FR Study Guide - Module 1 - 3rd Edition

CPA PROGRAM
FINANCIAL
REPORTING
3RD EDITION
MODULE 1
Published by Deakin University, Geelong, Victoria 3217 on behalf of CPA Australia Ltd, ABN 64 008 392 452
First published January 2010, updated July 2010, updated January 2011, reprinted July 2011,
updatedJanuary 2012, reprinted July 2012, updated January 2013, reprinted July 2012,
revisededitionJanuary 2013, reprinted July 2013, updated January 2014,
revised edition January 2015, updated July 2015, updated January 2016
Third edition published November 2016
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Authors
Nikole Gyles Australian Accounting Standards Board (AASB)
Janice Loftus University of Adelaide
Carmen Ridley Australian Financial Reporting Solutions
Dean Hanlon Monash University
CPA Australia would also like to acknowledge the contribution of Catherine Pozzi and earlier contributions
from Phil Hancock and Michael Jones.
2016 updates
Sorin Daniluc Australian National University
Stephen Marsden Queensland University of Technology
Alex Martin ANZ
Shaun Steenkamp Consultant
Darryn Rundell Consultant
Reviewers
Sally-Anne Attard Consultant
Karyn Byrne Consultant
Shan Goldsworthy Consultant
John Kidd Consultant
Janice Loftus University of Adelaide
Helen Yang Victoria University
Advisory panel
Peter Gerhardy Ernst & Young
Shan Goldsworthy Shans Accounting Services
Kris Peach KPMG
Daen Soukseun Department of Transport, Planning and Local Infrastructure, Victoria
Themin Suwardy Singapore Management University
Anne Vuong National Australia Bank
Mark Shying CPA Australia
Ram Subramanian CPA Australia
David Hardidge Telstra
CPA Program team
Kerry-Anne Hoad Alisa Stephens Sarah Scoble
Kristy Grady Yvette Absalom Belinda Zohrab-McConnell
Nicola Drury Neha Abat Sarah Yang-Spencer
Kellie Hamilton Elise Literski Alex Lawrence
Freia Evans Leilei Bi
Educational designer
Deborah Evans DeakinPrime
Acknowledgments
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FINANCIAL REPORTING
Module 1
THE ROLE AND IMPORTANCE OF
FINANCIALREPORTING
14 | THE ROLE AND IMPORTANCE OF FINANCIAL REPORTING
Contents
Preview 15
Introduction
Objectives
Teaching materials
MODULE 1
Information to CPA Program candidates studying FinancialReporting

2016 International Financial Reporting Standardsthe Red Book
Rounding
The role and importance of financial reporting 17
The role of financial reporting
The importance of financial reporting
What are the different types of financial reporting for users?
Non-IFRS reporting
Limitations of general purpose financial reporting
Who must prepare general purpose financial reports? Interactionbetween
financialreporting and the regulatoryenvironment
International initiatives to decrease financial reporting complexity
The Conceptual Framework for FinancialReporting 26
The purpose and application of the Conceptual Framework
Principles established in the Conceptual Framework
Qualitative characteristics of useful financialinformation 29
Fundamental qualitative characteristics
Enhancing qualitative characteristics
The cost constraint on useful financial reporting
Application of qualitative characteristics in the IFRSs
The elements of financial statements 36
Defining the elements of financial statements
Criteria for recognising elements of financial statements
Constraints on frameworks
Measurement of elements of financialstatements 42
Valuation techniques
Application of measurement principles in theIFRSs 56
Employee benefits
Accounting for share-based payments
Investment property
Professional judgment
Disclosures
Review 69
Suggested answers 71
References 77
STUDY GUIDE | 15
Module 1:
The role and importance
of financial reporting
MODULE 1
Study guide
Preview
Introduction
Financial reporting is the process of documenting an entitys financial status in the form
of financial reports/statements. The entity then uses the prepared financial reports as a
communication tool that assists users with decision-making. Financial reports are accessed by
a broad range of users, including shareholders, banks, competitors, employees and financial
analysts. Therefore, to assist users in their decision-making, it is critical that financial statements
are prepared in accordance with a recognised accounting framework.
The use of accounting standards as a consistent language for reporting helps ensure that
financial statements are understandable and can be compared between entities. International
Financial Reporting Standards (IFRSs) are the global language of accounting standards.
Thismodule considers the role and importance of financial reporting and discusses the
application of reporting in an international context. It then discusses the need for general
purpose financial statements (GPFSs) and the role that the Conceptual Framework for
FinancialReporting (Conceptual Framework) plays in financial reporting. We also discuss
thelimitations offrameworks.
In discussing the definitions and recognition criteria outlined in the Conceptual Framework,
thismodule examines their application in IFRSs in the context of selected issues. Measurementis
acomplex and controversial aspect of accounting. In this module, alternative measurement bases
are studied, and the application of the mixed measurement model is examined. Measurement
issues in relation to liabilities and expenses are considered in the context of employee benefits and
share-based payments. The module also explores the application of the ConceptualFramework
inthe context of investment properties.
Objectives
After completing this module you should be able to:
explain the role and importance of financial reporting;
explain the role of the IASB Conceptual Framework in financial reporting and
accountingstandards;
describe the objective and limitations of general purpose financial statements as identified
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inthe Conceptual Framework;

explain the definitions of the elements of financial statements and recognition criteria
adopted by the Conceptual Framework;
explain the application of the standards to the financial reporting process and apply
specificstandards;
discuss and demonstrate the importance of professional judgment in the financial
reportingprocess;
explain the implications of using cost and fair value accounting; and
explain how materiality is assessed and determine the materiality of transactions.
Teaching materials
International Financial Reporting Standards (IFRSs) (Red Book 2016) and the following
International Accounting Standards (IASs).
IASB The Conceptual Framework for Financial Reporting (2010)
IFRS 2 Share-based Payment
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations
IFRS 9 Financial Instruments
IFRS 13 Fair Value Measurement
IFRS 16 Leases
IAS 1 Presentation of Financial Statements
IAS 2 Inventories
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
IAS 16 Property, Plant and Equipment
IAS 19 Employee Benefits
IAS 36 Impairment of Assets
IAS 37 Provisions, Contingent Liabilities and Contingent Assets
IAS 40 Investment Property
Information to CPA Program candidates studying

FinancialReporting
Candidates enrolled in Financial Reporting will note that the IFRSs (Red Book 2016) are used
inthe study materials. All the relevant extracts from the IFRSs required for your study and exam
purposes are presented in this study guide. It is not compulsory to access, print or purchase
the IFRSs for your study or exam. Candidates who would like to explore the standards in more
detail may consult the digital copy of the IFRSs, which is provided on My Online Learning inthe
Learning Resources and Additional Information folder. You can access the IFRSs from the
website of the International Accounting Standards Board (IASB), but please note that the IFRSs
on the website of the IASBs website may not be aligned with the version of the IFRSs used in this
edition of the Financial Reporting Study guide due to frequent amendments to the standards.
The exam will cover the version of the standards used in the study guide, which are aligned with
the Red Book 2016.
STUDY GUIDE | 17
2016 International Financial Reporting Standardsthe Red Book

Throughout this subject, the accounting standards issued as at 1 January 2016 as presented in
the 2016 Red Book are applied. The book is presented in two parts:
Part A includes the Conceptual Framework, as well as all of the accounting standards and
interpretations as issued at 1 January 2016.
Note that the paragraph references for the Conceptual Framework start with the letters OB
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for Chapter 1 and QC for Chapter 3.
Part B includes all of the supporting documents for the Conceptual Framework accounting
standards and interpretations as issued at 1 January 2016. These supporting documents
include:
the basis of conclusions and, for some accounting standards, the dissenting opinions;
implementation guidance;
details of amendments and impacts on other accounting standards; and
illustrative examples.
Rounding
In this subject, the questions and examples are sometimes rounded to the nearest dollar or
thousands of dollars. In financial reporting, rounding is used in preparing financial statements,
but any requirement to round is jurisdiction-specific and is not a requirement of the IFRSs.
Inthissubject, where decimal places are used, all rounding should be to two decimal places
unless otherwise stated.
The role and importance of financial reporting

Financial reporting is a process that provides entities with an important communication
tool allowing the management of an entity (preparers) to produce financial information for
externalstakeholders (users). Financial statements are the key financial reporting tool that
preparers use to communicate to users. Financial statements provide users with information
about how an entity is being managed, including its financial position, financial performance
andcash flows.
The role of financial reporting

The role of financial reporting is to provide users with information to enable them to achieve
effective decision-making. It also provides a stewardship or accountability role by requiring
managers to give an account of how they have used the resources provided.
Identification of target users of financial statements is crucial. The IASB incorporates a narrow
range of users for general purpose financial reportsspecifically, existing and potential investors,
lenders and other creditors (Conceptual Framework, para. OB2). For example, investorsmay
use financial statements to make decisions about when and how to invest their money,
includingassessing how well the management of an entity has run the entity.
Effective financial reporting communicates the story of the entity during the period so that
theusers can understand what the entity has achieved and how it has achieved it. Improving the
communication effectiveness of financial statements is one of the central themes of the IASBs
standard-setting work (IASB 2016a, http://www.ifrs.org/Features/Pages/Hans-Hoogervorst-better-
communication.aspx).
Financial reporting sits in a framework of other reporting provided by an entity. Other types of
reporting include investor updates, sustainability reporting, corporate governance reporting
and other prospective, or forward-looking, information. For example, when an entity is intending
to list on a stock exchange, it would normally be required to provide some forward-looking
information to potential investors to help them make their investment decision.
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Financial reports provide information about an entitys financial position, and the effects
of transactions and other events that give rise to changes in financial position (Conceptual
Framework, paras OB12OB16). The presentation of financial reports is prescribed to ensure
that they are comparable with the entitys previous financial statements and with the financial
statements of other entities (IAS 1, para. 1). The statement of financialposition (orbalance
sheet) provides information about the financial position of the entity. The profit or loss
statement(alsoreferred to as the statement of profit or loss and other comprehensive
income or statement of financial performance) reports on performance on an accrual basis.
Thestatement of cash flows reports on performance on a cash basis. Other changes in the net
assets, orequity,are reported in the statement of changes in equity.
The importance of financial reporting

Financial reporting is important because of the level of resources under the care of managers
and the significance and financial impact of the decisions made by users that are based on
thisinformation. This importance is reflected in company regulators and stock exchanges
aroundthe world requiring financial statements to be prepared by entities as part of their
reporting obligations.
Users of financial statements are not limited to existing investors but also include potential
investors, lenders and other creditors. The types of decisions that financial statementsmight
beused for are highlighted in Figure 1.1.
Figure 1.1: Financial statement user decisions
Shareholders Competitors
Should I invest money How has the company

in the company? performed in comparison
to its competitors?
?
Suppliers Banks
Should I sell goods Should I lend money

to the company? to the company?
Source: CPA Australia 2016.

STUDY GUIDE | 19
Information needs of the user

The information needs of users differ depending on their outlook. For example, potential
investors or current investors deciding whether to hold or to sell their investment may have
varying or even conflicting information needs.
The IASBs approach to resolving conflicting user information needs is to seek to provide the
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information that will meet the needs of the maximum number of primary users. However, it is
noted that focusing on common information needs does not prevent an entity from providing
additional information that may be useful to a group of users (Conceptual Framework, para.OB8).
Conflicting information needs are shown in Figure 1.2. The shaded area represents the
common information needs of primary user groups. Conflict arises where the information
needs do notoverlap, as indicated by the unshaded areas, and where the information needs
of only twouser groups are shared (striped areas). The unshaded and the striped areas depict
differinginformation needs, where choices made by standard setters and preparers may result in
the needs of some primary users being met at the expense of the needs of other primary users.
Figure 1.2: Maximising the number of primary users whose information needs
aremet (IASB 2010)
Investors Lenders
Other creditors
Source: CPA Australia 2015, based on IASB 2010.
Consider, for example, lenders as users of financial statements. Lenders are interested in
makingan assessment of an entitys capacity to meet its principal and interest obligations and
the level of risk associated with the loan. As investors invest equity, they are also interested in the
assessment of risk and the ability of the entity to service its debt, so that the entity can continue
its operations and provide a return to investors.
These varying demands may give rise to different preferences for the measurement of assets or
the timing of the recognition of revenue. For example, creditors may prefer a measure of the net
realisable value of certain assets to assess whether the security is sufficient in the event that the
entity defaults on repayment. However, investors may prefer measurement based on value in use,
which provides a better indication of the expected benefits to be derived from the continued
useof the assets.
Trying to meet the needs of the maximum number of users may have different implications
depending on the context. For example, for some entities, investors may be the largest group
ofusers, but for others, lenders may represent a larger group of users.
Question 1.1
Consider the following statement:
By focusing on the information needs of investors, lenders and other creditors, financial
reporting will not be useful for other users.
Do you agree or disagree? Give reasons for your answer.
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Limitations of the decision-usefulness objective

The objective of financial reporting is to meet the information needs of the maximum number
of primary users. It is not to provide all possible information about the financial position,
performance and changes in financial position; rather, it is to provide information that is useful
toa wide range of users. There are limitations to a decision-usefulness criterion in judging
whether information should be included or required in financial statements. Consider the
following problems.
Lack of familiarity with new types of information: If users of financial statements

are not familiar with an item of information, it is difficult to assess its usefulness to the
users decision-making processes. Users are unable to incorporate information into their
decision-making if it is not disclosed. A decision-usefulness objective may result in bias in
favour of maintaining the status quo instead of facilitating innovative solutions to financial
reporting problems.
Decision-usefulness may vary among users: For example, some investors may consider
environmental performance to be very relevant, whereas others might exclude it from their
decision-making models. The differences in what users find relevant are likely to depend on
the decision being made. The information needs of customers deciding whether to enter
into a long-term purchase contract will differ from those of employee representative groups
negotiating remuneration and working conditions for employees.
Capable of multiple interpretations: The decision-usefulness criterion appears to be

capable of supporting too many different measurement bases. For example, using fair
value as the relevant measurement attribute may support capital market assessments of the
required rate of return on assets of equivalent risk, whereas entity-specific measurement
attributes (such as value in use) may be consistent with managements plans and expectations
regarding particular assets. These competing user needs are difficult to reconcile under the
currently specified objective of general purpose financial reporting.
Question 1.2
Consider the following statement:
The decision-usefulness objective provides unambiguous guidance in resolving financial
reporting problems.
Do you agree? Give reasons for your answer.
STUDY GUIDE | 21
What are the different types of financial reporting for users?

We can split financial reporting into two types: general purpose financial reporting and special
purpose financial reporting.
As outlined in Table 1.1, whether general purpose or special purpose financial reporting is
appropriate depends on whether the target users of the financial reporting are able to request
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specifically tailored reports to meet their needs.
Table 1.1: Use of different financial reporting types
Source of decision-making
Type of financial reporting Users information
General purpose financial Unable to request reports to meet GPFSs

reporting (broad focus) their particular information needs
(e.g.investors)
Special purpose financial In a position to request that the entity Special purpose financial
reporting (narrow focus) prepares reports to meet their particular statements (SPFS)
information needs (e.g. banks, regulators)
For example, a bank extending credit

to a corporate customer may require
information about the timing of expected
cash receipts and payments in more
frequent maturity bands than those
required by the accounting standards
used in the preparation of ageneral
purpose financial report.
In this module, the terms financial reports and financial reporting refer to general purpose
financial reports and general purpose financial reporting unless otherwise noted. GPFSs such as
the statement of profit or loss, statement of financial position, statement of changes in equity,
and the statement of cash flows make up the body of general purpose financial reports that are
prepared for external users.
Non-IFRS reporting
Not all entities are required to prepare financial reports in accordance with the IFRSs. Anentity
may use alternative bases for accounting if this is required or permitted. For example, inMalaysia,
private entities comply with the Malaysian Private Entities Reporting Standard (MPERS) rather
than with the IFRSs. Alternatively, an entity that is not required to report separately in accordance
with the IFRSs may still need to provide information to a parent entity for inclusion in a set of
consolidated financial statements that must comply with the IFRSs. Thismodule and this subject
will only address an entitys obligations under the IFRSs.
Furthermore, although the IFRSs and the Conceptual Framework are also applied in the
not-for-profit sector in some jurisdictions, emphasis throughout this subject is on profit-seeking
entities in global financial markets.
Question 1.3
According to the Conceptual Framework, who are the primary users of general purpose financial
reports, and why do you think they are regarded as the primary users?
Limitations of general purpose financial reporting

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There are limitations to the extent that financial reporting can provide useful information to
all users. The IASB recommends the use of other sources (Conceptual Framework, para. OB6)
tohelp gain a clearer understanding and also explains that the reports are not designed to show
the value of the organisation but to help decision-makers make their own estimates as to its
value (Conceptual Framework, para. OB7). In addition, financial reporting has a historical focus
that may be an indicator of future performance.
If you wish to explore this topic further, read paras OB6OB11 of the Conceptual Framework for
Financial Reporting (in Part A of the Red Book).
Who must prepare general purpose financial reports?

