Introduction and the IAS Framework JOIN KHALID AZIZ COACHING CLASSES ICMAP STAGE 1,2,3,4,5 ICAP...

Introduction and the IAS Introduction and the IAS FrameworkFramework

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MA-ECONOMICSMA-ECONOMICS0322-33857520322-3385752

KARACHI, PAKISTANKARACHI, PAKISTAN

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Introduction and the Framework Introduction and the Framework The Canadian and U.S. experiences The Canadian and U.S. experiences

to date to date Looking aheadLooking aheadMeasurement model Measurement model End-of-chapter practiceEnd-of-chapter practice

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Introduction and the IAS Introduction and the IAS FrameworkFramework

A common set of global accounting A common set of global accounting standards standards

Conceptual framework for the Conceptual framework for the preparation and presentation of preparation and presentation of financial statementsfinancial statements

GAAP hierarchyGAAP hierarchy

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A Common Set of Global A Common Set of Global Accounting StandardsAccounting Standards

Do we need a common set of global accounting Do we need a common set of global accounting standards?standards?

Various GAAP have been developed in many countries due to Various GAAP have been developed in many countries due to differences in the legal, regulatory, social, economic, and differences in the legal, regulatory, social, economic, and cultural environments.cultural environments. Results in financial statements that are not comparable and Results in financial statements that are not comparable and

difficult for users to interpretdifficult for users to interpret

This acts as a barrier for global capital movementThis acts as a barrier for global capital movement

Recently, there has been a movement toward harmonization Recently, there has been a movement toward harmonization and convergence of GAAPand convergence of GAAP most significant initiative being led by the International most significant initiative being led by the International

Accounting Standards Board (IASB)Accounting Standards Board (IASB)


IASB:IASB: Reports to the IASC FoundationReports to the IASC Foundation Structure: Structure: www.iasb.orgwww.iasb.org 12 full time and 2 part time members12 full time and 2 part time members IFRIC assists the IASB through timely IFRIC assists the IASB through timely

identification, discussion and resolution of identification, discussion and resolution of issuesissues

Mandate – single set of high quality, Mandate – single set of high quality, understandable, enforceable global standardsunderstandable, enforceable global standards Transparent, comparable informationTransparent, comparable information

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The IASB works with national accounting standard setters to move The IASB works with national accounting standard setters to move toward global convergencetoward global convergence To date, nearly 100 countries haveTo date, nearly 100 countries haveconverged (require or allow IFRS) or are on the path to convergence. converged (require or allow IFRS) or are on the path to convergence.

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Political and Regulatory IssuesPolitical and Regulatory Issues

One issue with convergence is enforcementOne issue with convergence is enforcement In Canada, regulation takes place at the provincial and territorial levelIn Canada, regulation takes place at the provincial and territorial level

Once standard setting moves to a global arena, this fragmented regulatory Once standard setting moves to a global arena, this fragmented regulatory environment will prove to be a challengeenvironment will prove to be a challenge

With so many entities regulating the markets, is it possible to be consistent?With so many entities regulating the markets, is it possible to be consistent? In October 2005, IOSCO announced that it would create an IFRS database for In October 2005, IOSCO announced that it would create an IFRS database for

regulators to share decisions on the application of IFRSregulators to share decisions on the application of IFRS

Is there or can there ever be total acceptance of IFRS? Is there or can there ever be total acceptance of IFRS? It may be required only for consolidated financials and for public companies It may be required only for consolidated financials and for public companies National GAAPs are still in existence and are widely usedNational GAAPs are still in existence and are widely used

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Can one set of standards meet the needs of all Can one set of standards meet the needs of all users?users?

There is a concern that private companies would not benefit There is a concern that private companies would not benefit from using IFRS from using IFRS

Many operate in a local market and have more simplified Many operate in a local market and have more simplified business modelsbusiness models

On the international front, there is a move to establishing more On the international front, there is a move to establishing more simplistic standards for these entitiessimplistic standards for these entities

Canada is also in the process of deciding what GAAP will be for Canada is also in the process of deciding what GAAP will be for these non-publicly accountable enterprisesthese non-publicly accountable enterprises

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A Common Set of Global A Common Set of Global Accounting StandardsAccounting StandardsPrinciples or rules—which are better?Principles or rules—which are better?

