS 1 Presentation of Financial Statements) prescribes the basis for presentation of general purpose financial statements to ensure comparability both with the entity’s financial statements of previous periods and with the financial statements of other entities. It sets out overall requirements for the presentation of financial statements, guidelines for their structure and minimum requirements for their content (IAS 1 Presentation of Financial Statements par.1)

An entity shall apply this Standard in preparing and presenting general purpose financial statements in accordance with International Financial Reporting Standards (IFRSs) (IAS 1 Presentation of Financial Statements par. 2)

IAS 1 applies to all entities, including profit-oriented and not-for-profit entities. Not-for-profit entities in both the private and public sectors can apply this standard, however they may need to change the descriptions used for particular line items within their financial statements and for the financial statements themselves.

Financial statements are a structured representation of the financial position and financial performance of an entity.

The objective of financial statements is to provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. Financial statements also show the results of the management’s stewardship of the resources entrusted to it.

To meet this objective, financial statements provide information about an entity’s: (a) assets, (b) liabilities, (c) equity, (d) income and expenses, including gains and losses, (e) contributions by and distributions to owners in their capacity as owners, and (f) cash flows.

This information along with other information in the notes, assists users of financial statements in predicting the entity’s future cash flows and, in particular, their timing and certainty.

Par. 10 of IAS 1 rules that a complete set of financial statements must comprises the following :

1. A statement of financial position as at the end of the period. The previous version of IAS 1 used the title “balance sheet”. The revised standard uses the title “statement of financial position.”

2. A statement of comprehensive income for the period

3. A statement of changes in equity for the period

4. A statement of cash flows for the period. The previous version of IAS 1 used the title “cash flow statement.”

5. Notes, comprising a summary of significant accounting policies and other explanatory information; and

6. A statement of financial position as at the beginning of the earliest comparative period when an entity applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements.

An entity shall present with equal prominence all of the financial statements in a complete set of financial statements.

The financial statements, except for cash flow information, are to be prepared using accrual basis of accounting.

As permitted by paragraph 81 of IAS 1, an entity may present the components of profit or loss either as part of a single statement of comprehensive income or in a separate income statement.

When an income statement is presented it is part of a complete set of financial statements and shall be displayed immediately before the statement of comprehensive income.

Many entities present, outside the financial statements, a financial review by management that describes and explains the main features of the entity’s financial performance and financial position, and the principal uncertainties it faces.

Such a report may include a review of : (a) the main factors and influences determining financial performance, including changes in the environment in which the entity operates, the entity’s response to those changes and their effect, and the entity’s policy for investment to maintain and enhance financial performance, including its dividend policy; (b) the entity’s sources of funding and its targeted ratio of liabilities to equity; and (c) the entity’s resources not recognized in the statement of financial position in accordance with IFRSs.

Many entities also present, outside the financial statements, reports and statements such as environmental reports and value added statements, particularly in industries in which environment factors are significant and when employees are regarded as an important user group.

Reports and statements presented outside financial statements are outside the scope of IFRSs.

Source of this article : IAS 1 Presentation of Financial Statements (amendments resulting from IFRS issued up to 17 January 2008)

How IAS 16 regulates the recognition of PPE

IAS 16 Property, Plant and Equipment paragraph 7 to 14 regulates the recognition of PPE.

Recognition Principle (par. 7) - the cost of an item of property, plant and equipment shall be recognized as an asset if, and only if : (a) it is probable that future economic benefits associated with the item will flow to the entity; and (b) the cost of the item can be measured reliably.

Spare parts and servicing equipment are usually carried as inventory and recognized in profit and loss as consumed. However, major spare parts and stand-by equipment qualify as PPE when an entity expects to use them during more than one period.

Similarly, if the spare parts and servicing equipment can be used only in connection with an item of PPE, they are accounted for as property, plant and equipment.

This Standard does not prescribe the unit of measure of recognition, i.e. what constitutes an item of PPE. Thus, judgment is required in applying the recognition criteria to an entity’s specific circumstances. It may be appropriate to aggregate individually insignificant items, such as moulds, tools and dies, and to apply the criteria to the aggregate value.

An entity evaluates under this recognition principle all its PPE costs at the time they incurred. These costs include costs incurred initially to acquire or construct an item of PPE and costs incurred subsequently to add to, replace part of, or service it.

