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Reference
LO1
Explain the meaning of generally accepted accounting principles and identify the
key elements of the IASB Conceptual Framework for Financial Reporting and its
relationship to accounting standards
LO1.1
LO1.2
LO1.4
Topic list
1
2
3
4
5
Introduction
Before you learn how to prepare financial reports, it is important to understand why they are prepared.
Sections 1 3 of this chapter introduce some basic ideas about financial reports and give an indication of
their purpose, including consideration of the main users of financial statements and their needs.
In Sections 4 and 5, we introduce the regulatory system run by the International Accounting Standards
Board (IASB), and how the Standards it produces contribute to International GAAP.
The chapter content is summarised in the diagram below.
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There are references in brackets indicating where in the chapter you can find the information, and you will
also find a commentary at the back of the Study Manual.
1
(Section 1)
(Section 2)
Who are the main user groups of financial statements, and why are they interested in financial
information?
(Sections 3.1 and 3.2)
Which four international bodies are involved in the regulation of accounts and financial reporting?
(Section 4)
(Section 4)
What is GAAP?
(Section 5)
Yes
No
(The answer is at the end of the chapter)
A reporting entity is defined in Australia as 'an entity in respect of which it is reasonable to expect the
existence of users who rely on the entity's general purpose financial statements for information that will be
useful to them for making and evaluating decisions about the allocation of resources. A reporting entity can
be a single entity or a group comprising a parent and all of its subsidiaries'.
The 'reporting entity' concept is not, however, one that is currently adopted outside Australia and at
present International standard-setters have no official equivalent definition. Internationally therefore, a
reporting entity is taken quite simply to be an entity, or group of entities, which prepare accounts. A
project is currently underway to develop an international 'reporting entity' concept.
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1
LO
1.2
Why do businesses need to produce financial statements? If a business is being run efficiently, why should it
have to go through all the bother of accounting procedures in order to produce financial information?
The International Accounting Standards Board states in its document The Conceptual Framework for Financial
Reporting (The Conceptual Framework) which we will examine in detail later in this Study Manual:
'The objective of general purpose financial reporting is to provide financial information about the
reporting entity that is useful to existing and potential investors, lenders and other creditors in
making decisions about providing resources to the entity. Those decisions involve buying, selling or
holding equity and debt instruments, and providing or settling loans and other forms of credit.'
In other words, a business should produce information about its activities because there are particular
groups of people who want or need to know that information. This sounds rather vague: to make it clearer,
we will study the classes of people who need information about a business. We need also to think about
what information in particular is of interest to the members of each class.
Large businesses are of interest to a greater variety of people and so we will consider the case of a large
public company, whose shares can be purchased and sold on a stock exchange. The Conceptual Framework
specifically mentions investors and lenders, but in practice these may not be the only users.
3.2
Shareholders of the company, i.e. the company's owners, want to assess how well the
management is performing. They want to know how profitable the company's operations are and
how much profit they can afford to withdraw from the business for their own use.
(b)
Providers of finance to the company might include a bank which allows the company to operate
an overdraft, or provides longer-term finance by granting a loan. The bank wants to ensure that the
company is able to meet interest payments, and eventually to repay the amounts advanced.
(c)
Trade contacts include suppliers who provide goods to the company on credit and customers who
purchase the goods or services provided by the company. Suppliers want to know about the company's
ability to pay its debts; customers need to know that the company is a secure source of supply and is in
no danger of having to close down.
Managers of the company appointed by the company's owners to supervise the day-to-day
activities of the company. They need information about the company's financial situation as it is
currently and as it is expected to be in the future. This is to enable them to manage the business
efficiently and to make effective decisions.
(e)
The taxation authorities want to know about business profits in order to assess the tax payable
by the company, including sales taxes.
(f)
Employees of the company should have a right to information about the company's financial
situation, because their future careers and the size of their wages and salaries depend on it.
(g)
Financial analysts and advisers need information for their clients or audience. For example,
stockbrokers need information to advise investors; credit agencies want information to advise
potential suppliers of goods to the company; and journalists need information for their reading
public.
(h)
Government and their agencies are interested in the allocation of resources and therefore in
the activities of business entities. They also require information in order to provide a basis for
national statistics.