IFRS is referred to as being IFRS is referred to as being principlesprinciples basedbased They are more loosely framed, allowing for professional judgement They are more loosely framed, allowing for professional judgement

to be appliedto be applied Results in accounting that is more flexible to deal with unique Results in accounting that is more flexible to deal with unique

economic and business circumstanceseconomic and business circumstances Some argue that allowing professional judgement introduces biasSome argue that allowing professional judgement introduces bias

At the other end of the spectrum is a At the other end of the spectrum is a rules-basedrules-based GAAP GAAP model that is more prescriptivemodel that is more prescriptive Provides a rule for every situation Provides a rule for every situation Body of knowledge too large and complicated Body of knowledge too large and complicated Although more guidance is a comfort to some, it becomes difficult Although more guidance is a comfort to some, it becomes difficult

to ensure that the standards are all consistent.to ensure that the standards are all consistent.

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In January 2008, the CEOs of the Big 6 accounting firms In January 2008, the CEOs of the Big 6 accounting firms concluded that the key elements of a principles-based concluded that the key elements of a principles-based accounting standard were as follows:accounting standard were as follows:

CONCEPTUAL FRAMEWORK FOR THE CONCEPTUAL FRAMEWORK FOR THE PREPARATION AND PRESENTATION OF PREPARATION AND PRESENTATION OF

FINANCIAL STATEMENTSFINANCIAL STATEMENTSPurposePurposeFormal statusFormal statusUsers and objectivesUsers and objectivesQualitative characteristicsQualitative characteristicsElementsElements

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FINANCIAL STATEMENTSFINANCIAL STATEMENTSWhat is the role of a conceptual framework?What is the role of a conceptual framework? The conceptual framework sets out the concepts that underlie The conceptual framework sets out the concepts that underlie

the preparation of the financial statements the preparation of the financial statements

The purpose of the framework is to:The purpose of the framework is to:

(a) assist the IASC in the development of future International Accounting (a) assist the IASC in the development of future International Accounting Standards (IAS)Standards (IAS)

(b) assist the IASC Board in promoting harmonization of regulations(b) assist the IASC Board in promoting harmonization of regulations

(c) assist national standard-setting bodies in developing national (c) assist national standard-setting bodies in developing national standardsstandards

(d) assist preparers of financial statements in applying IAS(d) assist preparers of financial statements in applying IAS

(e) assist auditors in forming an opinion on whether financial statements (e) assist auditors in forming an opinion on whether financial statements conform with IAS conform with IAS

(f) assist users in interpreting the information contained in financial (f) assist users in interpreting the information contained in financial statements prepared according to IAS andstatements prepared according to IAS and

(g) provide those who are interested in the work of IASC with information (g) provide those who are interested in the work of IASC with information about its approach to the formulation of IASabout its approach to the formulation of IAS

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FINANCIAL STATEMENTSFINANCIAL STATEMENTSWhat is the formal status of the conceptual framework?What is the formal status of the conceptual framework? Not an IAS in and of itself and nothing in the framework overrides a Not an IAS in and of itself and nothing in the framework overrides a

specific accounting standardspecific accounting standard

IASB notes that there may be cases where the framework is in conflict IASB notes that there may be cases where the framework is in conflict with a specific standard and, in these cases, the standard would override with a specific standard and, in these cases, the standard would override the framework the framework

Where there is no specific standard, the framework should govern the Where there is no specific standard, the framework should govern the accounting accounting

Applies to the financial statements of all entities, whether public or Applies to the financial statements of all entities, whether public or privateprivate

Currently the subject of a joint project between IASB and FASBCurrently the subject of a joint project between IASB and FASB

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FINANCIAL STATEMENTSFINANCIAL STATEMENTS

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FINANCIAL STATEMENTSFINANCIAL STATEMENTSUsers and ObjectivesUsers and Objectives According to the framework, users of financial statements include:According to the framework, users of financial statements include:

Investors, employees, lenders, suppliers, creditors, customers, governments Investors, employees, lenders, suppliers, creditors, customers, governments and the publicand the public

The overall objective of financial reporting is to produce financial statements that The overall objective of financial reporting is to produce financial statements that present fairly the results of operations and the financial positionpresent fairly the results of operations and the financial position

The objective is articulated in the framework as follows:The objective is articulated in the framework as follows:

-Financial statements are to provide information about the financial position, -Financial statements are to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisionsrange of users in making economic decisions

-Financial statements prepared for this purpose meet the common needs of most -Financial statements prepared for this purpose meet the common needs of most usersusers

-Financial statements also show the results of the stewardship of management, or -Financial statements also show the results of the stewardship of management, or the accountability of management for the resources entrusted to itthe accountability of management for the resources entrusted to it

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FINANCIAL STATEMENTSFINANCIAL STATEMENTSQualitative Characteristics of Useful InformationQualitative Characteristics of Useful Information