Interactionbetween financialreporting and the
regulatoryenvironment
The IFRSs are silent on which entities should prepare general purpose financial reports.
Suchmatters are considered to be better left to governments and regulatory agencies in each
jurisdiction, and reporting obligations for entities are usually set out in local legislation and other
regulatory requirements.
In Australia, the reporting obligations for companies are found in Part 2M.3 (Financial Reporting)
of the Corporations Act 2001 (Cwlth). This includes section 292, which specifies that financial
reports must be prepared by all disclosing entities, public companies, large proprietary
companies and registered schemes, and section 296 stipulates that the financial report must
comply with accounting standards. The obligations of other types of entities are included in
other pieces of federal or state-based legislation. For example, for associations, the appropriate
legislation would be the appropriate state-based Incorporated Associations Act.
In other jurisdictions, the appropriate legislation includes the Financial Markets Conduct Act 2013
(New Zealand) and the Financial Reporting Act 2013 (New Zealand), Singapore Companies Act
1969 (Singapore) and the Companies Act 1965 (Malaysia). The legislation will specify the content
of the financial statements, the regularity of reporting and the basis on which the financial
statements are prepared.
In 2013, New Zealand introduced several tiers or levels of financial reporting for different types
of reporting entities. This has led to a reduction in who must prepare GPFSs, with many small or
medium-sized organisations being excluded from this requirement (Ernst & Young 2013).
In addition to formal regulations, there are examples of guidance on who should prepare reports
based on professional judgment linked to the needs of external users. For example, in Australia,
Statement of Accounting Concept (SAC) 1, para. 41, states that reporting entities shall prepare
general purpose financial reports in accordance with accounting standards (Australian
Accounting Research Foundation (AARF) & Accounting Standards Review Board (ASRB1990).
In para. 40, it also defines reporting entities based on user needs rather than the organisations
legal structure or physical size:
Reporting entities are all entities (including economic entities) in respect of which it is reasonable to
expect the existence of users dependent on general purpose financial reports for information which
will be useful to them for making and evaluating decisions about the allocation of scarce resources
(AASB, SAC 1).
STUDY GUIDE | 23
The actual financial reporting performed by an entity will depend on both the type of
organisation and the jurisdiction in which it operates. The regulatory environment will specify
which standards require compliance as well as any additional reporting requirements.
The objective of general purpose financial reporting is to provide useful financial information to
various users to support their decision-making needs. In addition, there is a stewardship function,
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which involves reporting on how efficiently and effectively management has used the resources
entrusted to it. Chapter 1 of the Conceptual Framework discusses these objectives in greater
detail, and it identifies potential users and the types of decisions that they may need to make.
If you wish to explore this topic further, read paras OB1OB5 of the Conceptual Framework for
Financial Reporting (in Part A of the Red Book).
International initiatives to decrease financial reporting complexity

An ongoing criticism of financial reporting is the complexity of financial reports. Improving the
communication effectiveness of financial reporting is a key focus for the IASB currently (IASB2016b,
http://www.ifrs.org/Features/Documents/2016/Hans-Hoogervorst-Zurich-Conference-2016.pdf),
andthere are a growing number of initiatives to help combat the issue, including:
reducing differences in reporting standards between countries;
reducing reporting requirements of specific organisations; and
catering to the information needs of multiple stakeholders.
Some examples of these initiatives are described as follows.

Overall, the complexity in financial reporting has decreased due to increased acceptance of
theIFRSs in most parts of the world. More than 110 jurisdictions worldwide require the use of the
IFRSs for their publicly listed companies (IFRS Foundation 2016c).
The global acceptance of the IFRSs led to the commitment of the US Financial Accounting
Standards Board (FASB) to work with the IASB to explore the possibilities of convergence of
USGenerally Accepted Accounting Principles (GAAP) with the IFRSs. In 2007, the US Securities
and Exchange Commission (SEC) eliminated the requirement for foreign companies listed on the
US SEC reconcile their IFRSs-based financial statements to US GAAP. However, the US SEC does
not permit domestic issuers to adopt the IFRSs (SEC 2007).
Reducing reporting requirements of specific organisations

The complexity of the full IFRSs led the IASB and accounting standards-setting bodies to specify
less complex standards for some entities. Examples of such reductions are as follows.
IASB
To reduce the complexity of following the full IFRSs for small and medium-sized entities (SMEs),
the IASB has introduced the IFRSs for SMEs. The IFRS for SMEs is described as being less
complex than the full IFRS because of the following:
Topics not relevant to SMEs, such as earnings per share, interim financial reporting and
segment reporting, are omitted.
Many principles for recognising and measuring assets, liabilities, income and expenses in
the full IFRSs are simplifiedfor example, amortised goodwill, expense all borrowings and
development costs; cost model for associates and jointly controlled entities; and undue cost
or effort exemptions for specific requirements.
Significantly fewer disclosures are required (about a 90% reduction).
The standard has been written in clear, easily translatable language.
To further reduce the burden on SMEs, revisions are expected to be limited to once every three
years (IFRS Foundation 2016a).
AASB
In 2009, the AASB introduced a differential reporting framework that organisations meeting the
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category of Tier 2 can follow, Tier 2: Australian Accounting StandardsReduced Disclosure

Requirements (RDR) (AASB 2015). In contrast, others need to follow the full standards.
The RDR is available to a wide range of entities in both the private and public sectors in preparing
general purpose financial statements:
(a) for-profit private sector entities that do not have public accountability;
(b) all not-for-profit private sector entities; and
(c) public sector entities other than the Australian Government and State, Territory and Local
Governments (AASB 2016).
External Reporting Board (XRB), New Zealand

In 2012, XRB issued a new multi-tiered accounting standards framework in which the level of
disclosure and compliance requirements depend on the nature of the organisation.
Tier 1publicly accountable or large for-profit entities follow the NZ IFRSs.
Tier 2non-publicly accountable and non-large for-profit public sector entities follow
NZIFRS Reduced Disclosure Regime (NZ IFRS RDR).
Tier 3non-publicly accountable entities where either all of its owners are members of the
entitys governing body, or the entity is not large, need to follow NZ IFRS RDR, which includes
public benefit entity (PBE) Simple Format Reporting Standard Accrual (PSFR-A).
Tier 4entities that are non-publicly accountable, not required to file financial statements,
and not large, need to follow old GAAP, which include PBE Simple Format Reporting
Standard Cash (PSFR-C) (External Reporting Board 2016).
Overview of Accounting Standards Framework
The new Accounting Standards Framework involves a two sector, multi-standards, tiered approach
as summarised in the following table. For further details please see the Accounting Standards
Framework document.
Table 1.2: New Accounting Standards Framework tiered approach
For-Profit Entities Public Benefit Entities
Accounting Accounting
Entities Standards Entities Standards
Tier 1 Publicly accountable NZ IFRS Publicly accountable PBE Standards

(as defined); or (as defined); or
Large (as defined) Large(as defined)
for-profit public
sectorentities
Tier 2 Non-publicly NZ IFRS Reduced Non-publicly PBE Standards

accountable and Disclosure Regime accountable Reduced
Non-large for-profit (NZ IFRS RDR) (asdefined) Disclosure Regime
public sector entities and non-large (PBEStandards RDR)
Which elect to be (asdefined)
inTier 2 Which elect to
beinTier 2
STUDY GUIDE | 25
For-Profit Entities Public Benefit Entities
Accounting Accounting
Entities Standards Entities Standards
Tier 3 Non-publicly PBE Simple Format

accountable Reporting Standard -
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(asdefined) with Accrual(PSFR-A)
expenses 2 million
which elect to be
inTier 3.
Tier 4 Entities allowed PBE Simple Format

by law to use cash Reporting Standard -
accounting Cash(PSFR-C)
which elect to
beinTier 4.
Source: External Reporting Board (XRB), New Zealand, 2015, Overview of Accounting Standards
Framework, accessed November 2016, https://www.xrb.govt.nz/Site/Financial_Reporting_Strategy/
Accounting_Standards_Framework.aspx.
Catering to the information needs of multiple stakeholders

One aspect of the current complexity in reporting, which has attracted the attention of accounting
standards-setting bodies worldwide, has resulted from the need to measure performance
from multiple perspectives. This requirement cannot be met simply by the reporting of financial
statements. A companys performance is a multifaceted measure. Therefore, there is a need for
information such as the progress of the companyin terms of strategy and planrather than
financial measures such as profit, assets and liabilities. Althoughthe reporting of the strategy and
plan is material to investors, lenders and other stakeholders, there is no requirement to report this
information in the IFRSs.
The increase in the reporting of non-mandatory information in annual reports (relative to the
financial section) makes financial reporting seem like a mere compliance exercise rather than an
exercise that communicates the information needs of multiple stakeholders (IFRSFoundation2013).
Some of the present research projects in progress across the world are asfollows.
IASB
In response to user and preparer concerns about the increasing complexity of IFRS requirements,
the IASB has been working on multiple projects to reduce the complexity of financial reporting.
Some of the key initiatives of the IASB are outlined below.
Principles of disclosure
The aim of this research project is to develop a disclosure standard that binds financial
statements and their contents. The focus includes IAS 1 Presentation of Financial Statements
and IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
Standards level review of disclosure

The aim of the standards level review of disclosures project is to improve disclosure
related to the respective standards, with the principles of disclosure project informing such
improvement (IFRS Foundation 2016c).
Materiality
The aim of this project is to provide guidance on the application of materiality to help
preparers of financial statements, auditors and regulators to report material information.
Thediscussion stems from whether the definition of materiality needs to clarify that
materiality is not only enhanced by reporting of material information but also by reducing
disclosure of overwhelming and distracting immaterial information (IASB 2015, http://www.
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ifrs.org/Current-Projects/IASB-Projects/Disclosure-Initiative/Materiality/Exposure-Draft-
October-2015/Documents/ED_IFRSPracticeStatement_OCT2015_WEBSITE.pdf).
Financial Reporting Council (FRC), UK

To improve corporate reporting so that it provides clearer understanding of the underlying
performance of a company (FRC 2016), the FRC introduced the Financial Reporting Lab in 2011
as a forum for companies and investors to solve contemporary reporting needs. The lab works
with 65 companies, 60 investment organisations and more than 300 retail investors with the aim
of improving disclosures. Two of the themes that the lab focuses on are Digital Present and
Towards Clear & Concise Reporting (FRC 2016).
Summary
Accounting standard setters have had a renewed focus on decreasing complexity in financial
reporting. Challenges still exist with regard to developing an overarching disclosure model to
measure performance without increasing the complexity of reporting.
The Conceptual Framework for

FinancialReporting
In this section we look at the IASB Conceptual Framework for Financial Reporting
(ConceptualFramework).
The Conceptual Framework:

sets out the concepts that underlie the preparation and presentation of financial statements. Itis
apractical tool that assists the IASB when developing and revising IFRSs (ConceptualFramework,
para. 1).
In September 2010, the IASB issued a version of the Conceptual Framework that partially updated
the previous (1989) version. The IASB has a current project on its agenda to update the 2010
Framework and to fill in the gaps in the current version. The stated objective of this project is:
to improve financial reporting by providing a more complete, clear and updated set of
concepts. To achieve this, the Board is building on the existing Conceptual Frameworkupdating
it, improving it and filling in the gaps instead of fundamentally reconsidering all aspects of the
Conceptual Framework (IASB 2016, http://www.ifrs.org/current-projects/iasb-projects/conceptual-
framework/Pages/Conceptual-Framework-Summary.aspx).
In this module, and throughout this subject, only the 2010 version of the Conceptual Framework,
which is found in Part A of the Red Book, is considered.
STUDY GUIDE | 27
The Conceptual Framework is structured as shown in Table 1.3.
Table 1.3: Structure of the Conceptual Framework
Chapter Content
MODULE 1
Introduction Provides a detailed description of the purpose, status and scope of the
Conceptual Framework
1. Objective Sets out the objective of general purpose financial reporting,

Includes paragraphs identified as OB before their
paragraphnumbers
2. Reporting entity Content not yet been included; to be developed as part of the
current Conceptual Framework revision project
3. Qualititve characteristics Provides guidance on the qualitative characteristics of useful

financialinformation
Includes paragraphs identified as QC before their
paragraphnumbers
4. Remaining text of the Includes the rest of the Conceptual Framework

1989 Framework Sets out the going concern assumption as well as the definitions
ofthe elements of financial statements and the recognition criteria
The purpose and application of the Conceptual Framework will now be discussed, and its
components will be examined in detail.
The purpose and application of the Conceptual Framework

Accounting standards do not cover all possible transactions an entity may enter into.
Whenstandards do not provide guidance or sufficiently specific guidance, it is the role
oftheConceptual Framework to provide guidance to facilitate consistency in the reporting
oftransactions and events.
Having a common framework is an important foundation in guiding the development

ofaccounting standards and accounting practice.
The Conceptual Framework provides a formal frame of reference for:

the types of transactions and events that should be accounted for;
when transactions and events should be recognised;
how transactions and events should be measured; and
how transactions and events should be summarised and presented in financial statements.
For example, IAS 36 Impairment of Assets applies the principle that the carrying amount of an
asset should not exceed its recoverable amount. This principle is consistent with the concept of
an asset adopted in the Conceptual Framework:
a resource controlled by the entity as a result of past events and from which future economic
benefits are expected to flow to the entity (para. 4.4).
As an asset represents a resource that provides future benefits, the amount at which it is reported
in the statement of financial position should not exceed the expected benefits to be derived
from the asset.
The Conceptual Framework is applied in several ways, as shown in Table 1.4.
Table 1.4: Applying the Conceptual Framework
Who is applying the

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Conceptual Framework How the Conceptual Framework is applied
Standard setters To develop accounting standards
Preparers Guidance when issues that are not directly covered by a standard or
interpretation arise (Specifically, IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors requires the Conceptual Framework to be
considered when there is an absence of a specific accounting standard or
interpretation (IAS 8, paras 1011)).
Auditors To help form an opinion on compliance with an IFRS
Users To better understand and interpret the financial reports they are reviewing
Where there is a conflict with an IFRS, the requirements of the particular standard override those
of the Conceptual Framework.
Principles established in the Conceptual Framework

There are two important assumptions that form the foundation of general purpose financial
reporting. These are the assumption of the accrual basis of accounting and the assumption that
the entity is a going concern.
Accrual basis
The accrual basis of accounting recognises the effects of transactions and other events when they
occur (which may not correspond to the time that cash is exchanged in response to a transaction)
and reports them in the financial statements in the periods to which they relate.
The accrual basis of accounting requires an entity to recognise expenses when they are incurred
rather than when cash is paid. For example, an entity recognising revenue from selling goods or
services on credit recognises the related expenses (cost of goods sold) incurred in earning that
revenue, regardless of when the cash outflow relating to those expenses takes place. The accrual
basis requires an entity to recognise the depreciation of a non-current asset (with a limited useful
life) as the economic benefits of that asset are consumed or expire; an entity does not account
for the asset as an expense in the period in which it is acquired.
The accrual basis is used on the assumption that it provides a better basis for assessing the
entitys past performance and predicting future performance than relying only on financial
statements prepared on a cash basis (Conceptual Framework, para. OB17).
If you wish to explore this topic further, read paras OB17OB19 of the Conceptual Framework.
STUDY GUIDE | 29
Question 1.4
In its first year of operations, Tower Ltd purchased and paid for widgets costing $50 000.
Duringthat year, Tower Ltd sold 60 per cent of the widgets. The widgets on hand at the end of
the year cost $20 000. The sales were on credit terms. Tower Ltd received $37 000 in cash from
customers, and $3000 remained uncollected at the end of the year. During the last quarter of the
first year of operations, Tower Ltd entered into a property insurance contract for losses arising
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from fire or theft. The annual premium of $4000 was paid in cash and the insurance expired nine
months after the end of the reporting period.
Calculate Tower Ltds profit for the first year of operations on an accrual basis and on a cash basis.
Explain the difference between the two measures. Which of the two profit measures is more
useful for assessing Tower Ltds performance during its first year of operations? Give reasons
for your answer.
Going concern
Financial statements prepared in accordance with the going concern assumption presume
that the entity will continue to operate for the foreseeable future. The carrying amount of
assets and liabilities in the statement of financial position are normally based on the going
concern assumption. For example, the carrying amount of property, plant and equipment
whethermeasured on a cost or fair value basisassumes that the carrying amount will be
recoverable through the entitys continuing operations. Some assets, such as property and
plant,maybe stated at amounts that exceed their disposal value because the entity expects
toobtain greatereconomic benefits through the continued use of such an asset.
Where the going concern assumption is not appropriate (e.g. because of the entitys intention or
need to wind up operations), the financial statements should be prepared on some other basis.
The Conceptual Framework does not specify an alternative basis. However, one approach may
be to state assets at their net realisable valuewhich in the case of certain intangible assets
maybenegligibleand liabilities at the amount required for their immediate settlement.
If you wish to explore this topic further, read para. 4.1 of the Conceptual Framework.
Qualitative characteristics of useful

financialinformation
Chapter 3 of the Conceptual Framework focuses on qualitative characteristics. To be useful,
financial information must:
be relevant and faithfully represent what it purports to represent. The usefulness of
financial information is enhanced if it is comparable, verifiable, timely and understandable
(ConceptualFramework, para. QC4).
This is illustrated in Figure 1.3.

