Chapter 1: The Objective of General-Purpose Financial Reporting

This chapter lays out why we prepare financial reports in the first place. The main goal is to provide
financial information about a company to various groups of people who need to make decisions
about providing resources to that company. These primary users are existing (SHAREHOLDERS) and
potential investors, lenders, and other creditors. They rely on these general-purpose financial
reports for much of the financial information they need.

These users need information to help them make assessments about:

 The company's economic resources, the claims against the company (like debts), and how
these resources and claims change over time. This gives a picture of the company's financial
position.

 How efficiently and effectively the company's management has used the company's
economic resources.

To make these assessments, the financial reports provide information about:

 Economic resources and claims: This includes what the company owns (its assets) and what
it owes to others (its liabilities), as well as the owners' stake in the company (its equity).

 Changes in economic resources and claims: This shows how the company's financial
position has changed due to its business activities and other events. These changes can be
broken down into:

o Financial performance reflected by accrual accounting: This means recording

income and expenses when they are earned or incurred, not necessarily when cash
changes hands. This gives a better picture of performance over a period.

o Financial performance reflected by past cash flows: This shows how the company
has generated and used cash in the past.

o Changes in economic resources and claims not resulting from financial

performance: These are changes that aren't directly related to the company's profit-
making activities, such as issuing new shares.

 Information about the use of the entity’s economic resources: This helps users evaluate
how well the management is doing in managing the company's assets.

It's important to remember that financial reports are prepared for users who have a reasonable
understanding of business and economic activities and who will review and analyse the information
carefully. Some complex topics might even require these users to seek help from an advisor.
Chapter 2: Qualitative Characteristics of Useful Financial Information

This chapter discusses the qualities that make financial information useful for the people who read
the reports. These characteristics help users make informed decisions. There are fundamental
qualitative characteristics and enhancing qualitative characteristics.

Fundamental Qualitative Characteristics:

 Relevance: Relevant financial information can influence the decisions of users. Information
is relevant if it has predictive value (helps users forecast future outcomes), confirmatory
value (helps users confirm or correct past evaluations), or both. Materiality is an aspect of
relevance; information is material if omitting it or misstating it could be expected to
influence the decisions of primary users. Materiality can be in magnitude(amount) or nature
(affect the reputation of the entity)

 Faithful Representation: Faithfully represented information reflects the actual economic

phenomena it is supposed to represent. To be perfectly faithful, information would need to
be:

o Complete: Including all information necessary for users to understand the

phenomenon, including necessary descriptions and explanations.

o Neutral: Without bias in the selection or presentation of financial information.

Prudence – Not overstating our assets and income and understating our expenses
and liabilities.

o Free from error: Containing no errors or omissions in the description of the

phenomenon and in the process used to produce the reported information.
However, perfect accuracy might not always be achievable, and estimates are often
necessary.

Enhancing Qualitative Characteristics: These characteristics improve the usefulness of information

that is already relevant and faithfully represented.

 Comparability: Information is more useful if it can be compared with information about

other entities and with information about the same entity for different periods. This allows
users to identify similarities and differences.

 Verifiability: Verifiable information allows different independent observers to reach a

general agreement, although not necessarily complete agreement, that a particular
depiction is a faithful representation. Verifiability can be direct (e.g., by observing a price) or
indirect (e.g., by checking the inputs to a model).

 Understandability: Classifying, characterising, and presenting information clearly and

concisely makes it understandable. However, some complex phenomena cannot be made
easy to understand, and excluding information about them might be misleading. Financial
reports are prepared for users with a reasonable knowledge of business.
  Timeliness: Having information available to decision-makers in time to be capable of
influencing their decisions. Generally, the older the information, the less useful it is.

The Cost Constraint on Useful Financial Reporting:

Reporting financial information involves costs, and the benefits of useful information should justify
the cost of providing and using it. Assessing whether the benefits outweigh the costs is a judgement
that takes into account factors like the nature and amount of the benefits and costs, and who bears
those costs and receives those benefits.
Chapter 3: Financial Statements and the Reporting Entity

This chapter focuses on the financial statements themselves and the entity that is reporting.
Financial statements are a specific type of general-purpose financial report.