Understandability:Understandability: One benefit of a common set of quality accounting standards is that One benefit of a common set of quality accounting standards is that

they create less confusion and are more likely to be understood by they create less confusion and are more likely to be understood by users internationally users internationally

Relevance: Relevance: Relevant information must at least have the following characteristics:Relevant information must at least have the following characteristics:

1. 1. Predictive valuePredictive value— — many users use historic information to predict many users use historic information to predict the company’s future profits and cash flows. Although the past does the company’s future profits and cash flows. Although the past does not necessarily allow users to predict the future, it does provide not necessarily allow users to predict the future, it does provide information that can be used to assess the future potential of the information that can be used to assess the future potential of the entityentity

2.2. Confirmatory valueConfirmatory value— — many users use the information to confirm many users use the information to confirm their prior expectations and to assess management performancetheir prior expectations and to assess management performance

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FINANCIAL STATEMENTSFINANCIAL STATEMENTSRelevance (continued): Relevance (continued):

The concept of materiality is useful in that it defines the level of The concept of materiality is useful in that it defines the level of inclusion of informationinclusion of information

As noted in the framework, information is As noted in the framework, information is material material and useful if its and useful if its omission or misstatement could influence the economic decisions of omission or misstatement could influence the economic decisions of usersusers

Information might be material based solely on its nature or Information might be material based solely on its nature or alternatively, on its size or dollar valuealternatively, on its size or dollar value

Currently the standard does not have a quantitative definition for Currently the standard does not have a quantitative definition for what is material and what is notwhat is material and what is not

Often in the past, materiality has been defined as an item that is Often in the past, materiality has been defined as an item that is larger than 5 –10% of incomelarger than 5 –10% of income

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FINANCIAL STATEMENTSFINANCIAL STATEMENTSReliability:Reliability: Information is considered reliable if it has the following characteristics:Information is considered reliable if it has the following characteristics:1. 1. Faithful representationFaithful representation—the objective of financial reporting is to —the objective of financial reporting is to

communicate information about the entity and its economic events and communicate information about the entity and its economic events and transactions. In the proposed framework, this concept replaces reliabilitytransactions. In the proposed framework, this concept replaces reliability

2. 2. Substance over formSubstance over form—this is often referred to as economic substance over —this is often referred to as economic substance over (legal) form. Accounting should reflect the substance of a transaction and (legal) form. Accounting should reflect the substance of a transaction and should look beyond the legal formshould look beyond the legal form

3. 3. NeutralityNeutrality—unbiased information is better information. Biased information is —unbiased information is better information. Biased information is of lesser quality since it is not objectively preparedof lesser quality since it is not objectively prepared

4. 4. PrudencePrudence—this concept is similar to conservatism. Many uncertainties are —this concept is similar to conservatism. Many uncertainties are associated with information in the statements and prudence acts to ensure associated with information in the statements and prudence acts to ensure that the assets and income are not overstated. In the proposed framework, that the assets and income are not overstated. In the proposed framework, this concept disappearsthis concept disappears

5. 5. CompletenessCompleteness—refers only to material items and, in terms of the other —refers only to material items and, in terms of the other criteria, the benefits must exceed the costscriteria, the benefits must exceed the costs

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FINANCIAL STATEMENTSFINANCIAL STATEMENTSComparability:Comparability: The main benefit of having one set of global standards is The main benefit of having one set of global standards is

comparability comparability Use of the conceptual framework by all entities, whether they are Use of the conceptual framework by all entities, whether they are

publicly accountable or not, would enhance thispublicly accountable or not, would enhance this IFRS still allows a fair bit of choice in the various standards and the IFRS still allows a fair bit of choice in the various standards and the

IASB is trying to reduce the number of incidences where choices are IASB is trying to reduce the number of incidences where choices are availableavailable

Balance/trade-offs: Balance/trade-offs: The proposed framework separates the qualitative characteristics The proposed framework separates the qualitative characteristics

into two categories -“fundamental” and “enhancing” into two categories -“fundamental” and “enhancing” It is proposed that It is proposed that fundamentalfundamental characteristics will include characteristics will include

relevance and representational faithfulness, while relevance and representational faithfulness, while enhancingenhancing characteristics will include comparable, verifiable, timely, and characteristics will include comparable, verifiable, timely, and understandable understandable

Materiality and cost will be seen to be pervasive constraintsMateriality and cost will be seen to be pervasive constraints