Figure 1.3: Qualitative characteristics of financial reporting
Relevance
Fundamental
qualitative
characteristics Faithful
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representation
Comparability
Verifiability
Enhancing
qualitative
characteristics
Timeliness
Understandability
Fundamental qualitative characteristics

Relevance
Information is relevant when it is capable of influencing the decisions of users (Conceptual
Framework, para. QC6). This influence can occur through the predictive value or the confirmatory
value of information, or both. Table 1.5 shows how relevant information helps users.
Table 1.5: How relevant information helps users
The Conceptual Framework

requires relevant
information that helps How this relates to
users financialreporting An example
in forming expectations This relates to the Financial statements can be used to predict
about the outcomes of past, predictivevalue of the future cash flows of an entity and the
present and futureevents accounting information timing and uncertainty of those cash flows.
in confirming or correcting This is referred to Expectations of future cash flows can be

their past evaluations as feedback, or the compared with actual cash flows when
confirmatory value of financial statements relating to those future
accounting information periods are issued and the reasons for any
differences between expected cash flows
and actual cash flows are investigated.

STUDY GUIDE | 31
Materiality
Relevance also encompasses materiality. A subjective approach to materiality is adopted in the
Conceptual Framework:
Information is material if omitting it or misstating it could influence decisions that users make on the
basis of financial information about a specific reporting entity (Conceptual Framework, para.QC11).
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Materiality is an aspect of relevance that can be affected by the nature or the size of an item
of information, or both. Quantitative thresholds for materiality are not used in the Conceptual
Framework because the application of the concept of materiality is entity-specific (Conceptual
Framework, para. QC11). Consider the following examples:
An entity may engage in transactions with its directors that involve amounts that are not
material to the entity. However, the disclosure of these related-party transactions may be
relevant to users needs, irrespective of the amounts involved, because of the nature of the
relationship between the directors and the entity and their accountability to shareholders.
An entity may engage in new activities, the results of which have little impact on profit at
present. However, the results may be relevant to the decision-making needs of users because
they may affect the users assessment of the entitys risk profile.
Whether information is material is a matter of judgment that depends on the facts and
circumstances of an entity. The IASB released a draft Practice Statement in 2015 that highlighted
some ways in which management can identify whether information is useful to the primary
users,outlined in Table 1.6.
Table 1.6: Identifying information useful to users of financial reports
Consideration Example
User expectations How users think the entity should be managed (i.e. stewardship) gathered
through discussions with users or from information that is publicly available
Management perspective Changing management perspective to think about decisions from the
perspective of the user (i.e. as if they were external users themselves and
did not have the internal knowledge held by management, for example,
aboutkey risks or key value drivers)
Observing user or market For example, on particular transactions or disclosures issued by the entity
responses to information oron responses by external parties such as analysts
Observing industry peers For example, observing what information peers within the industry are
presenting in their financial reports (Although there are similarities between
entities in the same industry, it does not mean that the same kind of
information will necessarily be material.)
Source: IASB 2015 http://www.ifrs.org/Current-Projects/IASB-Projects/Disclosure-Initiative/Materiality/

Exposure-Draft-October-2015/Documents/ED_IFRSPracticeStatement_OCT2015_WEBSITE.pdf
If you wish to explore this topic further, read paras QC4QC11 of the Conceptual Framework.
Faithful representation
Together with relevance, faithful representation is a fundamental qualitative characteristic of
useful financial information.
Faithful representation requires that financial statements faithfully represent the transactions
and events that they purport to represent (Conceptual Framework, para. QC12). For example,
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the statement of financial position should faithfully represent the events that give rise to assets,
liabilities and equity at the end of the reporting period. Ideally, faithful representation means that
financial information is complete, neutral and free from error. However, it is usually impractical to
maximise these three characteristics simultaneously.
Faithful representation implies that there should be a fair representation of economic outcomes
or reality. However, this assumes that there are accounting solutions to all of the problems
and financial reporting issues that need to be resolved to achieve a faithful representation.
Inpractice, difficulties in identifying the transactions and other events that must be accounted
for, as well as in applying or developing appropriate measurement and presentation techniques,
canimpede the achievement of faithful representation.
Application of fundamental qualitative characteristics

For information to be useful, it must be both relevant and faithfully represented. This may involve
professional judgment in making a trade-off between relevance and faithful representation.
Forexample, information about future cash flows to be derived from an asset may be highly
relevant, but it may be difficult to faithfully represent this aspect of the asset because of the
inherent uncertainty of future events. Paragraph QC18 of the Conceptual Framework suggests a
process for making such judgments.
Question 1.5
Coalite Ltd participates in an emissions trading scheme. It holds emission trading allowances,
which provide a permit for a specified amount of carbon emissions for the year. If its operating
processes result in carbon emissions, Coalite Ltd must deliver sufficient emission trading
allowances to the government to pay for the amount of carbon emitted during the year. If it
does not hold enough emission trading allowances, Coalite Ltd will need to buy more to settle
its obligation to the government. If the companys holding of trading allowances is surplus to its
needs, theallowances may be sold.
Assume that in determining how to apply the fundamental qualitative characteristics, the chief
financial officer (CFO) of Coalite Ltd has completed the first step by identifying the emission trading
allowances held as being potentially useful to the users of the companys financial statements.
(a) Identify the type of information about emission trading allowances that would be most
relevant if it were available and could be faithfully represented.
(b) Do you think the information that you suggested is likely to be available and able to be
represented faithfully? If not, what might be the next most relevant type of information
about the emission trading allowances?
STUDY GUIDE | 33
Enhancing qualitative characteristics

Comparability
Comparability is one of the four enhancing qualitative characteristics. Financial information is
more useful if it can be compared with similar information about other entities and with similar
information about the same entity for another reporting period. The ability to compare financial
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statements over time is important to enable users to identify trends in the entitys financial
position and performance. The ability to compare the financial statements of different entities
isimportant in assessing their relative financial position and performance.
Comparability also enables users to recognise similarities or differences between two sets of
economic phenomena. For example, an entity with an existing investment in Company A is
deciding whether to continue to invest in Company A or to move its investment to Company B.
Comparable financial information will help the investor in making the decision.
The Conceptual Framework refers to the concept of consistency, which is defined as the use
of the same methods for the same items (para. QC22). This may be in reference to the use
of consistent methods either by different entities for the same period or by the same entity
over different periods. Consistency of accounting methods is seen as contributing to the goal
ofcomparability.
Comparability is not satisfied by mere uniformity of accounting policies and methods. In fact,
theConceptual Framework (para. QC23) cautions against this interpretation because it may result
in dissimilar information appearing to be alike. For example, assets that form part of continuing
operations differ from assets that form part of discontinued operations. Future economic benefits
of assets that form part of continuing operations are expected to be recovered by the use and
disposal of those assets in the ordinary course of business. The future economic benefits of
assets forming part of discontinued operations are expected to be recovered principally through
sale rather than continued use. The adoption of consistent accounting methods to represent
economic information about assets that form part of continuing operations and those that form
part of discontinued operations would not enhance comparability. Such methods would fail to
reflect the differences in the way that economic benefits are expected to be derived from the
twotypes of assets.
Comparability of financial statements is enhanced by the disclosure of the accounting policies

adopted in preparing the financial reports and of any changes in those policies and their effects.
Disclosure of accounting policies is considered further in Module 2.
Verifiability
Verifiability exists if knowledgeable and independent observers can reach a consensus that the
information is faithfully represented. As shown in Table 1.7, verification may be direct or indirect.
Table 1.7: Form of verification
Form of verification Example
Direct Confirming the market price used to measure the fair value of an asset that
is traded in an active market
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Indirect Checking the inputs and processes used to determine the reported
information (e.g. verifying fair value with a model that checks inputs such
as the contractual cash flows and the choice of an appropriate interest rate,
and the methodology or rationale used to estimate fair value).
Consensus might refer to a range (e.g. an estimate of the fair value of a

corporate bond that is not traded in an active market as being between
$940 and $970) but not necessarily to a point estimate (e.g. the historical
cost being $990). Verifiability can help to assure users that information is
faithfully represented.
Source: CPA Australia 2016, adapted from Conceptual Framework, para. QC27
Timeliness
Timeliness enhances the relevance of information in GPFSs. Undue delays in reporting information
may reduce the relevance of that information to users decision-making. Thetimeliness of financial
information is critical for investment decisions. Unexpected surprises and delayed news that
impacts negatively on the financial statements will normally result in a loss of confidence and
plummeting share prices within the investment market.
To maintain the timeliness of information reported in financial statements, it may be necessary

to report on the effects of a transaction or other event before all of the required information is
available. Accordingly, it may be necessary to use estimates instead of waiting until more directly
observable information becomes available.
Understandability
Understandability requires the information in financial statements to be clearly and concisely
classified, characterised and presented (Conceptual Framework, para. QC30). Understandability
cannot be interpreted independently of the capability of users of the financial statements.
Usersare presumed to have reasonable knowledge of business and economic activities
(Conceptual Framework, para. QC32). This implies that the informed user should readily
understand the measurement attribute adopted for a particular financial statement item.
Information is not excluded from a financial report merely because it is difficult for usersto
understand (Conceptual Framework, para. QC31). This would be inconsistent with the
characteristic of completeness incorporated in faithful representation.
STUDY GUIDE | 35
Question 1.6
The objectives of IFRS 13 Fair Value Measurement include establishing a common definition of fair
value and common guidance for fair value measurement. The standard prescribes the following
fair value measurement hierarchy (in descending order):
Level 1 Quoted price for an identical asset or liability;
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Level 2 Model with no significant unobservable inputs; and
Level 3 Model with significant unobservable inputs.
Explain how the enhancing qualitative characteristics, comparability and verifiability, are applied
in the requirements of IFRS 13.
Application of enhancing qualitative characteristics

Although enhancing characteristics improve the relevance or faithful representation of information,
they do not make irrelevant or unfaithfully represented information useful. Ifinformation were
omitted from financial statements, rendering them incomplete (not faithfully represented),
theconsistent omission of that information over multiple periods may provide comparability,
but it would not make the information useful. For example, if an entity omitted several material
subsidiaries from its consolidated financial statements, repeating this omission in each reporting
period may provide comparability. However, financial statements that do not faithfully represent
the financial position and financial performance of the group that they report on are not useful for
user decision-making.
Preparers need to exercise professional judgment in balancing the qualitative characteristics

andin assessing the relative importance of enhancing characteristics in different contexts.
Inselecting an appropriate accounting policy, such as a measurement attribute, preparers
may need to make a trade-off between an enhancing qualitative characteristic and another
qualitativecharacteristic. For instance, the preparer may need to forego the enhancing
qualitative characteristic of comparability to change an accounting policy in the interests of
providing more relevant or more faithfully represented information.
For example, an entity may adopt fair value measurement in order to provide more relevant
information at the expense of comparability with previous periods. Additional disclosures,
suchas the reason for and effects of the change of accounting policy, and the restatement of
reported comparative amounts may improve comparability to assist users in making decisions
about the particular entity.
Module 2 considers the application of comparability in IAS 8 Accounting Policies, Changesin

Accounting Estimates and Errors in the context of disclosure requirements for changes
inaccounting policies.
The cost constraint on useful financial reporting

The Conceptual Framework (para. QC35) notes that a pervasive constraint on financial statements
is the balance between the costs of providing information versus the benefits derived from their
preparation and presentation. The costs of collecting, processing, verifyingand disseminating
financial information fall mainly on the entities responsible for preparing financial reports.
Theusers of financial reports also incur costs to analyse and interpret the information. Ifuseful
information is not provided, users may make estimates or, where possible, incuradditional costs
to obtain it from other sources.
Providing useful financial information also facilitates the efficient functioning of capital markets
and lowers the cost of capital (Conceptual Framework, para. QC37). The provision of relevant and
faithfully represented financial information enables users to make more informed decisions and
to make their decisions more confidently. However, even if it were possible, the cost of meeting
all information needs of all users would be prohibitive. Materiality plays an important role in
helping preparers and users of financial reports decide what information needs to be provided.
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Inaddition, the IASB provides specific exemptions within standards. For example, in IFRS 16
Leases, the IASB does not require a lessee to recognise assets and liabilities for leases of less
than 12 months because the cost of obtaining that information is considered to be more than the
benefit of providing the information to users (IASB 2016c, http://www.ifrs.org/Current-Projects/
IASB-Projects/Leases/Documents/IFRS_16_effects_analysis.pdf).
Application of qualitative characteristics in the IFRSs

The qualitative characteristics are reflected in the underlying principles of the IFRSs. IAS1
Presentation of Financial Statements, paras 1524, refers to the Conceptual Framework
definitions and recognition criteria, objectives and qualitative characteristics. Specifically,
IAS1,para. 15, states:
Financial statements shall present fairly the financial position, financial performance and
cash flowsof an entity. Fair presentation requires the faithful representation of the effects of
transactions, other events and conditions in accordance with the definitions and recognition
criteria for assets, liabilities, income and expenses set out in the Framework. The application
ofIFRSs, withadditional disclosure when necessary, is presumed to result in financial statements
thatachieveafairpresentation.
The elements of financial statements

Now that the fundamentals of financial reporting have been discussed, how the Conceptual
Framework addresses the elements that make up the financial statements will be considered.
Theelements of financial statements are assets, liabilities, equity, income and expenses.
Figure1.4 presents the key decisions relating to the elements of the financial statements.
The firsttwo decisions (definition and recognition) will be discussed in this section,
whilemeasurement will beconsidered later in the module.
Note: The 2010 version of the Conceptual Framework does not address disclosure.
However,thereis a proposal to include disclosure in the revised Conceptual Framework.
STUDY GUIDE | 37
Figure 1.4: Key decision areas in accounting for transactions and other events
Did a past event, or events, give rise to an item that satisfies

1. Definition
the definition of an element of financial statements?
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Does an item that meets the definition of an element need to be
2. Recognition
incorporated in the financial statements?
How to measure the items that are recognised in financial

3. Measurement
statements?
How should items be disclosed or presented in the financial

4. Disclosure/Presentation
statements or notes to the accounts?
Defining the elements of financial statements

Assets
Note that the definitions of assets and liabilities are fundamental because the definitions of
theother elements flow from them. The Conceptual Framework defines an asset as:
a resource controlled by the entity as a result of past events and from which future economic
benefits are expected to flow to the entity (Conceptual Framework, para. 4.4(a)).
The three key components of the asset definition are:

1. the requirement for the entity to have control of the asset;
2. that a past event has occurred; and
3. the need for future economic benefits to arise.
It is important to note that the definition does not require the asset to be a physical asset.
Manyassets, such as patents and copyrights, are intangible in nature. These assets give rise
tofuture economic benefits (in the form of royalties or sales) but do not have a physical form.
For an entity to have control, it does not necessarily follow that the entity has ownership of the
asset. For example, IFRS 16 Leases requires a right-of-use asset to be recognised for a leasedasset,
even though the entity does not own the underlying asset (e.g. the building). Thisisbecause the
entity controls the benefits arising from using the asset during the lease term.
A past event normally occurs when the asset is purchased or produced (Conceptual Framework,
para. 4.13). However, assets may also arise in other circumstances. For example, an asset may
be gifted to the entity as part of a government grant program. It is important to draw the
distinction between past events and transactions or events that are expected to occur in the
future. Futuretransactions do not give rise to assets until such time as they occur. For instance,
ifan entity develops an operational plan that requires the purchase of an item of machinery in six
MODULE 1
months, the definition of an asset is not met until such time as the machinery is purchased.
Consider the following example. A mining company has responsibility for maintaining a private
road on land over which it holds a lease. The road provides access to the mine. Recently,
thecompany paid for the road to be resealed (resurfaced) at a cost of $3 million. The economic
benefits from the resealed road are expected to be obtained over several accounting periods,
but the association with income can only be broadly or indirectly determined.
In accordance with IAS 16 Property, Plant and Equipment, the expenditure on resealing the road
should be capitalised as part of the road. The new seal enhances the economic benefits that
the company expects to obtain from the use of the road. Control has been established because
the resealed road is on land over which the company has obtained control by entering into a
lease. The costs of resealing the road should then be recognised as expenses (i.e. depreciation)
progressively over the useful life of the road.
Liabilities
A liability is defined as:
a present obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits
(ConceptualFramework, para. 4.4(b)).
The key components of the liability definition are:

1. the requirement for the entity to have a present obligation;
2. that a past event has occurred; and
3. the need for an outflow of future economic benefits.
A present obligation may be legally enforceable, or it may arise from normal business practice,
custom and a desire to maintain good business relationships or to act in an equitable manner.
For example, an entity selling goods may choose to accept the return of faulty goods for a
full exchange, even after the contractual warranty period has expired, to maintain favourable
relationships with its customers. It is important to note that a decision by management
to undertake a particular transaction in the future (e.g. to acquire a new item of plant and
equipment) does not, of itself, give rise to a present obligation (Conceptual Framework, 4.16).
Liabilities only arise from a past event or transaction. For example, if an entity purchases an item
of equipment for $1 million and agrees to pay for the equipment in 90 days, the past event is
purchasing the asset (the equipment), and the entity has an obligation to pay for the equipment.
The outflow of resources embodying economic benefits (i.e. an outflow of assets) is often
referredto as the settlement of a liability. Paragraph 4.17 of the Conceptual Framework
providesexamples of how a liability might be settled, as shown in Figure 1.5.
STUDY GUIDE | 39
Figure 1.5: Examples of how a liability might be settled
Transfer of
other assets
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Payment Liability Provision
of cash settlement of services
Replacement of
Conversion of
the obligation
the obligation
with another
to equity
obligation
Source: CPA Australia 2016, adapted from Conceptual Framework, para. 4.14.
The replacement of an obligation with another obligation and the conversion of an obligation to
equity do not directly involve an outflow of resources embodying economic benefits. Consider,
for example, the issue of shares to debt-holders in settlement of a liability. Theissue ofshares
would normally involve consideration passing to the entity. If debt is settled by conversion
to shares, the consideration paid by the debt-holders is the surrender of their debt claim
against the entity. From the perspective of the entity issuing the shares, theconsideration is the
discharge of the obligation for the debt. Instead of receiving an inflow of assets in consideration
for the issue of shares, it has avoided an outflow of assets. The economic substance is the same
as if the new shareholders had contributed cash or other assets for the shares and those assets
were used to settle the liability.
Equity
Equity is defined as the residual interest in the assets of the entity after deducting all its
liabilities (Conceptual Framework, para. 4.4(c)).
The definition of equity flows from the definitions of assets and liabilities. Equity is simply the
difference between assets and liabilities. Furthermore, the amount at which equity is shown in
thestatement of financial position is derived from the recognition and measurement of assets
and liabilities.
If you wish to explore this topic further, read paras 4.24.23 of the Conceptual Framework.
Income
Income is defined as:
increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in increases in equity, other than
thoserelating to contributions from equity participants (Conceptual Framework, para. 4.25(a)).
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The two essential characteristic of income are:

1. an increase in assets or a reduction in liabilities; and
2. an increase in equity, other than as a result of a contribution from owners.
Income does not arise from an increase in assets if there is a corresponding increase in liabilities
because there would not be an increase in equity. For example, if an entity receives revenue
in advance of services being provided, it would recognise an increase in assets (i.e. cash) and
an equivalent increase in liabilities (i.e. unearned revenue or revenue received in advance)
representing services yet to be rendered. Income does not arise until the liability is reduced.
Asthe services are rendered, the entity recognises income and a corresponding reduction in
theliability.
Income refers to both revenue and gains. Revenue arises in the course of the ordinary activities
of an entity (e.g. through sales). Revenue from contracts with customers, a subset of revenue,
isdiscussed in Module 3. Gains are those items that meet the definition of income that may or
may not arise in the course of ordinary activities of an entity (e.g. sale of a non-current asset).
Theyare not a separate element in the Conceptual Framework as they are not considered
different in nature to revenue (Conceptual Framework, para. 4.30).
Expenses
Expenses are defined as:
decreases in economic benefits during the accounting period in the form of outflows or depletions
of assets or incurrences of liabilities that result in decreases in equity, other than those relating to
distributions to equity participants (Conceptual Framework, para. 4.25(b)).
The two essential characteristics of an expense are:

1. a decrease in economic benefits that may arise through outflows or depletions of assets
oranincrease in a liability; and
2. a decrease in equity, other than those arising from distributions to equity participants.
An expense is the opposite of income. An example of an expense is wages, which involve

outflows of cash and cash equivalents to employees for the provision of services. Depreciation
is an example of an expense involving the depletion of assets. The accrual of electricity charges
gives rise to an expense involving the incurrence of a liability.
Under the IFRSs, not all items that meet the definition of income and expenses are recognised
in profit. For example, revaluation gains on property, plant and equipment under the valuation
model are required to be recognised in other comprehensive income and accumulated in
equity, unless a prior downward revaluation is being reversed (IAS 16 Property, Plant and
Equipment). Gains and losses that are recognised in other comprehensive income are reported
in the statement of profit or loss and other comprehensive income in accordance with IAS 1
Presentation of Financial Statements (refer to Module 2).
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Criteria for recognising elements of financial statements

An item that meets the definition of an element of financial statements should be recognised if:
(a) it is probable that any future economic benefit associated with the item will flow to or from
theentity; and
(b) the item has a cost or value that can be measured with reliability (Conceptual Framework,
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para.4.38).
The first recognition criterion relates to probability, which is not defined or clarified in the
Conceptual Framework. However, there is a statement that probability refers to the degree of
uncertainty associated with the flow of future economic benefits to or from the entity (para. 4.40).
Probable is often interpreted in the mathematical sense of having a likelihood of occurrence
greater than 0.5 and is defined in IFRS 5 Non-current Assets Held for Sale and Discontinued
Operations as being more likely than not.
The second recognition criterion is that the item has a cost or value that can be measured
withreliability. This is not to say that the cost or value must be known or be directly observable.
The Conceptual Framework states: the use of reasonable estimates is an essential part of
the preparation of financial statements and does not undermine their reliability (para. 4.41).
Determining a reasonable estimate is subjective and may require professional judgment.
Items that do not meet the probability criterion or the reliable measurement criterion
(butotherwise meet the definition), such as contingent liabilities, may warrant disclosure in
thenotes to the financial statements (covered in Module 3).
The recognition of income occurs:

when an increase in future economic benefits related to an increase in an asset or a decrease of a
liability has arisen that can be measured reliably (Conceptual Framework, para. 4.47).
When income is recognised, there is a corresponding increase in assets, such as an increase

in accounts receivable, or a decrease in liabilities, such as a reduction in a liability for
unearnedrevenue.
The recognition of expenses occurs:

when a decrease in future economic benefits related to a decrease in an asset or an increase of a
liability has arisen that can be measured reliably (Conceptual Framework, para. 4.49).
The Conceptual Framework notes that the recognition of expenses is simultaneous with the
recognition of a reduction in an asset or the increase in a liability. For example, the recognition
ofa cost of goods sold expense coincides with a reduction in the amount recognised as an asset
for inventory.
As noted earlier, the definitions and recognition criteria for assets, liabilities, income and
expenses set out in the Conceptual Framework are referenced in IAS 1, para. 15.
If you wish to explore this topic further, read paras 1524 of IAS 1 Presentation of Financial Statements.
Constraints on frameworks
The business and legal environments in which entities operate, and the social and political
environment within which standard setting occurs, may impose limitations on some of the
claimed benefits of a conceptual framework. Although a framework may establish principles,
itdoes not necessarily remove the need for professional judgment by accountants.
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For technical reasons, it may not always be possible to have conceptual consistency between
accounting standards, but inconsistency may also arise because of the need to take economic
constraints or consequences into consideration. The application of accounting standards can
have economic consequences that management and user groups consider disadvantageous.
For example, an accounting standard might prohibit the recognition of certain intangible
assets, or it might reduce the incidence of their recognition by requiring that very stringent
conditions be satisfied before such assets are recognised. Applying such an accounting standard
could reduce the reported profit of some entities and increase the volatility of the reported
profit of others. In turn, this could cause share prices of the affected entities to fall because
of investors perceptions that the risk of investing in such entities has increased. Moreover,
ifmanagers salaries are based (even in part) on share prices, their remuneration may decrease.
Economicconsequences of this kind may lead to accounting standard setters departing from
a conceptually pure approach outlined in a framework in order to satisfy interest groups who
claim that their interests would otherwise be adversely affected.
Other types of constraints include social and political constraints. These may arise because
professional accountants feel that their ability to exercise autonomy and judgment is constrained
by the Framework and related standards. Political constraints may arise as external regulators
seek to impose their own desires on how reporting is performed.
A final constraint is based on human resources and cost. A considerable amount of time and cost
is required to create and apply the framework, and it is necessary to work with a wide range of
stakeholders. Lack of funding and time is often a constraint in this regard.
Measurement of elements of
financialstatements
After it has been determined that an event has resulted in an item that meets the definition
of anelement of financial statements (item 1 of Figure 1.4) and that the recognition criteria
are satisfied (item 2 of Figure 1.4), the next decision is in relation to how the item should be
measured (item3of Figure 1.4).
In relation to assets and liabilities, there are two stages of the measurement decision:
1. how to measure the asset or liability at initial recognition; and
2. how to measure the asset or liability subsequent to initial recognition.
Changes in assets and liabilities affect the reported income, expenses and equity. Therefore,
themeasurement attributes chosen for assets and liabilities have clear implications for the
amount of income and expenses reported in financial statements.
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In accounting, the properties, or attributes, of elements of financial statementsas distinct

from the elements themselvesare measured. However, the distinction between measuring
the attributes of financial statement items and their definitions and recognition criteria is not
clear-cut. The probability that future economic benefits will flow to or from the entity is one
of the recognition criteria used in the Conceptual Framework. However, the probability of the
flow of future economic benefits may also affect the measurement of the elements of financial
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statements. For example, the uncertainty of the flow of future economic benefits is reflected in
the use of a risk-adjusted discount rate in calculating the present value (PV) of future cash flows.
Further, accounting measurement is problematic because various attributes of a particular

element can be measured in the same unit of measurement. For example, the value in use
ofan asset (an entity-specific value) or its value in exchange can be measured using the same
currencyunit.
Different bases can be adopted in measuring the same attribute. For example, the value in
exchange of an asset may be measured at market price or at net realisable value.
The Conceptual Framework merely defines measurement and identifies alternative measurement
bases, before concluding with a description of practice. It fails to provide concepts or principles
to guide the selection of appropriate measurement bases. However, accounting standards
may state the measurement basis for a specific event; for example, IAS 2 Inventory states the
measurement basis for inventory at cost or net realisable value, whichever is lower.
Cost-based and value-based measures used in the IFRSs

In broad terms, cost-based measures in relation to assets include measures of the cost incurred
by an entity to acquire an asset or an estimate of the cost that would be incurred in replacing
anasset. Whether historical cost or replacement cost, cost-based measures of assets are based
on entry prices. An entry price is the price paid to acquire an asset or received to assume a
liability (IFRS 13, para. 57).
In relation to a liability, cost-based measures include the proceeds received in exchange for
the obligation, such as the proceeds of an issue of debentures, or the amounts of cash or
cash equivalents expected to be paid to satisfy the liability in the normal course of business
(e.g.provision for annual leave).
Variations of cost-based measures may adjust the cost for amortisation, depreciation or
interestexpense, as well as for any accumulated impairment.
Value-based measures broadly include those measurement attributes that require some
form of valuation to be undertaken, such as fair value. In practice, the distinction between
cost-based and value-based measures may have more to do with semantics than with substance.
Forexample, to measure the cost of acquiring an asset, it is necessary to measure the fair value
of the purchase consideration. Figure 1.6 depicts the key cost-based and value-based measures
used in IASB pronouncements. The key characteristics of the measures applied in the IFRSs
arealso described.
Figure 1.6: Measurement bases specified under IASB pronouncements
Measurement bases under IASB pronouncements

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Cost based Value based
Cost/historical cost Fair value
Amortised cost Current cost
Fair value less cost of disposal
Net realisable value
Present value
(measurement technique) Realisable (settlement) value
Value in use
Cost/historical cost
The first cost-based measure shown in Figure 1.6 is cost/historical cost. The Conceptual
Framework uses the term historical cost to refer to the same concept described as cost
invarious IFRSs. The definition of historical cost in the Conceptual Framework (para. 4.55(a)) is:
the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire
them at the time of their acquisition.
This definition is similar to the definition of cost used in a number of IASB pronouncements
forexample IAS 16 Property, Plant and Equipment, para. 6:
The amount of cash or cash equivalents paid or the fair value of the other consideration given to
acquire an asset at the time of its acquisition or construction or, where applicable, the amount
attributed to that asset when initially recognised in accordance with the specific requirements of
other IFRSs.
However, the Conceptual Framework extends its use of the concept of historical cost to liabilities,
noting that under historical cost:
liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in
some circumstances (e.g. income taxes), at the amounts of cash or cash equivalents expected to be
paid to satisfy the liability in the normal course of business (para. 4.55(a)).
Paragraph 4.56 of the Conceptual Framework notes that historical cost is the measurement
basis most commonly adopted by entities in preparing their financial statements. Whilecost,
orhistorical cost, is often applied to many classes of assets, such as property, plantand
equipment and most intangible assets, other measurement bases are also in common use.
STUDY GUIDE | 45
Present practice is best described as a modified historical cost measurement system or

mixedmeasurement accounting model.
The following advantages have been claimed for the historical cost basis of accounting:
Easily understoodby users and preparers of financial statements.
Relevant to decision-makingas it is the value of the consideration given or received in
exchange for an asset or a liability.
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Reliablehistorical cost provides evidence for income based on actual transactions with
external parties.
Inexpensive to implementthe measurement of historical cost is linked to the occurrence
of transactions and is therefore readily available at little or no additional cost.
The following deficiencies have been attributed to the historical cost basis of accounting:
Limited relevance to decision-making
Historical cost is merely a historical record of the sacrifice, not a forward-looking measure.
Therefore, it has limited predictive value.
Historical cost results in the distortion of performance measurement caused by old costs
being associated with current revenues. Some critics argue that it is better to match the
benefit received against the cost expended to replace the asset.
Under historical cost, profits are recognised when realised (i.e. when a transaction occurs),
not when the prices or other values of assets and liabilities change. Therefore, profit can
be affected by the selective timing of the sale of assets.
Historical cost must be supplemented by additional rules that check to see whether the
amount is recoverable. This is necessary to ensure that the carrying amount of the asset
(i.e. the amount at which it is recognised in the statement of financial position) does not
exceed the future economic benefits that the entity expects to derive from the asset.
By contrast, market value reflects the markets assessment of the recoverable amount
ofanasset.
Historical cost does not satisfactorily deal with assets acquired for nil or
nominalconsideration.
Undermines the comparability of financial reports