Financial Statements:

 Objective and scope: The objective of financial statements is to provide information about a
company's economic resources, claims against the entity, and changes in those resources
and claims that meet the definitions of the elements of financial statements (assets,
liabilities, equity, income, expenses).

 Reporting period: Financial statements are prepared for a specific period of time.

 Perspective adopted: Financial statements provide information about transactions and

other events viewed from the perspective of the reporting entity as a whole.

 Going concern assumption: Financial statements are normally prepared assuming the
reporting entity will continue to operate for the foreseeable future and will not be forced to
liquidate or cease trading. If this assumption is not appropriate, the financial statements
may need to be prepared on a different basis, and this would usually be disclosed.

The Reporting Entity:

A reporting entity is an entity that is required, or chooses, to prepare financial statements. It can be
a single entity or a group of entities.

 Consolidated and unconsolidated financial statements: If a reporting entity controls one or

more other entities (its subsidiaries), consolidated financial statements are prepared to
present the financial position and performance of the parent and its subsidiaries as a single
economic entity. Unconsolidated financial statements present information about the parent
entity alone.
Chapter 4: The Elements of Financial Statements

This chapter defines the basic building blocks of financial statements. These are the categories into
which the financial effects of transactions and other events are grouped.

Definition of an Asset:

An asset is a present economic resource controlled by the entity as a result of past events. An
economic resource is a right that has the potential to produce economic benefits.

 Right: A right can take many forms, such as a right to receive cash, a right to use property, or
a right from a contract.

 Potential to produce economic benefits: This means the right has the capacity, alone or
with other resources, to generate cash inflows or reduce cash outflows.

 Control: The entity has the ability to direct the use of the economic resource and obtain the
economic benefits that may flow from it and can prevent others from directing the use of
that resource and obtaining those benefits.

 Past events: The asset must have arisen from a transaction or other event that has already
occurred.

Definition of a Liability:

A liability is a present obligation of the entity to transfer an economic resource as a result of past
events.

 Obligation: This is a duty or responsibility that the entity has no practical ability to avoid. An
obligation can be legal (e.g., from a contract or law) or constructive (e.g., from the entity's
past actions or stated policies that have created a valid expectation in other parties).

 Transfer of an economic resource: The obligation will be settled by the entity giving up an
economic resource, such as cash, goods, or services.

 Present obligation as a result of past events: The obligation must exist now and must have
arisen from a transaction or other event that has already occurred.

Assets and Liabilities:

 Unit of account: This specifies what the asset or liability represents for the purpose of
recognition and measurement. For example, is it a single item or a group of items?

 Executory contracts: These are contracts where neither party has fully performed their
obligations. Generally, a right or obligation from an executory contract only becomes an
asset or liability when one of the parties performs.

 Substance of contractual rights and contractual obligations: Sometimes, the economic

substance of a contractual right or obligation may differ from its legal form. Financial
reporting should reflect the substance.
Definition of Equity:

Equity is the residual interest in the assets of the entity after deducting all its liabilities. It
represents the owners' stake in the company.

Definitions of Income and Expenses:

 Income 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 those relating to contributions from equity participants. This includes revenues, gains,
etc.

 Expenses are 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. This includes the cost of
sales, wages, depreciation, losses, etc.
Chapter 5: Recognition and Derecognition

This chapter explains when and how the elements of financial statements (assets, liabilities, equity,
income, and expenses) are included in the financial statements.

The Recognition Process:

Recognition is the process of including an item in the statement of financial position (for assets,
liabilities, and equity) or the statement(s) of financial performance (for income and expenses). It
involves describing the item in words and by a monetary amount and including that amount in the
totals of those statements. The amount at which an asset, liability, or equity is recognised in the
statement of financial position is called it carrying amount.

Recognition Criteria:

An item is recognised if it meets the definition of one of the elements of financial statements AND
recognition of that item provides users of financial statements with information that is relevant and
provides a faithful representation of that element.