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FINANCIAL STATEMENTSFINANCIAL STATEMENTSElements of Financial StatementsElements of Financial Statements Elements are recognized when probable and measurable with reliabilityElements are recognized when probable and measurable with reliability

Assets: Assets: a resource controlled by the entity as a result of past events and a resource controlled by the entity as a result of past events and

from which future economic benefits are expected to flow to the entityfrom which future economic benefits are expected to flow to the entity

Liabilities: Liabilities: a present obligation of the entity arising from past events, the 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 settlement of which is expected to result in an outflow from the entity of

resources embodying economic benefits. Liabilities may be legally resources embodying economic benefits. Liabilities may be legally

enforceable via a contract or law, but need not beenforceable via a contract or law, but need not be

Equity: Equity: a residual interest in the assets of the entity after deducting all its a residual interest in the assets of the entity after deducting all its

liabilitiesliabilities

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FINANCIAL STATEMENTSFINANCIAL STATEMENTSElements of Financial Statements (continued)Elements of Financial Statements (continued)

Income: Income: increases in economic benefits that result in increases in increases in economic benefits that result in increases in equity equity

(other than those related to contributions from shareholders)(other than those related to contributions from shareholders) Income includes both revenues (resulting from ordinary Income includes both revenues (resulting from ordinary

activities) and gainsactivities) and gains Gains are not treated as a separate element since they may also Gains are not treated as a separate element since they may also

arise due to ordinary activities. Income may be realized or arise due to ordinary activities. Income may be realized or unrealizedunrealized

Expenses:Expenses: decreases in economic benefits that result in decreases decreases in economic benefits that result in decreases in equity in equity

(other than those related to distributions to shareholders)(other than those related to distributions to shareholders) Expenses result from ordinary activitiesExpenses result from ordinary activities Similar to gains, losses may also result from ordinary activities Similar to gains, losses may also result from ordinary activities

so are not treated as separate elementsso are not treated as separate elements Expenses may be realized or not realizedExpenses may be realized or not realized

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GAAP HierarchyGAAP Hierarchy

IAS 8 identifies the GAAP hierarchy as follows:IAS 8 identifies the GAAP hierarchy as follows:

1. IFRS (including IFRS, IAS, IFRIC, and SIC) and 1. IFRS (including IFRS, IAS, IFRIC, and SIC) and implementation guidanceimplementation guidance

2. If no standards exist, financial statement 2. If no standards exist, financial statement preparers may look to similar situations and related preparers may look to similar situations and related issues that are covered by IFRS and the conceptual issues that are covered by IFRS and the conceptual framework andframework and

3. If there is no guidance, we may look to other 3. If there is no guidance, we may look to other standard-setting bodies as long as they do not standard-setting bodies as long as they do not conflict with the aboveconflict with the above

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The Canadian Experience to The Canadian Experience to DateDate

U.S. InfluenceU.S. Influence Canadian GAAP began as a principles-based body of knowledge, while the Canadian GAAP began as a principles-based body of knowledge, while the

U.S. model has been predominantly rules-basedU.S. model has been predominantly rules-based

Two things caused Canada to recently migrate toward the rules-based Two things caused Canada to recently migrate toward the rules-based approach:approach:

1. For the past several years, Canada has had a harmonization mandate 1. For the past several years, Canada has had a harmonization mandate with respect to U.S. GAAP. The objective was to facilitate the flow of with respect to U.S. GAAP. The objective was to facilitate the flow of capital in the North American marketplacecapital in the North American marketplace

2. The Canadian Securities Administrators currently allow Canadian 2. The Canadian Securities Administrators currently allow Canadian companies to use U.S. GAAP if they are SEC reporting issuerscompanies to use U.S. GAAP if they are SEC reporting issuers

International InfluenceInternational Influence In January 2006, the AcSB announced that Canadian GAAP would converge In January 2006, the AcSB announced that Canadian GAAP would converge

with IFRS for publicly accountable entities on or after January 1, 2011with IFRS for publicly accountable entities on or after January 1, 2011 Many standards in the Many standards in the Handbook Handbook are already substantially converged with are already substantially converged with

IFRSIFRS In 2011, the Canadian In 2011, the Canadian HandbookHandbook, will cease to exist for companies that are , will cease to exist for companies that are

publicly accountable and will be effectively replaced by IFRSpublicly accountable and will be effectively replaced by IFRS

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The Canadian Experience to The Canadian Experience to DateDate

TimelineTimeline

In addition, current GAAP regarding changes in accounting In addition, current GAAP regarding changes in accounting policy requires that the impact of accounting standards policy requires that the impact of accounting standards that have been issued but are not yet effective/applied be that have been issued but are not yet effective/applied be disclosed in the financial statementsdisclosed in the financial statements