Costs incurred at various points in time are aggregated as though they are equivalent in
economic terms.
In the case of self-constructed assets, the costs incurred depend on the efficiency of
theentity. For example, if two companies were building identical assets, the less efficient
of the two would incur the higher costs. Users may conclude that the company with the
higher cost base is superior to the company that incurred the lesser costs to construct
theasset.
Problems with reliability

There can be difficulties in objectively determining the historical cost when calculating
the fair value of the purchase consideration and other incidental costs.
Historical cost reflects, at a minimum, management expectations of the recoverability
ofan asset, rather than market expectations.
The historical cost of some items may have resulted from an arbitrary allocation of an
overall cost to assets, liabilities and expenses, for example, allocating overhead costs
across items of inventory. These allocations may be arbitrary and may undermine the
representational faithfulness of historical cost.
Question 1.7
The Sydney Harbour Bridge was officially opened on 19 March 1932. The total cost of the bridge
was approximately 6.25 million Australian pounds (AUD 13.5 million) and was eventually paid
off in 1988 (Sydney Online 2014).
Explain some of the limitations of using historical cost for the subsequent measurement of the
Sydney Harbour Bridge.
Amortised cost
The second cost-based measure depicted in Figure 1.6 is amortised cost. This is a measure
applied to certain financial assets and financial liabilities subsequent to initial recognition.
Amortised cost is defined in IFRS 9 Financial Instruments as:
the amount at which the financial asset or financial liability is measured at initial recognition minus
the principal repayments, plus or minus the cumulative amortisation using the effective interest
MODULE 1
method of any difference between that initial amount and the maturity amount, and, for financial
assets, adjusted for any loss allowance (IFRS 9, Appendix A).
Amortised cost is calculated using the effective interest method. This method uses the effective
interest rate to allocate interest income and interest expense over the effective life of a financial
asset or liability. The effective interest rate is the rate that discounts the estimated future cash
payments or receipts through the expected life of a financial asset or liability to the net carrying
amount of the financial asset or liability.
Example 1.1: Amortised cost

B Ltd issues a note payable with the following terms:
face amount (i.e. maturity value) of $100;
repayable at the end of Year 2; and
coupon interest at the rate of 10 per cent per period (year), which is payable at the end of each year.
The issuer of the note is obligated to pay $10 interest at the end of Year 1 (t1) and $110, being interest
and principal, at the end of Year 2 (t2). It is common for debt securities to be issued at an amount
other than face value.
The cash outflows are illustrated in Figure 1.7.
Figure 1.7: Cash outflows arising from issue of financial liability

$10 $110
($100 0.10) ($100 0.10 + $100)
t0 t1 t2
If the market expects a rate of return greater than 10 per cent for a debt security of equivalent risk,
the issuer will need to discount the issue price so that the holder effectively earns the expected rate
of return.
Example 1.2: Effective interest rate

Some of the facts from the previous example have been changed.
B Ltd issues a note payable with the following terms:

proceeds received on issue $96.62;
maturity value of $100;
repayable at the end of Year 2; and
coupon interest at the rate of 10 per cent per period (year), which is payable at the end of each year.
STUDY GUIDE | 47
The issuer of the note is still obligated to pay $10 interest at the end of Year 1 (t1) and $110, beinginterest
and principal, at the end of Year 2 (t2).
However, based on the consideration received, the market rate of interest (i.e. the effective interest
rate) demanded by purchasers of the debt security was 12 per cent. The effective interest rate is the
rate at which the PV of the contractual cash flows over the life of the debt security equals the initial
carrying amount of $96.62.
MODULE 1
The PV can be calculated by using PV tables available in many financial accounting, management
accounting and finance texts. PV tables provide discount factors for the calculation of the PV of $1
paid in n periods, for a given interest rate, r. For example, the discount factor for the PV of $1 paid one
period (one year) from now, given an interest rate of 12 per cent per period (p.a.), is 0.89286. ThePV
of $1 paid one year from now, assuming an interest rate of 12 per cent, is $0.89286.
The following table provides selected extracts from PV tables.
PV (discount) factors
Number of period (n) PV factor (r = 12%)
1. 0.89286
2. 0.79719
Based on the PV factors, the PV of the cash flows shown in this example, given an interest rate of
12per cent per annum, can be calculated as follows:
$
PV of $10 received at t1 = $10 0.89286 = 8.93
PV of $110, received at t2 = $110 0.79719 = 87.69
96.62
Alternatively, the tables for the PV of an annuity may be used. In this case, the cash flows are viewed
as two streams of cash flows: an annuity of $10 per annum for two years, payable in arrears; and a
payment of $100 at the end of two years. The discount factor to calculate the PV of an annuity for
two periods, given an interest rate of 12 per cent, is 1.69005. The PV of the cash flows shown in this
example, givenan interest rate of 12 per cent per annum, can then be calculated as follows.
$
PV of an annuity of $10 p.a. for two years = $10 1.69005 = 16.90
PV of $100, received at t2 = $100 0.79719 = 79.72
96.62
Example 1.3: Amortised cost at reporting date

Continuing to use the information from the previous examples, now consider amortised cost at
reporting date.
The note is carried by the issuer at amortised cost.
At t1, when discounted at the effective rate of interest, the PV of the remaining cash flows is $98.21
($110 / 1.12). The discounting procedure automatically takes into account any principal repayments
that have been made (at t1, no principal repayments have occurred in relation to the debt security) and
any cumulative amortisation of the initial discount on issue, as required by the definition of amortised
cost in IFRS 9 Financial Instruments.
This is illustrated by the calculation for the period ended t1 in the following table.
Amortisation schedule
Unamortised
Coupon Effective Discount discount Carrying
interest interest amortised balance amount
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Date (10%) (12%) $ $ $
t0 3.38(a) 96.62
t1 10.00(b) 11.59(c) 1.59(d) 1.79(e) 98.21(f)
t2 10.00(b) 11.79(g) 1.79(h) 100.00(i)
Total 20.00 23.38 3.38
(a) $100.00 $96.62 (f) $96.62 + $1.59 = $100.00 $1.79

(b) $100.00 0.10 (g) $98.21 0.12
(c) $96.62 0.12 (h) $11.79 $10.00
(d) $11.59 $10.00 (i) Before principal repayment
(e) $3.38 $1.59
At the date of issue, the PV of the debt security at a discount rate of 12 per cent was $96.62.
The unamortised discount at t0 was the difference between the maturity value of the debt, $100,
andthe issue price, $96.62, as shown in the first row in the amortisation schedule.
As shown in the second row in the amortisation schedule, the coupon interest of $10 was paid during
the period ended t1, but the effective interest expense on the amount of cash raised on issue of
the debt was $11.59 ($96.62 0.12). The difference between the effective interest, $11.59, and the
coupon interest, $10, was the amortised discount for the period, $1.59. The unamortised discount at
t1 was $1.79, which is the difference between the balance of the unamortised discount at t0 and the
discount that was amortised for the period ended t1. As there were no principal repayments until t2,
the amortised cost of the debt at t1 was $98.21 ($96.62 + $1.59).
Fair value
The first value-based measure shown in Figure 1.6 is fair value. This is defined in IFRS 13
FairValue Measurement as:
the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date (IFRS 13, para. 9).
A fair value measurement assumes that the asset or liability is exchanged in an orderly transaction
between market participants (IFRS 13, para. 15). The assumptions of an orderly transaction are
identified in IFRS 13 as follows:
A transaction that assumes exposure to the market for a period before the measurement
date to allow for marketing activities that are usual and customary for transactions involving
such assets or liabilities; it is not a forced transaction (e.g. a forced liquidation or distress sale)
(IFRS13,AppendixA).
The assumption of an orderly transaction is important for fair value. This enables fair value to
reflect an amount at which market participants would willingly exchange an item rather than
a liquidation or fire-sale price that might be achieved in a forced sale if the vendor were
financially distressed.
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Fair value can be considered in terms of an entry price or exit price. The IFRS 13 definition
of fair value is an exit pricethe price that would be received to sell an asset or paid to
transfer a liability. (IFRS 13, Appendix A). This can be compared to an entry price, which is the
pricepaid to acquire an asset or received to assume a liability in an exchange transaction.
(IFRS13,AppendixA).
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IFRS 13 does not prescribe the use of fair value. Rather, it establishes a hierarchy for the
measurement of fair value when another standard prescribes or permits its use. The hierarchy
ranks the inputs to valuation techniques based on their verifiability so as to enhance comparability
and consistency. The highest rank (Level 1) is given to inputs that reflect quoted market prices
for identical assets or liabilities, and the lowest rank (Level 3) is assigned to inputs that cannot be
observed in a market.
These levels are described as:

Level 1 inputs: quoted price for an identical asset or liabilityThese inputs reflect
quoted prices for identical assets or liabilities in active markets. For example, if a blue chip
ordinary share is valued, the stock exchange price for the share is a Level 1 input. Note that
the effective implementation of this level requires careful consideration of the definition of
activemarkets.
Level 2 inputs: model with no significant unobservable inputsWhere Level 1 inputs are
not available, fair value is estimated using a model with no significant unobservable inputs.
For example, the entity may use quoted market prices for comparable assets, liabilities or
equity instruments in active markets. Other examples include option valuation models or
PVtechniques.
Level 3 inputs: model with significant unobservable inputsWhen quoted prices and
other observable inputs are not available, the entity uses inputs that are developed on the
basis of the best information available about the assumptions that market participants would
use when pricing the asset or liability. For example, unobservable inputs into a valuation
model for residential mortgage-backed securities include prepayment rates, probability of
default and the severity of loss.
Fair value is considered by many to be more relevant than cost-based measures. However,
fairvalue has been criticised for reasons such as:
Lack of relevance to decision-makingin relation to assets that the entity does not intend
to sell, such as financial instruments that the entity intends to hold to maturity; and
Reliability problemsin relation to measuring the fair value of assets that are not traded
inan active market.
Question 1.8
Stanley Ltd holds a parcel of Alpha B redeemable 7 per cent cumulative preference shares issued by
Alpha Ltd. The Alpha B preference shares are unlisted. Stanley Ltds financial accountant measured
the value of the shares using the market price of Alpha A preference shares, whichare listed,
redeemable, cumulative 5 per cent preference shares, issued by Alpha Ltd. The Alpha A preference
shares have a very similar maturity date to the Alpha B preference shares. The accountant
determined the yield of the Alpha A preference shares by reference to the quoted price and to
the timing and amount of the contractual cash flows. The accountant then applied the same yield
in a discounted cash flow model, using the contractual cash flows of Alpha B preference shares.
Which input level has the accountant used to measure the fair value of the Alpha B preference
shares? Give reasons for your answer.
Current cost
Current cost is the second value-based measure shown in Figure 1.6. The current cost of
anasset is the amount of cash or cash equivalents that would have to be paid if the same or
anequivalent asset were acquired currently (Conceptual Framework, para. 4.55(b)). The current
cost of a liability refers to the undiscounted amount of cash or cash equivalents that would
berequired to settle the obligation currently (Conceptual Framework, para. 4.55(b)).
MODULE 1
In relation to assets, the definition implies that there are two concepts of current cost:
1. reproduction costcurrent cost of replacing an existing asset with an identical one; or
2. replacement costcurrent cost of replacing an existing asset with an asset of equivalent
productive capacity or service potential.
The current cost of replacing or reproducing an asset is commonly interpreted as the most
economic cost to replace the asset (IASB 2005, p. 97). Therefore, reproduction or replacement
cost may differ from historical cost where an entity could, through efficiencies, reproduce or
replace the service potential of an asset for an amount that differs from the fair value of the
purchase consideration given to acquire the asset.
Current cost (more specifically, current replacement cost) is an example of an entry price
valuation technique.
In some instances, reproduction of an existing asset, such as a brand name, may not be feasible
because of its uniqueness. Difficulties may also arise with replacing an asset with one that
provides equivalent capacity because advances in technology may mean that any available
replacement asset would increase capacity. For example, it would be difficult to replace a
computer without increasing capacity or service potential because of the rapid advances in
computer technology.
Current cost has been criticised on a number of grounds, including the following:
Lack of relevance to decision-making

Current cost is not a measure of the value received but of the amount of the sacrifice that
would be required to replace an asset, and therefore, it has limited predictive value.
Financial information based on current cost is difficult to interpret where an entity does
not intend to replace its assets.
Current costs applicability to non-renewable or irreplaceable assets such as oil and gas
reserves is questionable.
Current cost is not an independent measurement attribute. It must be supplemented by
additional rules to ensure that the amount represented by current cost is recoverable.
Reliability problems
Reliability may be reduced by the need to identify assets of equivalent productive
capacity or service potential and by measuring their most economic current cost.
There may be uncertainty about the reliability of measurement because replacement
costis an entity-specific measure that depends on managements strategies and
intentions about the level of capacity at which the asset is used.
Comparability problems
Management strategies and expectations with respect to the assets concerned
(e.g. nature of the use of a building and whether it is fully occupied) may change
inresponseto changes in the business environment or over time.
There may be significant differences between entities in the determination
ofcurrentcost.
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Question 1.9
Refer back to Question 1.7 regarding the Sydney Harbour Bridge. How might using an alternative
measure, such as current cost, overcome the limitations of cost outlined in that question?
Fair value less costs of disposal
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The third value-based measure, Fair value less costs of disposal, is a variant of fair value.
Costs of disposal are the incremental costs directly attributable to the disposal of an asset
or cash-generating unit, excluding finance costs and income tax expenses (IAS 36, para. 6).
Finance costs and income tax are similarly excluded from the measurement of costs to sell by
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations (Appendix A). Fair value
less costs of disposal is used in IAS 36, which defines the recoverable amount of an asset or
cash-generating unit as the higher of its fair value less costs of disposal and its value in use
(IAS36, para. 6).
Net realisable value

The fourth value-based measure shown in Figure 1.6 is net realisable value. This approach
measures the economic benefits that an entity expects to derive from selling an asset in the
ordinary course of business. The use of net realisable value in financial reporting is largely
restricted to its role in measuring inventories at the lower of cost and net realisable value,
inaccordance with IAS 2 Inventories. Net realisable value is:
the estimated selling price in the ordinary course of business less the estimated costs of completion
and the estimated costs necessary to make the sale (IAS 2, para. 6).
Applied to inventory, net realisable value is a measure of the net amount that the entity expects
to derive from the sale of the asset in the ordinary course of business.
Net realisable value differs from fair value less costs to sell, which measures the amount that
could be obtained from selling the asset in its current state. Net realisable value measures the
benefits that the entity expects to realise from the asset in the ordinary course of business.
Ifthe inventory is in a complete state, the difference is a matter of semantics. However, work-in-
progress inventory would be completed before being sold in the ordinary course of business.
Accordingly, the net realisable value of work-in-progress inventory usually differs from its fair
value less costs to sell.
Net realisable value may also reflect entity-specific expectations regarding the estimated selling
price in the ordinary course of business, the estimated cost of completion and costs necessary to
make the sale. These expectations may not be in accordance with market expectations on which
fair value would generally be based. For example, a second-hand car dealer may sell a specific
model of car for $10 000 in the normal course of business. Hence, the net realisable value of
the car to the dealer is $10 000. The same car is available for sale on second-hand car websites
for $8000, without selling costs, through private sales, which may be used as an indicator of fair
value. Therefore, if the second-hand car belongs to an entity whose main business is not to sell
cars, the entity may consider the fair value of the car as $8000. In this case, the fair value is$8000,
and the net realisable value is $10 000.
A criticism of the net realisable value basis of measurement is that the netting of costs to
complete the asset and make a sale against the estimated selling price can result in recognising
liabilities for future costs for which there is no present obligation. Such a practice would be
inconsistent with the definition of liabilities in the Conceptual Framework. It should be noted
that this problem does not arise in the measurement of inventory at the lower of cost and net
realisable value, where the effect of measurement at net realisable value involves decreasing,
rather than increasing, the carrying amount of inventory.
For example, assume an entity manufactures fence posts at a cost of $5 per post. The entity was
initially expecting to sell each fence post for $8, making a pre-tax profit of $3. However, due to
a downturn in the fencing industry, the entity has reliable evidence that the fence posts will now
only be sold for $4 each. The entity is required to write the inventory down to its net realisable
value of $4 per post, with $1 for each post being recognised as an expense in the profit or loss
inaccordance with IAS 2 Inventories.
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Realisable (settlement) value