 Relevance: As discussed in Chapter 2, relevance means the information can influence users'
decisions. Factors that can affect relevance include:

o Existence uncertainty: If there is significant doubt about whether an asset or liability

exists.

o Low probability of an inflow or outflow of economic benefits: If it is very unlikely

that economic benefits will flow to or from the entity. In some cases, it might be
more relevant to provide information in the notes rather than recognise the item in
the main statements.

 Faithful Representation: As discussed in Chapter 2, faithful representation means the

information reflects the actual economic phenomenon. Factors that can affect faithful
representation include:

o Measurement uncertainty: If the amount of an asset or liability cannot be measured

with sufficient reliability. Similar to relevance, information about uncertainties might
be provided in the notes.

o Other factors: Faithful representation also involves proper measurement,

presentation, and disclosure.

Derecognition:

Derecognition is the removal of a previously recognised asset or liability from the statement of
financial position. This generally occurs when the entity no longer meets the definition of the asset
or liability.

 Derecognition of an asset normally occurs when the entity loses control of all or part of the
recognised asset.
  Derecognition of a liability normally occurs when the entity no longer has a present
obligation for all or part of the recognised liability (e.g., when it is paid or otherwise
extinguished).

The objective of derecognition is to faithfully represent the assets and liabilities that remain in the
entity's statement of financial position.
Chapter 6: Measurement

This chapter discusses how the elements of financial statements are quantified in monetary terms.

Measurement Bases:

A measurement basis is the attribute chosen to be quantified for an asset or a liability. The
Conceptual Framework discusses several measurement bases:

 Historical cost: For assets, this is the price paid to acquire the asset plus any transaction
costs. For liabilities, it is the value of the consideration received in exchange for incurring the
liability minus any transaction costs.

 Current value: This is a broader category that reflects conditions at the measurement date.
It includes:

o Fair value: 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.

o Value in use (for assets) and fulfilment value (for liabilities): This is the present
value of the cash flows that an entity expects to derive from the asset or expects to
be required to settle the liability.

o Current cost: For assets, this is the cost of obtaining a similar asset at the
measurement date. For liabilities, it is the consideration that would be received
currently for incurring a similar liability.

Information Provided by Particular Measurement Bases:

Each measurement basis provides different types of information.

 Historical cost can provide relevant information about past transactions and how an entity
has used its economic resources. It can also be useful for assets that are used in combination
to produce goods or services.

 Current value provides information that is more up-to-date and can reflect changes in
market conditions. Fair value reflects market participants' current expectations. Value in use
and fulfilment value reflect the entity's specific circumstances. Current cost can provide
information about the current cost of replacing assets or settling liabilities.

Factors to Consider When Selecting a Measurement Basis:

Selecting the appropriate measurement basis depends on the specific asset or liability and the
objective of the financial information. The main factors to consider are:

 Relevance: The measurement basis should provide relevant information that is useful for
decision-making.
  Faithful representation: The measurement basis should result in a faithful representation of
the economic phenomenon. This includes considering measurement uncertainty.

 Enhancing qualitative characteristics and the cost constraint: The choice of measurement
basis should also consider the impact on comparability, verifiability, understandability, and
timeliness, as well as the cost of obtaining the information.

 Characteristics of the asset or liability: The nature of the asset or liability and how it
generates cash flows can influence the choice of measurement basis.

 Factors specific to initial measurement: At the time an asset or liability is first recognised, its
cost in a market transaction is often similar to its fair value. Ideally, the initial measurement
basis should be consistent with the subsequent measurement basis to avoid recognising
income or expenses solely due to a change in the basis.

More Than One Measurement Basis:

Sometimes, using more than one measurement basis for an asset or liability and related income and
expenses can provide the most relevant information that faithfully represents both the entity's
financial position and its financial performance. In such cases, the information is often presented
using a single measurement basis in the main statements, with additional information explained, and
any changes in current value may be separated into profit or loss and other comprehensive income.

Measurement of Equity:

The total carrying amount of equity is determined as the residual of assets less liabilities. However,
specific components of equity (e.g., share capital, retained earnings) may be subject to specific
measurement requirements or disclosures.

Cash-Flow-Based Measurement Techniques:

Present value techniques are often used when the measurement basis is value in use or fulfilment
value. These techniques involve estimating future cash flows and discounting them to their present
value using an appropriate discount rate.