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Week 1Topics
1. The conceptual framework -> The conceptual framework for reporting
2. Provisions -> IAS 37
3. Changes in accounting policies and estimates -> IAS 8
4. Fair value -> IFRS 13
Subject 1 - The conceptual framework
The framework is not a standard, but still quite important. It gives the basics and vocabulary that you need in
financial reporting.
To understand Framework: Think in terms of asset and liability approach
(balance sheet approach) vs income statement approach
-> Framework is based on an asset/liability view of accounting
-> Difference: from BS to consequences on the IC or the other way around.
In some cases it matters where you start your reasoning. The IASB likes to
start with the BS.
Essential Framework Content (what does it do?)
It expresses the basic steps that you have to take when you face the question “How are we going to account
for this event or this transaction?”
➔ The framework proposes 4 simple steps (go from 1 to 4 when you have an accounting issue)
1. Does something meet the definition of an element of financial statements? (BS or IS) -> (FW CH4)
▪ Assets/liabilities are the basic elements, income/expense are defined as changes in assets/liabilities
▪ Assets and liabilities are defined in economic substance, not as outcome of accounting entries
2. Does that element meet the recognition criteria? -> (FW CH 5)
▪ Not all items meeting definition of asset or liability are recognized on the balance sheet
3. Choose a measurement basis for that element -> (FW CH 6)
▪ Based on historical cost or some current value. No uniform measurement basis.
4. Classify equity movements as a result of changes in the element’s carrying amount -> (FW CH 7.15)
▪ Movements in equity are (1) profit or loss (2) OCI (3) direct movements in equity
, Step 1: Does something meet the definition of an element of financial statements? (BS or IS)
The 5 elements of financial statements:
1. Assets: A (1) present economic resource (2) controlled by the entity (3) as a result of past events (FW 4.3)
2. Liabilities: A (1) present obligation of the entity (2) to transfer an economic resource (3) as a result of past
events (FW 4.26)
3. Equity: The residual interest in the assets of the entity after deducting all its liabilities (FW 4.63)
4. Income: Increases in assets, or decreases in liabilities, that result in increases in equity, other than those
relating to contributions from holders of equity claims (FW 4.68)
5. Expenses: Decreases in assets, or increases in liabilities, that result in decreases in equity, other than those
relating to distributions to holders of equity claims (FW 4.69)
-> Important thing: The definitions of income and expenses (IS) are derived from the BS (income and expenses
are defined as changes in assets and liabilities)
(1) Assets (FW 4.3-4.25)
Asset = a right with the potential to produce
economic benefits in the future.
-> It has to generate cash
Unit of account: what is the group of rights?
(think of a building -> is it more rights or 1
right that produces cash)
(2) Liabilities (FW 4.26-4.47)
It is not just a credit in your BS from your bookkeeping
process. It is a real obligation to transfer economic
resources (rights to cash)
-> You have to give up cash to satisfy your obligation
-> I need to have a present obligation
Equity, income and expenses are the outcome of
changes in assets and liabilities.
Step 2: Does that element meet the recognition criteria?
Now that we know that something is an asset or a liability, do we put it on the BS?
-> There are many things that meet the definition of an asset/liability, but we do not put them on the BS.
-> Think of company employees -> they are not slaves, but you have contracts with them that generates cash
Recognition criteria (FW CH 5)
Decides which assets and liabilities
are recognized and which are not
, Step 3: Choose a measurement basis for that element
The 5 measurement bases (FW CH 6)
Once we decide that something meets the
recognition criteria for putting it on the BS, we
need to determine the measurement basis.
-> Choice: based on qualitative characteristics of
useful info
-> We often use historical cost accounting
- Fair value: ‘exit value’ verkoopwaarde op dit moment
- Value in use (assets): ‘future benefits’ (NPV cashflows)
- Fulfillment value (liabilities): ‘future outflows
- Current cost: fair value maar dan voor kosten.
Step 4: Classify equity movements as a result of changes in the element’s carrying amount
Profit or loss and other comprehensive income
Other comprehensive income (OCI):
- ‘Anything else’ is known in IFRS as ‘other comprehensive income’:
subclass of income/expenses, presented outside the income statement
- Total comprehensive income = net profit/loss + OCI
In IFRS, you can present the financial statements in 2 ways:
- Single-statement: Consolidated statement of comprehensive income (net income presented as subtotal)
- Two-statement: Consolidated statement of operations (ending with net income) + Consolidated statement
of comprehensive income (splits up net income into OCI…)
Other comprehensive income Consolidated statement of Comprehensive income
There is not much ‘theory’ behind OCI
(other comprehensive income)
-> Items of OCI are just plans items of
income and expenses
-> Exchange rate fluctuations (distort
financial performance)
IFRS gives a list of what you may put in
OCI. If you have them in your financial
statement, you have to report them in
OCI -> IAS 1.7
, Recycling of OCI items (‘Reclassification adjustments’)
Many OCI items are unrealized value changes (some assets went up in value, but you
have not sold them yet). There are 3 different ways to deal with this:
-> The issue: what to do with unrealised and realised value changes
1. Traditional approach: recognise value change in net income (profit or loss),
only when realised
➔ Measure the asset at cost and then you simply don’t see the value
increase in you income statement until it is actually sold.
2. If you want to show the increase as it occurs but don’t like unrealised gains
in P&L, you can recognise it in OCI:
➔ Now you just recognize it ones. When you sell the asset, there is no
further gain or loss. (equity does not change anymore)
3. Recycling: a value change is recognized twice first, when unrealized, in OCI and
second, when realized, in profit or loss
➔ When the value of an asset goes up, you recognize the gain in OCI. And when
you sell the asset, you recognize the same gain once again but then in the IS.
➔ In order to do that, you need to reverse your initial booking
IFRS is not based on a consistent view of recycling: some components of OCI lead to ‘reclassification
adjustments’ (IAS 1.7), others do not. (look at the list -> no theory behind it)
Example Nokia - reclassification of OCI items
Are they really gains and losses or are
they reverses of previous losses and
gains?
-> Do this when looking at OCI and
reclassifications adjustments
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