Initial Costs

Items of PPE may be acquired for safety or environment reasons. The acquisition of such PPE, although not directly increasing the future economic benefits of any particular existing item of PPE, may be necessary for an entity to obtain the future economic benefits from its other assets.

Such items of PPE qualify for recognition as assets because the enable an entity to derive future economic benefits from related assets in excess of what could be derived had those items not been acquired.

For example, a chemical manufacturer may install new chemical handling process to comply with environmental requirements for the production and storage of dangerous chemicals; related plant enhancements are recognized as an asset because without them the entity is unable to manufacture and sell chemicals. However, the resulting carrying amount of such an asset and related assets is reviewed for impairment in accordance with IAS 36 Impairment of Assets.

Subsequent Costs

Under the recognition principle in par. 7, an entity does not recognize in the carrying amount of an item of PPE the costs of the day-to-day servicing of the item. Rather, these costs are recognized in profit or loss as incurred.

Cost of day-to-day servicing are primarily the costs of labor and consumables, and may include the cost of small parts. The purpose of these expenditures is often described as for the ‘repairs and maintenance’ of the item of PPE.

Parts of some items of PPE may require replacement at regular intervals. Items of PPE may also be acquired to make a less frequently recurring replacement, such as replacing the interior walls of a building, or to make a nonrecurring replacement.

Under the recognition principle in par. 7, an entity recognizes in the carrying amount of an item of PPE the cost of replacing part of such an item when that cost is incurred if the recognition criteria are met.

The carrying amount of those parts that are replaced is derecognized in accordance with the de-recognition provisions of this Standard (as regulates in par. 67-72).

A condition of continuing to operate an item of PPE (for example, an aircraft) may be performing regular major inspections for faults regardless of whether parts of the item are replaced. When each major inspection is performed, its cost is recognized in the carrying amount of the item of PPE as a replacement if the recognition criteria are satisfied.

Any remaining carrying amount of the cost of the previous inspection (as distinct from physical parts) is derecognized. This occurs regardless of whether the cost of the previous inspection was identified in the transaction in which the item was acquired or constructed.

If necessary, the estimated cost of a future similar inspection may be used as an indication of what the cost of the existing inspection component was when the item was acquired or constructed (Hrd) ***

The Revaluation Model of PPE Measurement (after Recognition)

IAS 16 provides for two acceptable alternative approaches to accounting for long-lived tangible assets. The first of these is the historical cost method, under which acquisition or construction cost is used for initial recognition, subject to depreciation over the expected economic life and to possible write-down in the event of a permanent impairment in value. In many jurisdictions this is the only method allowed by statue, but a number of jurisdictions, particularly those with significant rates of inflation, do permit either full or selective revaluation and IAS 16 acknowledges this by also mandating what it calls the “revaluation model.”

The logic of recognizing revaluations relates to both the statement of financial position and the measure of periodic performance provided by the statement of comprehensive income. Due to the effects of inflation (which even if quite moderate when measured on an annual basis can compound dramatically during the lengthy period over which property, plant, and equipment remain in use) the statement of financial position can become a virtually meaningless agglomeration of dissimilar costs.

Furthermore, if the depreciation charge against profit is determined by reference to historical costs of assets required in much earlier periods, profits will be overstated, and will not reflect the cost of maintaining the entity’s asset base. Under these circumstances, a nominally profitable entity might find that is has self-liquidated and is unable to continue in existence, at least not with the same level of productive capacity, without new debt or equity infusions.

IAS 29, Financial Reporting in Hyperinflationary Economies, addresses adjustments to depreciation under conditions of hyperinflation. Use of the revaluation method is typically encountered in economies that from time to time suffer less significant inflation than that which necessitates application of the procedures specified by IAS 29.

As the basis for the revaluation method, the standard stipulates that it is fair value (defined as the amount for which the asset could be exchanged between knowledgeable, willing parties in an arm’s-length transaction) that is to be used in any such revaluations.

Furthermore, the standard requires that, once an entity undertakes revaluations, they must continue to be made with sufficient regularity that the carrying amounts in any subsequent statement of financial position are not materially at variance with then-current fair values.