Realisable (settlement) value, depicted in Figure 1.6, is a value-based measurement that is
defined in the Conceptual Framework:
Assets are carried at the amount of cash or cash equivalents that could currently be obtained by
selling the asset in an orderly disposal. Liabilities are carried at their settlement values; that is,
theundiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities
in the normal course of business (para. 4.55(c)).
The Conceptual Framework refers to a measurement concept that can be applied to both
assetsand liabilities. As several variations of realisable value (including fair value less costs to
selland net realisable value) have already been considered for assets, the discussion of realisable
(settlement) value will emphasise the application of this concept to liabilities.
The definition of settlement value used in the Conceptual Framework differs from the concept of
the fair value of a liability used by the IASB in IFRS 13 Fair Value Measurement. The fair value of a
liability is the amount that would be paid to transfer a liability in an orderly transaction between
market participants at the measurement date. In contrast, the settlement value refers to the
amount that would be paid to settle the liability with the counterparty.
The price paid to transfer a liability represents a market-based fair value measurement of
the liability because it is independent of entity-specific considerations. The settlement value
embodies entity-specific considerations, including whether the entity should settle the liability
using its own internal resources and the efficiency with which an entity can settle a liability
(whichdepends on the advantages and disadvantages that a particular entity has relative to
themarket).
Value in use
The final value-based measure shown in Figure 1.6 is value in use. This measure is defined in
IAS 36 (para. 6) as the present value of future cash flows expected to be derived from an asset
or cash-generating unit. Value in use is also frequently referred to as the entity-specific value.
Thevalue in use should reflect the estimated future cash flows that the entity expects to derive
from the asset (IAS 36, para. 30(a)). However, other elements of the value-in-use computation
may reflect market expectations rather than the entitys expectations. For example, the discount
rate that is applied to the expected cash flows must reflect the current market assessment of the
time value of money and the risks specific to the asset for which the future cash flow estimates
have not been adjusted (IAS 36, para. 55).
The entity-specific value-in-use measurement basis has the following advantages:

management is in the best position to judge the expected amount, timing and risk of future
cash flows. Accordingly, financial statements are considered to be more relevant and reliable
where they reflect management intentions and expectations; and
management would be held more accountable against measurements that reflect entity-
specific management objectives.
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The criticisms of the value-in-use basis of measurement include:
Reliability problems
Because value in use is normally calculated as the discounted net proceeds from the use
of an asset, it is specific to each entity and to each specific use. It therefore relates to only
one specific future course of action or combination of actions.
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Value in use is subjective and is not capable of being independently verified by others.
The application of value in use to assets that do not generate contractual cash flows
isproblematic.
An individual asset may work with other assets to generate cash flows. This results in the
need to allocate expected cash flows across assets. These allocations may be arbitrary.
Understandability. The lack of clarity regarding whether value in use should reflect
management or market expectations.
Valuation techniques
The Conceptual Framework describes present value in the following terms:
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 (para. 4.55(d)).
Figure 1.6 shows present value separately, as it is not a measurement basis; rather, it is a
measurement technique that underpins other measurement bases. For example, amortised
costand value in use rely on present value calculations. Similarly, IFRS 13 Level 2 or Level 3 fair
values may be determined based on a present value technique (IFRS 13, para. 74). The IFRSs
require the use of appropriate valuation techniques. For example, IFRS 13, para. 61, states:
An entity shall use valuation techniques that are appropriate in the circumstances and for which
sufficient data are available to measure fair value, maximising the use of relevant observable inputs
and minimising the use of unobservable inputs.
Issues that arise in the application of the valuation techniques include:

the uncertainty of future cash flows; and
the selection of an appropriate discount rate.
Uncertainty of future cash flows

The reliable measurement of the PV of individual assets and liabilities is problematic because
future cash flows often occur under conditions of uncertainty. Even for contractual amounts,
future cash flows may differ from those originally expected.
IAS 37 Provisions, Contingent Liabilities and Contingent Assets requires that the amount
recognised as a provision must be the best estimate of the expenditure required to settle
the present obligation at the end of the reporting period (para. 36). This is often expressed
as the amount required to settle the obligation immediately or to transfer it to a third party.
Wherethe effect of the time value of money is material, the provision is measured as the PV
of the expenditures expected to be required to settle the obligation (para. 45). The role of
uncertain future events must be taken into account where there is sufficient objective evidence
that they will occur (para. 48). This must be based on reasonable and supportable assumptions.
Forexample, where there is sufficient objective evidence that imminent changes in technology
will reduce the cost of settling obligations arising from a product warranty, such changes are
taken into account in measuring the provision.
A further difficulty can arise in determining the appropriate level of aggregation of cash flows.
The need to allocate cash flows to particular items when those cash flows are produced by the
interaction of more than one factor of production may introduce additional subjectivity into
PVcalculations. For example, IAS 36 Impairment of Assets contains requirements and guidance for
the measurement of value in use when assessing the recoverable amount of an asset. Whenitis
not possible to determine the recoverable amount of an individual asset, IAS36(para.66)
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requires the entity to determine the recoverable amount for the cash-generating unit to which
theassetbelongs.
Selection of appropriate discount rates

Another complexity in the application of valuation techniques is the need to select an appropriate
discount rate. PV may be sensitive to the rate chosen for the purpose of discounting future
amounts to a PV.
According to contemporary finance theory, investors require a rate of return that is commensurate
with the systematic risk of an investment, irrespective of whether the investment is in a financial
asset or a project involving non-monetary assets. Therefore, for the purpose of project evaluation,
managers should use a current, market-determined, risk-adjusted discount rate that reflects the
systematic risk of the asset, or group of assets, concerned.
The total risk of an asset comprises systematic risk and unsystematic risk. Systematic risk is
sometimes referred to as market risk or non-diversifiable risk. Systematic risk relates to the
extentthat the variability of the return earned on an asset, or group of assets, is due to economy-
wide factors affecting all assets. It can be contrasted with unsystematic risk, the risk that is
specific to a particular asset due to that assets unique features. Investors can drive asset-specific
(unsystematic) risk towards zero by holding a diversified portfolio of assets. However, systematic
risk cannot be eliminated in this manner. Because investors can eliminate unsystematic risk,
equilibrium returns reflect only the risk-free rate plus a return for bearing systematic risk in
excessof the risk-free rate.
It is important to note that this conclusion emerges from the investors capacity to diversify,
eitherdirectly or via a mutual fund. It is unrelated to a producing entitys capacity, or lack
of capacity, to diversify its investment projects. As investors can diversify their investments,
diversification or lack thereof by a producer does not add or reduce value for investors.
Investorswill not pay any more than the price associated with the return required to
compensatefor systematic risk. Thismeans that producing entities should accept a project
that has a positivenet present value when the cash flows are discounted at a rate adjusted
for the systematic risk of the project. That is, each project has its own discount rate adjusted
forsystematic risk.
There is a preference in accounting pronouncements for using discount rates that are risk-
adjusted when measuring the present values. For example, IAS 19 Employee Benefits states:
The rate used to discount post-employment benefit obligations (both funded and unfunded) shall
be determined by reference to market yields at the end of the reporting period on high quality
corporate bonds. For currencies for which there is no deep market in such high quality corporate
bonds, the market yields (at the end of the reporting period) on government bonds denominated
in that currency shall be used. The currency and term of the corporate bonds or government
bonds shall be consistent with the currency and estimated term of the post-employment benefit
obligations (IFRS 19, para. 83).
Another issue is whether to use a current market rate (whether risk-free or risk-adjusted)
orthe historical interest rate implicit in the original transaction. Historical and current rates
arenowconsidered.
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Historical rates
In the context of a historical cost system, the historical interest rate implicit in the original
contract is usually considered to be the rate at which the cash flows specified in the contract are
to be discounted. At the date of issuing a financial instrument, the discount rate implicit in the
original contract is the effective rate demanded by lenders. Where a financial instrument is traded
in an active market, the discount rate implicit in the original contract is a market-determined,
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risk-adjusted discount rate, current at the date of issue of the financial instrument.
Pronouncements that require the use of historical rates include IFRS 9 Financial Instruments.
Certain financial liabilities and assets are carried at amortised cost, using the effective-interest-
rate method (IFRS 9, paras 4.1.1 and 4.2.1).
IFRS 16 Leases requires lease liabilities and receivables to be recognised initially by lessees and
lessors, respectively, by discounting the relevant cash flows to present values using the interest
rate implicit in the lease.
Current rates
Current rates are based on a discount rate that is current at the end of the reporting period.
Current rates may be adjusted for risks (unless risks are otherwise adjusted for in the estimated
cash flows) and may be market-determined. The use of current market based, risk-adjusted rates
in determining PV is more consistent with a fair value approach to measurement, because it
reflects the rate that the market would use to discount the expected future cash flows.
Examples of pronouncements that specify the use of current rates include:

IAS 19 Employee Benefits. The standard adopts the position that employer obligations
arising from defined benefit plans and other long-term employee benefits, such as long
service leave (LSL), are measured at their present values at the end of the reporting period.
The rate used to discount such obligations is determined by reference to market yields on
high-quality corporate bonds with equivalent terms and currency at the end of the reporting
period (para. 83).
IAS 37 Provisions, Contingent Liabilities and Contingent Assets. The standard requires
provisions to be measured at present value using a pre-tax rate (or rates) that reflect(s)
current market assessments of the time value of money and the risks specific to the liability
(para. 47).
IAS 36 Impairment of Assets requires that the discount rate used in determining value in use
be a pre-tax rate that reflects current market assessments of the time value of money and the
risks specific to the asset for which the future cash flows have not been adjusted (para. 55).
Application of measurement principles in

theIFRSs
Mixed measurement models are adopted in various forms with a focus on different measures
and applications to provide accounting policy choice and, in some instances, to determine the
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required measurement basis. Where there is accounting policy choice, accountants have the
ability to exercise judgment according to the circumstances. At the same time, some degree of
comparability in measurement is maintained through the IFRSs.
Accounting standards provide the practical mechanism for achieving the overall objectives of
financial reporting, as well as outlining how best to achieve as many qualitative characteristics
aspossible. By specifying how accounting information should be treated and reported,
differentorganisations can gain considerably more consistency and understandability than
would be achieved if they used their own judgment when reporting their financial affairs. It also
limits the scope for abuse and misreporting that may arise when the economic self-interest of
organisations or their managers interferes with objective reporting.
Accounting standards go beyond specifying how items must be reported; they provide detailed
discussion of why the mandated approaches are required.
This section will take a closer look at the mixed measurement model applied in the IFRSs.
Thisdiscussion will focus on the following selected IFRSs:
IAS 19 Employee Benefits;
IFRS 2 Share-based Payment; and
IAS 40 Investment Property.
These issues have been selected because of their commercial relevance and their common
application in financial statements. The following discussion will also explain and highlight how
different the application of measurement principles can be.
Employee benefits
The principles for accounting for employee benefits are prescribed in IAS 19 Employee Benefits.
The standard defines employee benefits as all forms of consideration given by an entity in
exchange for service rendered by employees or for the termination of employment (IAS 19,
para.8).
Short-term employee benefits

Short-term employee benefits are defined as:
employee benefits (other than termination benefits) that are expected to be settled wholly before
12 months after the end of the annual reporting period in which the employees render the related
service (IAS 19, para. 8).
Examples of short-term employee benefits include: wages and salaries; non-monetary benefits;
and short-term compensated absences such as annual leave and sick leave (IAS 19, para. 9).
The liability for short-term benefits should be measured at the undiscounted amount expected
to be paid on settlement of the obligation. Recognition of the liability will usually give rise to
a corresponding expense, although in some circumstances it may be included in the carrying
amount of an asset such as plant and equipment or inventory.
If you wish to explore this topic further, read paras 911 of IAS 19.
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Employees may be entitled to compensation for absences for a variety of reasons, including
annual leave, sick leave and LSL. In accordance with para. 11 of IAS 19, short-term compensated
absences must be recognised at the undiscounted amount of employee benefit that the entity
expects to pay for the employees services. Compensated absences that are expected to
be settled beyond 12 months after the end of the reporting period are measured using the
PVtechnique (IAS 19, paras 1535).
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When compensated absences are considered, it is important to distinguish between:
accumulating and non-accumulating benefits; and
vesting and non-vesting benefits.
An accumulating compensated absence arises where the employees can carry forward their
entitlements to future periods. If the compensated absence does not accumulate, the benefit
isrestricted to a particular year.
An accumulating compensated absence may be vesting or non-vesting. A vesting benefit arises

when the employer has an obligation to make a payment to the employee for the benefit that
is not conditional on future employment (IAS 19, para. 15). That is, the employer is obligated
to settle a vesting benefit, even if the employee resigns or their employment is terminated.
Forvesting compensated absences, the employee will be paid either when the leave is taken or
on termination of employment.
If a compensated absence is non-accumulating, the cost of providing the benefit should not be
recognised until the absence occurs (IAS 19, para. 13(b)). A liability is not recognised before leave
is taken because the employees service does not increase the amount of the leave benefit and
benefits lapse as each year ends (IAS 19, para. 18).
When a compensated absence is accumulating and vesting, a liability for accumulated

compensated absences is recognised, as employees render services that increase their
entitlement to future compensation (IAS 19, para. 13(a)). In accordance with IAS 19, the nominal
approach must be used for accumulated unused compensated absence benefits that the entity
expects to settle within 12 months after the reporting period (paras 1116).
For compensated absences that are accumulating but non-vesting, the employee is only
compensated for absences (e.g. in Australia this is usually the case with sick leave). Ontermination
of employment, the employee is not compensated for any unused entitlement. Despite this,
itcan be argued that the definition of a liability is satisfied for unused benefits. Thatis, there has
been a past event (rendering services) that results in an obligation for accumulating, non-vesting
compensated absences to be carried forward as part of the employees benefits. However,
whether a liability for an accumulating, non-vesting compensated absence is recognised
depends on the probability that a payment will be made. For this reason, IAS 19 specifies that
entitiesshould:
measure the expected cost of accumulating paid absences as the additional amount that the
entity expects to pay as a result of the unused entitlement that has accumulated at the end of the
reporting period (para. 16).
A liability for non-vesting compensated absences should be recognised only for that part of
the accumulated entitlement that is expected to result in additional payments to employees.
The probability that the leave will be taken affects the decision to recognise the liability and
theamount of the liability, if any, that is recognised.
If you wish to explore this topic further, read paras 911 of IAS 19, noting in particular the
ExampleIllustrating Paragraphs 16 and 17.
Question 1.10
An entity has 500 employees who are provided with 10 days sick leave for each year of service
on a non-vesting accumulating basis. At 30 June 20X6, 20 per cent of employees had taken their
full entitlement of sick leave. The remaining employees had an average of 12 days accumulated
leave. Past experience indicates that:
20 per cent of employees use all of their sick leave in the year in which they become entitled
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to it and therefore have no accumulated sick leave at the end of the year;
50 per cent of the entitys employees use six days of accumulated sick leave in years
subsequent to their accumulation; and
30 per cent of employees take two days of accumulated sick leave in years subsequent to
their accumulation.
Assume that the average annual salary per employee is $40 000 and that employees have a
five-day working week.
(a) Measure the nominal amount of the provision for sick leave as at 30 June 20X6 in accordance
with IAS 19.
(b) Explain whether it is important to know the timing of the payments to employees for
accumulated sick leave in future reporting periods.
Long-term employee benefits