(i)
The public. Entities affect members of the public in a variety of ways. For example, they may make
a substantial contribution to a local economy by providing employment and using local suppliers.
Another important factor is the effect of an entity on the environment, for example in relation to
pollution.
Accounting information is summarised in financial statements to satisfy the information needs of these
different groups. Not all will be equally satisfied.
3.3
Operating profit
Retained earnings
Dividend payments
Directors remuneration
(The answer is at the end of the chapter)
LO
1.1
4.1
In an attempt to help the users of accounts process financial information from different sources and achieve
comparability between different organisations, accounting standards were developed. These are
developed at both a national level (in many countries) and an international level. In this Study Manual we are
concerned with International Accounting Standards (IASs) and International Financial Reporting
Standards (IFRSs).
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International Financial Reporting Standards (IFRSs) are produced by the International Accounting
Standards Board (IASB). The IASB develops IFRSs through an international process that involves the
worldwide accountancy profession, the preparers and users of financial statements, and national standardsetting bodies. Prior to 2003 standards were issued as International Accounting Standards (IASs). In 2003
IFRS 1 was issued and all new standards are now designated as IFRSs. Throughout this Study Manual, we will
use the abbreviation IFRSs to include both IFRSs and IASs.
4.2
4.3
4.4
The objectives of the IFRS Foundation, the IASB and the other bodies are:
(a)
To develop, in the public interest, a single set of high quality, understandable, enforceable and
globally accepted financial reporting standards based upon clearly articulated principles.
These standards should require high quality, transparent and comparable information in financial
statements and other financial reporting to help investors, other participants in the worlds capital
markets and other users of financial information to make economic decisions.
(b)
(c)
To take account of the needs of a range of sizes and types of entities in diverse economic settings.
(d)
In Australia, reporting entities must comply with Australian Accounting Standards. These are known as
Australian Equivalent to International Financial Reporting Standards (A-IFRSs). A-IFRSs are essentially IFRSs
as issued by the IASB, modified by additional paragraphs detailing the scope and applicability of the standard
in Australia.
4.5
(a)
(b)
(c)
As an international benchmark for those countries that develop their own requirements.
(d)
(e)
By companies themselves.
5 International GAAP
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Section overview
GAAP is a term which signifies all of the rules which govern accounting.
LO
1.1
Generally Accepted Accounting Principles, or GAAP, is a term which has arisen in recent years and signifies
all the rules, from whatever source, that govern accounting. The rules may derive from:
10
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Which of the following statements concerning the International Accounting Standards Board is true?
I
II
A
B
C
D
I only
II only
Both statements
Neither statement
Supplier
true
false
false
true
Which of the following is not a primary information need for the 'investor' user group of financial
statements?
A
B
C
D
Shareholder
false
false
true
true
According to the IASB Conceptual Framework which of the following are objectives of financial
statements?
I
II
Enabling investors to make decisions about whether to buy, hold or sell equity
Enabling suppliers to assess whether to provide credit to a company
A
B
C
D
I only
II only
Both I and II
Neither I nor II
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The International Accounting Standards Committee is the old name of the IASB; the IASB is
overseen by and accountable to the IFRS Foundation.
Although the shareholder needs to know the future prospects, he also needs to know that
the current position of the company is secure. Similarly, the supplier needs to know the
future prospects to ensure that he will be paid.
An entity's ability to repay is normally the main concern of lenders and suppliers rather than
investors.
The objective of general purpose financial reporting is to provide financial information about
the reporting entity that is useful to existing and potential investors, lenders and other
creditors in making decisions about providing resources to the entity.
The IFRS Foundation appoints the members of the IASB; the IFRS Interpretations Committee
issues Interpretations; and the IFRS Foundation oversees the work of the IFRS Interpretations
Committee.
The IFRS Foundation organises the funding of the IASB, although it does not itself fund the
development of new standards. The IFRS Foundation and the IASB aim to promote and
facilitate the use of International GAAP, but have no power to enforce its use.
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14
Financial reporting is carried out by all businesses, no matter what their size or structure.
Customers need to know that the business is making sufficient profits to be a secure source
of supply.