In other words, if the reporting entity adopts the revaluation model, it cannot report statements of financial position that contain obsolete fair values, since that would not only obviate the purpose of the allowed treatment, but would actually make it impossible for the user to meaningfully interpret the financial statements.

IAS 16 suggests that fair value is usually determined by appraisers, using market-based evidence. Market values can also be used for machinery and equipment, but since such items often do not have readily determinable market values, particularly if intended for specialized applications, they may instead be valued at depreciated replacement cost.

IAS 16 also requires that if any assets are revalued, all other assets in those groupings or categories must also be revalued. This is necessary to prevent the presentation of a statement of financial position that contains an unintelligible and possibly misleading mix of historical costs and current values, and to preclude selective revaluation designed to maximize reported net assets.

Although IAS 16 requires revaluation of all assets in a given class, the standard recognizes that it may be more practical to accomplish this on a rolling, or cycle, basis. This could be done by revaluing one-third of the assets in a given asset category, such as machinery, in each year, so that as of any statement of financial position date one-third of the group is valued at current fair value, another one-third is valued at amounts that are one year obsolete, and another one-third are valued at amounts that are two years obsolete.

Unless values are changing rapidly, it is likely that the statement of financial position would not be materially distorted, and therefore, this approach would in all likelihood be a reasonable means to facilitate the revaluation process.

Source of this article : Wiley IFRS 2008 – Interpretation and Application of IFRS

Several Accounting Changes Done by IASB in response to the Global Financial Crisis

CFO.com in its article today, October 15, 2008 titled "Fair Value Tweaking on a Global Scale" said that "In response to the global credit crisis, the International Accounting Standards Board has made its third announcement in as many days about slight changes to fair value accounting rules. The proposal issued today is a tweak to IASB's financial instrument disclosure rule, which is out for public comment until December 15.

The proposal streamlines disclosure requirements related to changes in valuation techniques for financial instruments. Rather than specifying what circumstances trigger new disclosures, the proposal simply requires that any change in valuation techniques be disclosed - plus the disclosure must include the reason for making the switch. The draft rule, which is a proposed amendment to IAS 39, applies to each class of financial instruments a company holds."

Further, the article said that "Earlier in the day, accounting regulators from the European Union voted in favor of an IASB fair value rule revision issued on Monday. The revision allows companies to reclassify financial assets to avoid marking the assets to market in some limited cases. The proposal must still be approved by the EU Parliament before taking effect.

The reclassification rule, which is part of a revised IAS 39, was finalized on October 13, and mirrors an existing U.S. standard - FAS 115."

Explore more in here : Fair Value Tweaking on a Global Scale

On October 13, 2008, IASB issued amendments to IAS 39 Financial Instruments : Recognition and Measurement and IFRS 7 Financial Instruments : Disclosures that would permit the reclassification of some financial instruments.

The amendments to IAS 39 introduce the possibility of reclassification for companies applying IFRSs, which were already permitted under U.S. GAAP in rare circumstances.

Here is the link to the story : IAS amendments permit reclassification of financial instruments

Next, on October 14, 2008, IASB provided an update on its work to consider the application of fair value when markets become inactive.

In May 2008 and at the request of the Financial Stability Forum (FSF) the IASB established and Expert Advisory Panel to consider the application of fair value when markets become inactive. The Panel has since met on seven occasions, the latest of which was on Friday, 10 October.

Several issues were discussed and agreed by the Panel during the meeting.

Click here to explore : IASB provides update on applying fair value in inactive markets

Latest, on October 15, 2008, as part of the IASB's response to the credit crisis, IASB published for public comment proposals to improve the information available to investors and others about fair value measurement of financial instruments and liquidity risk.

The proposals also reflect discussions by the IASB's Expert Advisory Panel on measuring and disclosing fair values of financial instruments when markets are no longer active.

For more information, click the following link : IASB proposes improvements to financial instruments disclosures

Using Depreciated Replacement Cost as a valuation approach of PPE Measurement

IAS 16 Property, Plant and Equipment provides for two acceptable alternative approaches to accounting for long-lived tangible assets.

Paragraph 29 of IAS 16 stated that an entity shall choose either the cost model in par. 30 or the revaluation model in par. 31 as its accounting policy and shall apply that policy to an entire class of property, plant and equipment.