As a result of providing services during a particular reporting period, employees may receive
benefits several years later. These benefits may be settled:
while the employee is still employed or upon resignation (e.g. LSL); or
subsequent to the employees employment (e.g. superannuation benefits and other
post-employment benefits).
This module focuses on LSL to illustrate the application of measurement principles and
techniques to long-term employee benefits.
LSL
In some countries, including Australia, LSL is another entitlement that accrues to employees as
they provide services to an entity. This entitlement accrues with years of service. Under some
industrial laws and employment contracts, employees are legally entitled to be paid LSL after
a certain number of years service have been completed (10 years is a typical benchmark).
LSLshould be recognised as a liability, once the definition of liability has been satisfied.
In the past, some entities only recognised a liability or expense for LSL when employees became
legally entitled to LSLthat is, when the leave became vested. In effect, employees who were
not legally entitled were excluded in measuring the liability. However, consistent with the
Conceptual Frameworks broader definition of a liability, IAS 19 is based on the view that the
definition of a liability or expense is satisfied as soon as employees provide services that result
inLSL entitlements. This is so, irrespective of whether the employee is legally entitled to LSL.
LSL benefits are paid in reporting periods after the employees provision of services, oftenmany
years into the future. Paragraph 155 of IAS 19 requires the amount of the liability for such
long-term employee benefits to be measured on a net basis as the PV of the obligation at the
reporting date (see paras 5698) minus the fair value at the reporting date of plan assets (if any)
out of which the obligations are to be settled directly (see paras 11319).
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Entities estimate the number of employees who may become eligible for LSL, as well as the
timing and amount of the payment. Projected salary levels (e.g. inflation, salary increase and
promotions) need to be factored into the calculation. The estimated LSL payment is discounted
to its PV at the reporting date.
In Australia, it would be rare for entities to hold assets in a long-term employee benefit fund
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to satisfy LSL obligations. Therefore, this module focuses on the determination of the PV of
theobligation.
If you wish to explore this topic further, read paras 5669 of IAS 19, which describe and provide
examples of the Projected Unit Credit Method used to measure long-term employee benefits.
In essence, the Projected Unit Credit Method determines the accumulated entitlement for service
on the basis of the ratio of the period of service completed up to the reporting date, tothe
periods of service required to accumulate the total entitlement. For example, if an employee has
served eight of the 10 years required for entitlement to LSL, the accumulated entitlement would
be 80 per cent of the total under the Projected Unit Credit Method.
Determination of the timing and amount of future cash flows requires professional judgment and
is often based on actuarial assessment.
Many employees of an entity will have an insufficient length of service to be legally entitled to an
LSL payment at the reporting date. Nevertheless, a proportion of employees in this category will
eventually qualify for LSL. As a result, a probability assessment must be undertaken to estimate
the number of employees currently in this situation who will eventually be paid for LSL. IAS 19
provides no guidance on this matter, leaving it to the preparers judgment.
Once the number of employees who will be paid LSL has been determined, the next task is to
determine the timing and amount of the payments that will result from services provided up to
the reporting date. To determine the future cash flows associated with LSL benefits, projected
annual salary levels must be estimated. The estimation of projected salaries is affected by
the expected timing of payment of LSL and involves consideration of factors such as inflation
andpromotions.
The estimated future LSL payments must be discounted to PV at the reporting date. The interest
rate used will have a significant effect on the measurement of an employers obligation for LSL.
This objective is reflected in the IAS 19 Employee Benefits requirement that the discount rate
used to measure LSL liabilities should be determined by reference to current market yields on
high-quality corporate bonds. In currencies with no deep market for high-quality corporate
bonds, the interest rates attaching to government bonds must be used (IAS 19, para. 83).
Itshould be noted that entities operating in different countries will have to select discount
ratesappropriate to the country in which the employee will be paid.
Question 1.11
At 30 June 20X7, Maynot Ltd has 100 employees. For simplicity, assume that the employees
have the following periods of service:
Years of service Number of employees
2 10
4 40
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8 30
10 10
15 10
100
The employees of Maynot Ltd are employed under an award that provides for LSL on the
basis of 90 calendar days after 13 years of service and nine days per year of service thereafter.
After 10years of service, employees are entitled to a pro rata payment if they resign or their
employment is terminated.
Outline the steps that you would need to take and the factors that you would need to consider
in determining Maynot Ltds liability for LSL.
Example 1.4 builds on the data in Question 1.11.
Example 1.4: Probability of entitlement to LSL

The following estimates of the likelihood that employees of Maynot Ltd will eventually take leave have
been determined by an actuary:
Probability that an employee

Years of will become entitled to
service LSL payments
1 0.20
2 0.20
3 0.25
4 0.40
5 0.40
6 0.70
7 0.75
8 0.90
9 0.95
10 1.00
As would be expected, the closer the employee is to completing the pre-entitlement period, thehigher
is the probability of payment. From the above calculations, it has been estimated that there is a
70percent probability that an employee with six years of service will be employed for 10 or more
years and will therefore become entitled to LSL. After nine years of service, it is estimated that there
is a 95 per cent probability that the employee will become entitled.
Based on the preceding probabilities, it can be estimated that, as at 30 June 20X7, the following
number of employees will eventually be eligible for LSL:
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Estimated number of
Years of Number of employees who will
service employees Probability become entitled to LSL
2 10 0.2 2
4 40 0.4 16
8 30 0.9 27
10 10 1.0 10
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15 10 1.0 10
100 65
Note: Only the probabilities applicable to the current employees are used.
The next task is to determine the future payments for services performed up to the end of the reporting
period that will be made to the 65 employees who, it is estimated, will receive LSL pay. Thisamount will
depend on projected future wages and salaries, as well as experience with employee departures and
periods of service. It is also necessary to make assumptions about when the leave will be taken, so that
the time to settlement can be taken into account in measuring the PV of the obligation. Employees do
not necessarily take LSL as soon as they become unconditionally entitled to do so. Some employees
may be paid LSL before they become fully entitled where the employment contract or legal environment
allows for leave to be paid on a pro rata basis if they resign or if the employment is terminated. Again,
experience with leave patterns will be a factor in estimating when LSL obligations will be settled.
Assume that the actuary has estimated that the employees who will become entitled to LSL will be
paid the following amounts in the following periods:
Years from Number of Amount expected

30 June 20X7 employees to be paid $
2 15 120 000
5 20 200 000
10 20 300 000
15 10 200 000
65 820 000
The final issue is to determine appropriate discount rates to measure the above payments at their PV.
This would involve selecting high-quality corporate bond rates with terms to maturity that match the
terms of the estimated cash payments. Again, for illustrative purposes, the following measurements
could have been made for Maynot Ltd:
Years from Discount Amount expected Present Present

30 June 20X7 rate to be paid $ value factor value $
2 0.08 120 000 0.85734 102 881
5 0.09 200 000 0.64993 129 986
10 0.10 300 000 0.38554 115 662
15 0.10 200 000 0.23939 47 878
820 000 396 407
These discount rates are illustrative market yields on high-quality corporate bonds for the appropriate term.
The PV factor is determined by using the discount rate indicated and the number of years to the payment.
This can be found in PV tables or calculated using the following formula: 1 / (1 + r)n, where r is the interest
rate and n is the number of periods to settlement.
Therefore, Maynot Ltd would recognise a liability for LSL of $396 407 as at 30 June 20X7.
Note: The liability for LSL includes amounts expected to be paid to employees who are not
yet entitled to LSL. Whether the obligation is settled and the amount payable is actually paid
depend on uncertain future events, including whether employees will continue in employment
for a sufficient period to become eligible for LSL. The estimation of future cash flows also
requires estimation of projected salary levels. The timing of the settlement may affect the level
ofprojected salaries, as well as the relevant discount factor because the liability is measured
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using PV techniques. This further illustrates some of the difficulties with PV techniques.
Accounting for share-based payments

Share-based payments provide an interesting illustration of the difficulty of fair value
measurement and its implications. Accounting for share-based payments falls within the scope
ofIFRS 2 Share-based Payment.
A share-based payment transaction is:

a transaction in which the entity
(a) receives goods or services from the supplier of those goods or services (including an
employee) in a share-based payment arrangement, or
(b) incurs an obligation to settle the transaction with the supplier in a share-based payment
arrangement when another group entity receives those goods or services (IFRS 2,
AppendixA).
Thus, a transaction may be a share-based transaction even though there is no exchange of the
entitys equity instruments. Share-based payment transactions may be cash-settled or equity-
settled. In a cash-settled share-based payment transaction, the entity acquires goods or services
by incurring a liability to transfer cash or other assets, the amount of which is based on the price
of the entitys equity instruments (IFRS 2, Appendix A). For example, an entity might agree to
paya cash bonus for employees services of 100 times the companys share price.
In an equity-settled share-based payment transaction, the entity acquires goods or services

as consideration for its own equity instruments, or it receives goods or services but has no
obligation to settle the transaction with the supplier (IFRS 2, Appendix A). Examples include
employee shares and executive stock options.
Goods or services acquired in a share-based payment transaction are recognised when the
goods or services are received (IFRS 2, para. 7). For an equity-settled share-based payment
transaction, a corresponding increase in equity is recognised. For a cash-settled share-based
payment transaction, a corresponding increase in liabilities is recognised.
If you wish to explore this topic further, read paras 79 of IFRS 2. The definitions of terms used
inthestandard are provided in IFRS 2, Appendix A.
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Example 1.5: Performance bonuses

Great Futures Ltd introduced performance-based remuneration for its senior executives as an incentive
to encourage and reward management performance and to align the interests of managers with those
of the shareholders. Subject to performance hurdles, including a return on equity of 10 per cent,
employees in the incentive scheme receive a bonus. Bonuses are payable three months after the end
of the reporting period.
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For the year ended 30 June 20X9, performance hurdles were met by several executives.
The bonus payable to the chief executive officer (CEO) was determined as 100 ordinary shares,
whichvested immediately. The bonuses payable to other executives were settled in cash, with the
amount determined as 10 times the companys average share price from 1 June 20X9 to 31 August 20X9.
The pro forma entry for the CEOs bonus at 30 June 20X9 was:
Dr Bonus expense XXX

Cr Equity XXX
The equity-settled share-based payment transaction resulted in an increase in expenses and a

corresponding increase in equity being recognised when the employee service was received.
The pro forma entry for the other executives bonuses at 30 June 20X9 was:
Dr Bonus expense XXX

Cr Liability XXX
The cash-settled share-based payment transaction resulted in an increase in expenses and a

corresponding increase in liabilities being recognised when the employee service was received.
Measurement of share-based payment transactions

Share-based payment transactions are measured as follows:
Equity-settled
Measure the goods or services received and the corresponding increase in equity at the
fair value of the goods or services received, provided that the fair value can be estimated
reliably. This is referred to as directly measuring the goods and services.
In some cases, the fair value of the goods or services received cannot be estimated
reliably, such as for transactions with employees and others providing similar services.
Under these circumstances, the fair value of the goods or services and the corresponding
increase in equity are measured indirectly, with reference to the fair value of the equity
instruments granted.
Cash-settled
Measure the goods or services received and the liability incurred at the fair value of
theliability.
Until the liability is settled, it may be re-measured at the end of each reporting period
and upon settlement, with changes in the fair value of the liability recognised in profit
orloss.
In the case of equity-settled share-based payment transactions, the fair value of the goods or
services acquired drives the measurement of equity, consistent with equity being the residual
element in the statement of financial position (and the accounting equation Assets Liabilities =
Equity). However, if the fair value of the goods or services acquired cannot be measured reliably,
IFRS 2 departs from this approach and requires indirect measurement based on the fair value of
the equity instruments. IFRS 2 reflects the qualitative characteristic of representative faithfulness
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and the recognition criteria for elements of financial statements in the measurement of assets
and expenses arising from share-based payment transactions.
If you wish to explore this topic further, read paras 1013A and 303 of IFRS 2.
Investment property
Investment property applies a mixed measurement model based on the purpose and nature
of the asset. Both measurement bases applied in IAS 40 Investment Property provide valuable
information based on the different fundamental qualitative characteristics. For example, the cost
model provides faithful representation but would, arguably, be less relevant in future reporting
periods. The fair value model provides the reverse relationship. This points to the difficulty of
measuring assets for the purpose of providing useful financial information.
Investment property is defined in IAS 40, para. 5, as:

property (land or a buildingor part of a buildingor both) held (by the owner or by the lessee as
a right-of-use asset) to earn rentals or for capital appreciation or both, rather than for:
(a) use in the production or supply of goods or services or for administrative purposes; or
(b) sale in the ordinary course of business.
Examples of investment property described in IAS 40, para. 8, are:

land held for long-term capital appreciation rather than for short-term sale in the ordinary
course of business;
land held for a currently undetermined future use ;
a building owned by the entity (or a right-of-use asset relating to a building held by the entity)
and leased out under one or more operating leases;
a building that is vacant but is held to be leased out under one or more operating leases; and
property that is being constructed or developed for future use as investment property.
IAS 40 specifies the accounting for investment property as distinct from property, plant and
equipment accounted for in accordance with IAS 16 Property Plant and Equipmentproperty,
plant and equipment being tangible assets that are used by an entity in the production or supply
of good or services, for rental to others, or for administrative purposes (para. 6).
IAS 16 permits an entity to choose either the cost model or the revaluation model for property,
plant and equipment after the assets initial recognition. Where the revaluation model is
the accounting policy, the increase in the assets carrying amount is recognised in other
comprehensive income and is accumulated in equity. A decrease in the carrying amount
(notreversing a previous increase) is recognised in profit or loss in a similar manner to the
investment property. To provide some consistency in the measurement, IAS 16 requires the choice
of measurement basis (i.e. cost model or revaluation model) to be applied across a class of assets.
STUDY GUIDE | 65
IAS 40 also allows entities to choose whether to carry their investment properties at either
cost or fair value (IAS 40, para. 30). Similarly to IAS 16, the accounting policy choice must be
applied to a class of investment properties. The fair value model results in the gains or losses
arising from a change in the fair value of investment property being recognised in profit or loss
(IAS40,para.35).
MODULE 1
If you wish to explore this topic further, read paras 305 of IAS 40.
One of the enhancing qualitative characteristics in the Conceptual Framework is comparability.

Comparability refers to information as being more useful if it can be compared with similar
information about other entities and with similar information about the same entity for a
comparable reporting period.
The accounting policy choice provided in IAS 40 in relation to the measurement of investment
properties is arguably inconsistent with the qualitative characteristic of comparability, as some
entities will value investment properties at cost, whereas other entities will value investment
properties at fair value. The cost and fair value of an investment property could be materially
different. However, this issue of inconsistency is also outweighed by the usefulness of
theinformation.
The need for consistent information is addressed by requiring entities that choose to hold
their investment properties at cost to disclose the fair value of the investment properties in the
notes to the financial statements. This requirement helps to ensure that users have access to
comparable information (IAS 40, paras 759).
Another measurement issue arises with the recognition of fair value movements on investment
property through profit or loss. Valid questions are often raised about whether these unrealised
gains satisfy the definition of an asset in the Conceptual Framework. Questions may be raised
about whether the economic benefits will flow to the entity because these gains or losses will
only be realised on the sale of the asset, which is not necessarily probable or likely to occur in
thenear future.
The usefulness of showing unrealised movements through profit or loss is challenged, as the
result for the year is affected by fair value movements (i.e. market forces, economic climate)
rather than by the entitys operational performance. Therefore, an entitys financial performance
does not necessarily show the results of the operating activities.
Professional judgment
Financial reporting is not just a mechanical practice based on following specified rules. It is
focused on meeting an important objective, and this requires careful thought and professional
judgment when deciding how to deal with particular items. Instead of a checklist approach,
judgment is required to evaluate whether the overarching objective is being met in the most
appropriate way. An example of the application of judgment includes determining the materiality
of particular items.
Professional judgment is an important characteristic of professional practice. It requires a

combination of conceptual and practical knowledge and is described as the ability to diagnose
and solve complex, unstructured values-based problems of the kind that arise in professional
practice (Becker 1982). Professionals are expected to make decisions based on an objective
review of the relevant data rather than on a choice of outcomes that suit the employer or
client. Professional judgment may often involve making a trade-off between relevance and
faithful representation, which are two qualitative characteristics that accounting information
shouldpossess.
The selection and application of accounting policies, and the recording and communication of
financial information based on these decisions, are essential functions that require professional
judgment. West (2003) suggests that without judgment, accounting becomes nothing more than
a book of rules for compliance. Moreover, the Conceptual Framework acknowledges that to a
large extent judgment is required when preparing financial reports (para. OB11).
MODULE 1
In general, the IFRSs reflect a principles-based approach rather than very specific rules about
what must be done. This provides significant scope for the exercise of judgment in the
application of principles to specific situations.
As identified in the Institute of Chartered Accountants of Scotland (ICAS) Professional

