Paper 2.

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CHAPTER 1
BASIC CONCEPTS REVIEWED AND THE
REGULATORY FRAMEWORK
1 OBJ ECTIVE OF FINANCIAL STATEMENTS
The objective of financial statements is to provide information about a business entity
to a range of users:
Shareholders and other investors, current and potential
Lenders, suppliers and other creditors
Employees
Customers
Government, taxation authorities and statisticians
Environmental groups
General public
Information must be - Relevant
Reliable
Understandable
Comparable
Material
2 THE FRAMEWORK
To ensure the above objective is met there are rules governing the preparation of
financial statements. These rules are laid down from two sources:
[1] COMPANIES ACT 1985 (amended by CA 1989) which sets out the rules
concerning disclosure. The act also requires that financial statements show a True
and
Fair View. This is a concept requiring financial statements to be representative of
the
reality of the financial circumstances of the business entity. This has the effect of
recognizing that in certain cases the real position is better represented by deviating
fromthe prescribed rules. It is of paramount importance to show the substance over
legal form.
[2] REPORTING STANDARDS which provide rules concerning accounting
treatment. These are developed by the Accounting Standards Board (ASB).
From these sources the regulatory framework develops. There are a number of
terms
and concepts referred to as part of the framework. These are as follows:
Generally Accepted Accounting Practice (GAAP) is the umbrella concept for all rules
governing accounting.
The conceptual framework is a systemof agreed principles in accordance with which
GAAP is developed.
The Financial Reporting Council (FRC) is a body whose purpose is to:
Promote sound financial reporting
Guide the ASB
Ensure financial reporting is efficient
Review ASB funding
The Statement of Principles is a list of topics set out by the Accounting Standards
Board (ASB) whose aims are to establish and improve financial accounting and
reporting. The eight Statements of Principle are:
Objective of financial statements
Accounting for interests in other entities
Qualitative characteristics of financial information
Elements of financial statements
Recognition in financial statements
Measurement in financial statements
Presentation of financial statements
The reporting entity
The Urgent Issues Task Force (UITF) exists to provide a rapid reaction when
conflicting
or unsatisfactory interpretations arise.
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The Public Sector Liaison Committee liaises with the ASB regarding differences in
the
public and private sectors.
The Financial Reporting Review Panel (FRRP) reviews and if necessary enforces the
adherence to accounting standards and best practice.
3 FINANCIAL REPORTING STANDARDS
Financial Reporting Standards (FRSs) are rulings made by the ASB regarding best
practice. The process involves discussion with the accounting profession and
business.
The first stage after a problem is identified is the issue of a Discussion Document.
After extensive discussion has taken place this becomes a Financial Reporting
Exposure Draft and eventually an FRS.
Prior to FRSs there were Statements of Standard Accounting Practice (SSAPs).
Many
of these have now been superseded by FRSs but those which have not have been
ratified by the ASB and still stand. FRSs and SSAPs have the effect of being legally
binding.
4 ACCOUNTING CONVENTIONS
Financial accounting conventions are assumptions adopted in the preparation of
financial statements.
4.1 ACCOUNTING CONCEPTS
The four Fundamental accounting concepts are:
Going concern
Accruals
Consistency
Prudence
These were set out by SSAP 2 Disclosure of accounting policies, which has been
superseded by FRS 18 Accounting policies. The latter has given greater
prominence to
going concern and accruals, but all remain important to good accounting practice.
4.2 FRS18: ACCOUNTING POLICIES
Accounting policies aimto ensure that an entity:
Adopts appropriate policies
That the policies are regularly reviewed
That there is sufficient disclosure for maximumunderstanding
The main effects of FRS 18 are:
That recognition, measurement and presentation are addressed when determining
if an accounting policy has been changed
Clarification of policy changes regarding prior year adjustment
Going concern and accruals are the overriding accounting concepts
Consistency and prudence are no longer fundamental although desirable
There is further disclosure required if in order to provide a true and fair view a
departure is made fromthe requirements of an accounting standard
There is a distinction between accounting policies and estimation techniques
4.3 FURTHER ACCOUNTING PRINCIPLES
Separate entity
Accounting period
Stable standard of measurement
Materiality
Objectivity
Substance over form.
5 EC DIRECTIVES
According to the aims of the European Union (EU) that members will eventually
operate as a single economic entity, businesses must operate within some of the
constraints of the EC Directives. The effect of these is that:
Financial statements must be presented in prescribed formats
There are exemptions from some of the requirements of the Companies Acts for
small and medium-sized companies
There are various requirements relative to groups of companies.
6 THE STOCK EXCHANGE
The Stock Exchange imposes rules on Public Companies and those desiring a Stock
Exchange listing.
7 INTERNATIONAL ACCOUNTING STANDARDS
The International Accounting Standards Committee (IASC) came into existence in
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1973
after agreement by accountancy bodies in various countries. In 2001 the
International
Accounting Standards Board (IASB) became the standard setter for International
Financial Reporting Standards (IFRSs). Member countries are working to make their
own FRSs consistent with IFRSs where possible.
In 2002 the European Union agreed to the use of IFRSs, and this will become
mandatory for the consolidated financial statements of listed companies with regard
to
accounting periods beginning on or after 1st J anuary 2005. This impacts some 7,500
companies within the EU.
The challenges for the preparers of IFRS compliant financial statements are
considerable as the accounting regulatory framework undergoes considerable
change.
In 2004 the IASB completed an Improvements Project for many of their existing
standards to reduce some of the variation between and IFRSs and national
GAAP (Generally Accepted Accounting Practice)
New IFRSs continue to be issued
In the UK new company legislation is awaited plus the ASB continue to issue
their own accounting standards for the many companies not required to
transfer to IFRS (these new standards largely mirror their international
counterparts)
The USA and Canada are highly resistant to the implementation of international
accounting regulations, but there is a long termdesire in the accounting
community to move towards a single worldwide accounting framework. To this
end a Convergence Project has been started, but will not be completed in the near
future.
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