Using the 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 (par. 30).

Using the 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 (par. 31).

Further, par. 32 of IAS 16 stated that “The fair value of land and buildings is usually determined from market-based evidence by appraisal that is normally undertaken by professionally qualified valuers. The fair value of items of plant and equipment is usually their market value determined by appraisal.”

Furthermore, par. 33 stated that “If there is no-market-based evidence of fair value because of the specialized nature of the item of property, plant and equipment and the item is rarely sold, except as part of a continuing business, an entity may need to estimate fair value using an income or a depreciated replacement cost approach.”

Wiley – IFRS 2008, Interpretation and Application of IFRS explained that replacement cost deals with the service potential of the asset, which is after all what truly represents value for its owner.

An obvious example can be found in the realm of computers. While the cost to reproduce a particular mainframe machine exactly might be the same or somewhat lower today versus its original purchase price, the computing capacity of the machine might easily be replaced by one or a small group of microcomputers that could be obtained for a fraction of the cost of the larger machine.

Even replacement cost, if reported on a gross basis, would be an exaggeration of the value implicit in the reporting entity’s asset holdings, since the asset in question has already had some fraction of its service life expire. The concept of sound value addresses this concern.

Sound value is the equivalent of the cost of replacement of the service potential of the asset, adjusted to reflect the relative loss in its utility due to the passage of time or the fraction of total productive capacity that has already been utilized.

Example of depreciated replacement cost (sound value) as a valuation approach :

An asset acquired January 1, 2005 at a cost of € 40,000 was expected to have a useful economic life of 10 years. On January 1, 2008, it is appraised as having a gross replacement cost of € 50,000. The sound value, or depreciated replacement cost, would be 7/10 x € 50,000 or € 35,000. This compares with a book, or carrying value of € 28,000 at the same date. Mechanically, to accomplish a revaluation at January 1, 2008, the asset should be written up by € 10,000 (i.e from € 40,000 to € 50,000 gross cost) and the accumulated depreciation should be proportionally written up by € 3,000 (from € 12,000 to € 15,000). Under IAS 16, the net amount of the revaluation adjustment, € 7,000 would be recognized in other comprehensive income and accumulated in revaluation surplus, an additional equity account.

(Source : Wiley IFRS 2008 : Interpretation and Application of International Accounting and Financial Reporting Standards 2008)

The Fair Value Guidance (FSP FAS 157-3)

CFO.com in its October 10, 2008 article titled "Fair Value Guidance to Go Live" reported that 'The Financial Accounting Standards Board will likely issue final guidance on fair value accounting by Monday. The board is working today and perhaps over the weekend to tweak some of the language to clarify how assets in illiquid markets are valued.

FASB decided to rework two sections of the draft document that was put out for public comment one week ago - but stuck to its guns regarding mandating companies to use significant judgement when valuing financial assets in inactive markets.'

Further, CFO.com wrote that 'The guidance clarifies items contained in FAS 157, the accounting rule that governs how to measure assets and liabilities using the fair value method. FAS 157 provides a measurement hierarchy that outlines ways to value securities depending on how liquid they are. Regularly traded securities are valued on their selling price, whereas securities that are thinly traded or in illiquid markets have a different set of inputs. In practice, however, many experts suspect that banks and financial institutions gave undue weight to the last observable selling price of their securities before the markets froze completely.'

Read further in here : Fair Value Guidance to Go Live

FASB in the FASB Staff Position publication No. FAS 157-3 Determining the Fair Value of a Financial Asset When the Market for That Asset is not Active, in the Objective section stated that 'This FASB Staff Position (FSP) clarifies the application of FASB Statement No. 157, Fair Value Measurements, in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active.

In the Background section, the FSP FAS 157-3 explained that 'The FASB staff obtained extensive input from various constituents, including financial statement users, preparers, and auditors, on determining fair value in accordance with Statement 157. Many of those constituents indicated that the fair value measurement framework in Statement 157 and related disclosures have improved the quality and transparency of financial information.

However, certain constituents expressed concerns that Statement 157 does not provide sufficient guidance on how to determine the fair value of  financial assets when the market for that asset is not active.'

Read the complete guidance in here : FSP FAS 157-3