JudgementFramework:
The validity and usefulness of financial reporting relies upon good judgements being made,
especially as business transactions become more complex. It is also fundamental that judgements
can be demonstrated to be reasonable at the time they are made and in light of the facts and
circumstances then present (ICAS 2012, p. 3).
The Conceptual Framework and IFRSs have not been developed with the intention of eliminating
professional judgment. What frameworks do in this context is provide a coherent set of objectives,
assumptions, principles and concepts within which those judgments are made.
Accounting standards provide the principles that an entity needs to apply, but they do not
provide all of the answers as to how to apply them. For example, in accordance with IAS 16
Property, Plant and Equipment, an entity is required to write off the cost of an asset over its
useful life. Determining what the useful life is requires professional judgment. Another example
is found in IFRS 7 Financial Instruments: Disclosures, which indicates that the identification
of concentrations of risk in relation to financial instruments requires judgment that takes into
account the circumstances of the entity (para. B8).
Applying professional judgment to estimates and accounting policy

Professional judgment is particularly important in making estimates and in developing
accounting policies. In many circumstances, the exact amounts to be disclosed in the financial
statements cannot be able to be determined, and therefore, estimates are required. This is
acknowledged in para. OB11 of the Conceptual Framework, which states that to a large extent,
financial reports are based on estimates, judgments and models rather than exact depictions.
The combination of professional judgment and a disciplined approach to estimation ensures

that the information provided is still relevant and reliable. This is also acknowledged in
the Conceptual Frameworks discussion on faithful representation, which suggests that a
representation of an estimate:
can be faithful if the amount is described clearly and accurately as being an estimate, the nature
and limitations of the estimating process are explained, and no errors have been made in selecting
and applying an appropriate process for developing the estimate (para. QC15).
Paragraph QC26 also allows for a range of probability estimates to be provided, rather than a
single amount, and to be regarded as verifiable.
It is important that the choice of accounting policies is aligned with estimates that are focused
on providing the most accurate and faithful representation of the organisation. There may be a
temptation to select accounting policies or estimates that provide a particular viewpoint ofthe
organisation, but professional judgment and ethics must ensure that the selection made is
themost suitable.
STUDY GUIDE | 67
Preparers of financial reports need to refer to the Conceptual Framework when developing
accounting policies and estimates for which no specific accounting standard exists, such as when
assessing whether a transaction should be expensed or capitalised and determining the timing
ofrecognition of certain transactions.
Disclosures
MODULE 1
This module concludes by briefly considering the role of disclosures and how to determine when
disclosures are required. This provides a clear link to Module 2, which focuses on the presentation
of the financial statements, including the disclosures required for each financialstatement.
Effective disclosures play an important role in helping the decision-making of users. Entities need
to ensure that their financial reporting disclosures are clear and effective in informing users as to
the entitys performance during the year, as well as its financial position. Simply providing more
information to users is not sufficient to meet user needs, as disclosure overload is a concern
formany users.
The role and purpose of disclosures

Disclosure is a broad term and refers to items presented in the financial statements and in items
disclosed in the notes to the financial statements (IAS 1, para. 47). The role of these disclosures is
linked to the objective of financial reporting, which is to provide an account of the organisation
so that users have useful information with which to guide their decision-making. The focus on
disclosures transitions from the theoretical discussion found in the Conceptual Framework to
Module 2 and how financial statements are presented. The primary financial statements on
their own are not sufficient for users to be able to make informed decisions. Disclosures provide
additional information and explanations to assist users in understanding the financial statements.
Criteria for determining whether disclosure is required

Disclosure is included in financial statements in accordance with the disclosure requirements
of the accounting standards. These are often linked to the definitions and recognition criteria
that discussed throughout this module. In addition, IAS 1 Presentation of Financial Statements,
para.15, notes that compliance with the IFRSs, with additional disclosures when necessary,
ispresumed to result in the fair presentation of the financial statements. This is further expanded
upon in IAS1, para. 17:
In virtually all circumstances, an entity achieves a fair presentation by compliance with applicable
IFRSs. A fair presentation also requires an entity:
(a) to select and apply accounting policies in accordance with IAS 8 Accounting Policies, Changes
in Accounting Estimates and Errors. IAS 8 sets out a hierarchy of authoritative guidance that
management considers in the absence of an IFRS that specifically applies to an item;
(b) to present information, including accounting policies, in a manner that provides relevant,
reliable, comparable and understandable information; and
(c) to provide additional disclosures when compliance with the specific requirements in IFRSs is
insufficient to enable users to understand the impact of particular transactions, other events
and conditions on the entitys financial position and financial performance.
Management may believe that compliance with a specific requirement in an IFRS would be
very misleading. If the item is believed to be so misleading that it would conflict with the
overall objective of financial statements, the entity may depart from that requirementthat is,
it may account for it in a different manner. This departure is only permitted if the legal rules in
that country or jurisdiction allow it (IAS 1, para. 19). This situation is only considered to arise in
extremely rare circumstances, and there are specific disclosure obligations if an entity should
MODULE 1
consider this departure to be appropriate (para. 20).
The importance of a consistent approach to disclosure

A consistent approach to disclosure can be clearly linked back to the Conceptual Frameworks
qualitative requirements of comparability and understandability.
Accounting provides powerful and useful information that can highlight managers poor
performance and stewardship. Organisations facing difficulty may be tempted to mask
poor results by providing information in a manner that is not easily interpreted or analysed.
Onemethod that may cause confusion involves formally disclosing all relevant items but
in such amanner that they are not easily compared to previous periods or able to be
properlyunderstood.
This type of disclosure goes against the requirements of fair presentation and hinders the
usefulness of accounting information. A consistent approach to disclosure must therefore be
maintained, and any deviations should be clearly justified and carefully explained.
STUDY GUIDE | 69
Review
This module explained the role and importance of financial reporting as a communication tool for
entities to provide information to users to help with decision-making. It discussed how financial
reports are accessed by a broad range of users, including shareholders, banks, competitors,
employees and financial analysts. It also considered the importance of an internationally
MODULE 1
accepted conceptual framework in creating financial reports that meet the information needs
ofusers.
The use of accounting standards as a consistent language for reporting enables financial
statements to be prepared that users will understand and be able to compare between entities.
The IFRSs are the global language of accounting standards. This module considered the role
and importance of financial reporting for users and discussed the application of reporting in
an international context. It then discussed the need for GPFSs, the role that the Conceptual
Framework plays in financial reporting and the limitations of frameworks.
A conceptual framework plays a key role in assisting users in their decision-making by providing
consistency in the development of accounting standards and in providing a common set
of definitions, recognition principles and measurement principles. These act as a guide in
accounting for transactions not covered by accounting standards, including emerging financial
reporting issues. A conceptual framework also provides a source of legitimacy to the standard-
setting process and enhances the consistency of accounting standards. These benefits are
subject to the economic, legal, social and political constraints that apply to conceptual
frameworks. Furthermore, there is a continuing need for professional judgment in accounting.
In this module, the IASBs Conceptual Framework for Financial Reporting was analysed.
Themajor components of the Conceptual Framework, including the qualitative characteristics
ofuseful financial information and the elements of financial statements, were examined.
This module also discussed the different approaches to measuring the elements of financial
statements and applying the measurement bases to the measurement of liabilities and expenses
for employee benefits, share-based payments and investment property.
The module concluded with a consideration of the purpose of disclosure to help meet the
decision-making needs of users. This discussion also provided a link to the Module 2 discussion
of presentation of financial statements.
MODULE 1
SUGGESTED ANSWERS | 71
Suggested answers
MODULE 1
Suggested answers
Question 1.1
The focus of financial reporting is on the information needs of primary users, but this does not
mean that financial reports will be irrelevant to other users. Although the reports may not be
specifically tailored to meet their needs, other parties, such as regulators and members of the
public, may find general purpose financial reports useful (Conceptual Framework, para. OB10).
One reason for this is that the information needs of primary users and other groups of users
overlap. For example, customers of a construction company may need information about
cash flows, sources of funds and risk to assess whether the company is likely to continue its
operations. This may help them to decide whether to trust the construction company with a
long-term project. They would not wish to hire a company to do a job that it could not complete.
Similarly,investors and creditors need information about cash flows, sources of funds and risk to
assess the long-term viability of the construction company.
Question 1.2
The decision-usefulness objective of financial reporting provides some guidance to standard
setters because it provides the underlying purpose that should be served in making deliberations
about accounting standards. That is, the standard setters should seek to determine what types
of information are most useful for decisions made by users of financial statements. However,
the decision-usefulness objective fails to provide unambiguous guidance in solving financial
reporting problems, because any evaluation of the usefulness of items of information to users
is biased by their familiarity with the information. It is difficult to find evidence of the usefulness
of information that is not available. Also, decision-usefulness may vary between users because
they make different types of decisions, such as whether to sell their shares or whether to
extend credit. Even for similar decisions, users may use different decision-making models,
givingrise to different information needs. Finally, the decision-usefulness objective is capable
of multiple interpretations and has been used to support a variety of measurement approaches
inaccounting standards.
MODULE 1
REFERENCES | 77
References
MODULE 1
References
Australian Accounting Research Foundation and the Accounting Standards Review Board
(AARF& ASRB) 1990, Statement of Accounting Concepts 1 (SAC 1): Definition of the Reporting
Entity, AARF & ASRB, Melbourne, accessed September 2016, http://www.aasb.gov.au/admin/file/
content102/c3/SAC1_8-90_2001V.pdf.
Australian Accounting Standards Board (AASB) 2015, Reduced Disclosure Requirements, AASB,
Melbourne, accessed September 2016, http://www.aasb.gov.au/admin/file/content102/c3/
Differential_Reporting_Project_Update_12_01_2015.pdf.
Australian Accounting Standards Board (AASB) 2016, Tier 2 Requirements, accessed September
2016, http://www.aasb.gov.au/Work-In-Progress/Reduced-Disclosure-Requirements/Tier-2-
Requirements.aspx.
Becker, E. A. 1982, Is public accounting a profession?, The Woman CPA, vol. 44 no. 4, pp. 24.
Ernst & Young 2013, The great divide: The new financial reporting framework in New Zealand
nears finalisation, Ernst & Young, New Zealand, accessed September 2016, http://www.ey.com/
Publication/vwLUAssets/The_great_divide/$FILE/The%20great%20divide.pdf.
External Reporting Board (XRB) 2016, Accounting Standards Framework, XRB, accessed
November 2016, http://www.xrb.govt.nz/Site/Financial_Reporting_Strategy/Accounting_
Standards_Framework.aspx.
Financial Reporting Council (FRC) 2016, Financial Reporting Lab, FRC, Wellington, accessed
September 2016, https://frc.org.uk/Our-Work/Codes-Standards/Financial-Reporting-Lab.aspx.
ICAS 2012, A Professional Judgement Framework for Financial Accounting, ICAS, Edinburgh.
IFRS Foundation 2016a, Jurisdiction profiles, IFRS Foundation, London, accessed November
2016, http://www.ifrs.org/Use-around-the-world/Pages/Jurisdiction-profiles.aspx.
IFRS Foundation 2016b, About the IFRS for SMEs, IFRS Foundation, London, accessed
November 2016, http://www.ifrs.org/IFRS-for-SMEs/Pages/IFRS-for-SMEs.aspx.
IFRS Foundation 2016c, Disclosure initiative, IFRS Foundation, London, accessed November
2016, http://www.ifrs.org/Current-Projects/IASB-Projects/Disclosure-Initiative/Pages/Disclosure-
Initiative.aspx.
International Accounting Standards Board (IASB) 2005, Measurement Bases for Financial
ReportingMeasurement on Initial Recognition. Discussion Paper, International Accounting
MODULE 1
Standards Committee Foundation, London.
International Accounting Standards Board (IASB) 2010, Exposure Draft: Conceptual Framework
for Financial ReportingThe Reporting Entity, International Accounting Standards Committee
Foundation, London.
International Accounting Standards Board (IASB) 2015, Exposure Draft ED/2015/8: IFRS Practice
Statement: Application of Materiality, October, IASB, accessed November 2016, http://www.
ifrs.org/Current-Projects/IASB-Projects/Disclosure-Initiative/Materiality/Exposure-Draft-
October-2015/Documents/ED_IFRSPracticeStatement_OCT2015_WEBSITE.pdf.
International Accounting Standards Board (IASB) 2016a, Better communication, IFRS, 30

June, accessed November 2016, http://www.ifrs.org/Features/Pages/Hans-Hoogervorst-better-
communication.aspx.
International Accounting Standards Board (IASB) 2016b, IASB speech: Better communication,
IFRS, 30 June, accessed November 2016, http://www.ifrs.org/Features/Documents/2016/Hans-
Hoogervorst-Zurich-Conference-2016.pdf.
International Accounting Standards Board (IASB) 2016c, IFRS 16 Leases, January, IASB,
London, accessed November 2016, http://www.ifrs.org/Current-Projects/IASB-Projects/Leases/
Documents/IFRS_16_effects_analysis.pdf.
Securities and Exchange Commission (SEC) 2007, Acceptance from foreign private issuers of
financial statements prepared in accordance with international financial reporting standards
without reconciliation to U.S. GAAP, Release Nos. 33-8879; 34-57026; International Series Release
No. 1306; File No. S7-13-07, December, accessed November 2016, https://www.sec.gov/rules/
final/2007/33-8879.pdf.
Sydney Online 2014, Splendour and power of the Sydney Harbour Bridge, accessed September
2016, http://www.sydney.com.au/bridge.htm.
West, B. P. 2003, Professionalism and Accounting Rules, Routledge, New York.

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CPA PROGRAM

Edited and designed by DeakinPrime

ISBN 978 0 7300 0076 1

Information to CPA Program candidates studying FinancialReporting

inthe Conceptual Framework;

Information to CPA Program candidates studying

2016 International Financial Reporting Standardsthe Red Book

The role and importance of financial reporting

The role of financial reporting

The importance of financial reporting

Figure 1.1: Financial statement user decisions

Should I invest money How has the company

Should I sell goods Should I lend money

Source: CPA Australia 2016.

Information needs of the user

Source: CPA Australia 2015, based on IASB 2010.

Limitations of the decision-usefulness objective

Lack of familiarity with new types of information: If users of financial statements

Capable of multiple interpretations: The decision-usefulness criterion appears to be

What are the different types of financial reporting for users?

Table 1.1: Use of different financial reporting types

General purpose financial Unable to request reports to meet GPFSs

For example, a bank extending credit

Source: CPA Australia 2016.

Limitations of general purpose financial reporting

Who must prepare general purpose financial reports?

International initiatives to decrease financial reporting complexity

Some examples of these initiatives are described as follows.

Reducing reporting requirements of specific organisations

category of Tier 2 can follow, Tier 2: Australian Accounting StandardsReduced Disclosure

External Reporting Board (XRB), New Zealand

Overview of Accounting Standards Framework

Table 1.2: New Accounting Standards Framework tiered approach

For-Profit Entities Public Benefit Entities

Tier 1 Publicly accountable NZ IFRS Publicly accountable PBE Standards

Tier 2 Non-publicly NZ IFRS Reduced Non-publicly PBE Standards

For-Profit Entities Public Benefit Entities

Tier 3 Non-publicly PBE Simple Format

Tier 4 Entities allowed PBE Simple Format

Catering to the information needs of multiple stakeholders

Standards level review of disclosure

Financial Reporting Council (FRC), UK

The Conceptual Framework for

The Conceptual Framework:

The Conceptual Framework is structured as shown in Table 1.3.

Table 1.3: Structure of the Conceptual Framework

1. Objective Sets out the objective of general purpose financial reporting,

3. Qualititve characteristics Provides guidance on the qualitative characteristics of useful

4. Remaining text of the Includes the rest of the Conceptual Framework

Source: CPA Australia 2016.

The purpose and application of the Conceptual Framework

Having a common framework is an important foundation in guiding the development

The Conceptual Framework provides a formal frame of reference for:

The Conceptual Framework is applied in several ways, as shown in Table 1.4.

Table 1.4: Applying the Conceptual Framework

Who is applying the

Conceptual Framework How the Conceptual Framework is applied

Standard setters To develop accounting standards

Auditors To help form an opinion on compliance with an IFRS

Source: CPA Australia 2016.

Principles established in the Conceptual Framework

Qualitative characteristics of useful

This is illustrated in Figure 1.3.