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The U.S. Experience to DateThe U.S. Experience to Date

The rise of principles-based standards?The rise of principles-based standards? Historically, U.S. GAAP developed without much outside Historically, U.S. GAAP developed without much outside

influence and has been viewed as being a very robust model influence and has been viewed as being a very robust model and gold star standardand gold star standard

The pressures to converge are mounting due to the recent The pressures to converge are mounting due to the recent and not-so-recent abuses of the rules-based GAAP such as and not-so-recent abuses of the rules-based GAAP such as Enron and WorldComEnron and WorldCom

IFRS for Foreign FilersIFRS for Foreign Filers Since the SEC has now allowed foreign filers to use IFRS Since the SEC has now allowed foreign filers to use IFRS

without a reconciliation to U.S. GAAP, the question arises as without a reconciliation to U.S. GAAP, the question arises as to why U.S. companies are not able to follow IFRSto why U.S. companies are not able to follow IFRS

The SEC has just published (September 08) a roadmap that The SEC has just published (September 08) a roadmap that proposes to allow public companies to use IFRS starting in proposes to allow public companies to use IFRS starting in 20142014

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The U.S. Experience to DateThe U.S. Experience to Date

Convergence with IASBConvergence with IASB In terms of the convergence/harmonization mandate, the following In terms of the convergence/harmonization mandate, the following

steps have been taken:steps have been taken: The Norwalk Agreement (2002)The Norwalk Agreement (2002) Roadmap for convergence (2006)Roadmap for convergence (2006)

Roadblocks in the RoadmapRoadblocks in the Roadmap The fate of the codification project?The fate of the codification project?

Significant funds spent to dateSignificant funds spent to date Additional disclosures and safe harbour rulesAdditional disclosures and safe harbour rules

IFRS requires more disclosures in the financial statements – IFRS requires more disclosures in the financial statements – will this mean more risk of lawsuits for preparers and will this mean more risk of lawsuits for preparers and auditors?auditors?

Any legal protection?Any legal protection? Decreasing influence of U.S. constituentsDecreasing influence of U.S. constituents Funding for IASB – independence?Funding for IASB – independence?

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Looking AheadLooking Ahead The IASB is currently overhauling the framework with FASBThe IASB is currently overhauling the framework with FASB

According to the proposed framework currently being finalized:According to the proposed framework currently being finalized:

The objective of general purpose financial reporting is to provide financial The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to present and information about the reporting entity that is useful to present and potential investors and creditors in making decisions as capital providerspotential investors and creditors in making decisions as capital providers

The emphasis is on resource allocation (lending and investing) and The emphasis is on resource allocation (lending and investing) and assessment of management stewardshipassessment of management stewardship

With regards to the qualitative characteristics of useful financial With regards to the qualitative characteristics of useful financial information:information: Faithful representation is attained when the substance of an economic Faithful representation is attained when the substance of an economic

phenomenon is depicted completely, accurately, and neutrallyphenomenon is depicted completely, accurately, and neutrally Conservatism/prudence will be excluded from the qualitative Conservatism/prudence will be excluded from the qualitative

characteristics of accounting information as they conflict with neutralitycharacteristics of accounting information as they conflict with neutrality Reliability is now gone from the framework (absorbed into the concept Reliability is now gone from the framework (absorbed into the concept

of faithful representation)of faithful representation)

Looking AheadLooking Ahead The IASB and FASB have agreed on the following changes in The IASB and FASB have agreed on the following changes in

definitions. (these views have not yet been exposed in an definitions. (these views have not yet been exposed in an Exposure Draft)Exposure Draft)

The following definitions have been proposed:The following definitions have been proposed:

-An -An asset asset of an entity is a of an entity is a present economic resource present economic resource to to which, through an which, through an enforceable right enforceable right or other means, the or other means, the entity has access entity has access or can limit the access of othersor can limit the access of others

-An -An economic resource economic resource is something scarce that has positive is something scarce that has positive economic value. It is capable of being used to carry out economic value. It is capable of being used to carry out economic activities, such as production and exchangeeconomic activities, such as production and exchange

-A -A liability liability of an entity is a present economic obligation that is of an entity is a present economic obligation that is enforceable against the entity. The framework will define a enforceable against the entity. The framework will define a liability as an economic obligation rather than a probable future liability as an economic obligation rather than a probable future sacrificesacrifice

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Measurement Model Measurement Model

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End-of-Chapter PracticeEnd-of-Chapter Practice

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