KCB Notes - Regulatory and Conceptual Framework

Question 1

What is the role of the regulatory framework

Answer 1

1. To ensure Finance Reporting is regulated through Financial Reporting Standards. IFRS, UK GAAP, US GAAP

2.To ensure financial information is reported objectively to provide relevant, reliable and faithfully represented information.

3. To provide adequate minimum level of information
4. To ensure financial information is comparable and consistent.
5. To improve transparency and credibility of financial reports.

Question 2

Describe the differences between rules based and principals based in relation to regulatory frameworks

Answer 2

Rule Based – Rules are designed to cover every aspect of reporting
e.g: US GAAP system.

Principles Based – It uses a ‘conceptual framework’ to provide an underlying set of principles within which standards are developed.
e.g: IFRS system

Question 3

What are some advantages and disadvantages of a rules or principals system?

Answer 3

ADVANTAGES

Rule based system minimises the exercise of subjective judgement. So there is less scope for controversial arguments.

Principle based system allows flexibility

DISADVANTAGES

A rigid regulatory system will have detrimental effect in the long term.

Political , economical and social differences of different countries are ignored.

Arbitrary valuations are possible.

Rigid standards remove the need for judgements.

Does not provided precision and comparability.

Increased complexity.

Question 4

What does the IASB conceptual framework cover?

Answer 4

The IASB conceptual framework covers:

1. the objectives of financial reporting;
2. the underlying assumptions;
3. the qualitative characteristics; *
4. the elements of financial statements;
5. the recognition (and derecognition) of the elements;
6. the measurement of the elements; and
7. the concepts of capital and capital maintenance.

Question 5

What are the advantages of the IFRS ?

Answer 5

1. Financial statements presented under IFRS make global comparisons easier.
2. Cross-border listing is facilitated, making it easier to raise funds and make investments abroad.
3. Multinational companies with subsidiaries in foreign countries have a common, company-wide accounting language.
4. Foreign companies can be more easily appraised for mergers and acquisitions.
5. Multinational companies benefit for the following reasons: – preparation of group financial statements may be easier;
   a reduction in audit costs might be achieved;
   management control would be improved;
   transfer of accounting knowledge and expertise across national borders would be easier

Question 6

What are the disadvantages of IFRS?

Answer 6

1. The cost of implementing IFRS.
2. The lower level of detail in IFRS.
3. International Financial Reporting Standards are principles-based standards which require the application of judgement. Many do not favour this approach. For example, US GAAPs are more rules-based standards. US accountants are subject to a high degree of litigation and their defence is usually that they complied with the relevant sections of detailed standards which make up US GAAP. They fear that adoption of IFRS will remove this defence.
4. There are challenges in adopting IFRS in emerging economies, namely: – the economic environment; – incompatible legal and regulatory environments; – concern around SMEs; – level of preparedness; and – education needs of auditors

Question 7

What are barriers to global harmonisation?

Answer 7

Legal system: this affects the accounting standardisation process – such as whether the legal system is based on common law or code law. The differences in the legal system can restrict the development of certain accounting practices.

Business financing and accounting practices: decision-making processes regarding arrangement of funds may include accounting practices. Many countries do not have strong independent accountancy or business bodies which would press for higher standards and greater harmonisation.

Tax system: a country’s tax system is very influential, particularly in terms of its connection with accounting. In most countries, tax authorities may influence the accounting rules around recording of revenues and expenses.

Level of inflation: this is likely to influence valuation methods for various types of assets.

Political and economic relationships: while Commonwealth countries may share similarities in their accounting and tax systems, cultural differences may still result in accounting systems differing from country to country. In addition, developing countries may have less developed standards and principles, although this is not always the case. Some countries may be experiencing unusual circumstances (civil war, currency restrictions) which affect all aspects of everyday life. Others may resist the adoption of ‘another country’s standard’ for nationalism reasons.

Question 8

What type of companies need to adopt what systems?

Answer 8

Listed companies – must adopt IFRS
Non-listed Companies - Choice between IFRS or UK GAAP.
3 major FRS – FRS 100, FRS 101, FRS 102.
The important FRS for our study is FRS 102

Question 9

What does FRS102 relate to?

Answer 9

This standard is the standard based on IFRS for Small and Medium enterprises.

Question 10

In FRS 102, what is the size of a small and medium company?

Answer 10

Small
Turnover £632k - £10.2m
Assets £513k - £5.1m
No. of Employees 10-50

Medium
Turnover £10.2m - £36m
Assets £5.1 - £18m
No. of Employees 50-250

Question 11

There are 11 important differences between UKGAPP and IFRS regimes Conceptual framework deals with 6 issues. What are they?

Answer 11

Conceptual Framework deals with six issues.

1.the objective of general-purpose financial reporting

2.the qualitative characteristics that determine the usefulness of information in financial statements

3.financial statements and the reporting entity

4.the definitions, recognition, derecognition and measurement of the elements from which financial statements are constructed

5.concepts and guidance related to presentation and disclosure

6. concepts of capital and capital maintenance

Question 12

What is the purpose of Conceptual Framework?

Answer 12

1. to assist the IASB in the development of future IFRS.
2. to provide a basis for reducing the number of alternative accounting treatments permitted by IFRS
3. to assist national standard setting bodies in developing national standards
4. to assist preparers of financial statements in applying IFRS
5. to assist auditors in forming an opinion as to whether financial statements comply with IFRS
6. to assist users of financial statements in interpreting the financial statements prepared in compliance with IFRS
7. to provide those who are interested in the work of the IASB with information about its approach to the formulation of IFRS

Question 13

What is the objective of general purpose financial reporting?

Answer 13

The objective of general purpose financial reporting is ‘to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders and other users in making decisions about providing resources to the entity’.

Question 14

What are the Qualitative Characteristics of financial information?

Answer 14

Qualitative Characteristics
RELEVANCE - Financial information is regarded as relevant if it is capable of influencing the decisions of users.
What is relevant? Consider the materiality test.
Materiality- items are material if their omission or misstatement could influence the economic decisions of users.

FAITHFUL REPRESENTATION means that financial information must meet three criteria: completeness, neutrality and be free from error.

In addition, the information should be
Completeness: all information that users need to understand the item is given.
Neutral or unbiased: there is no bias in the selection or presentation of information.
Free from error: there are no omissions, errors or inaccuracies in the process to produce the information.
Prudence concept - Exercise of caution when making judgements under conditions of uncertainty. ​Do not overstate assets and income​, do not understate liabilities and expenses.

Question 15

What are the enhanced Qualitative Characteristics of financial information?

Answer 15

COMPARABILITY - The accounting methods must be applied consistently for similar situations. This facilitates comparison with similar information about other entities and with similar information about the same entity for another period.

VERIFIABILITY - The accounting information presented in financial statements must be checked to be true, accurate or justified. If something is not verifiable, it is unlikely to be auditable; hence, its reliability and usefulness is diminished.

TIMELINESS of accounting information is important due to its usefulness and relevance to the decision-making needs of the users of financial statements. Local legislation and market regulations impose specific deadlines on certain entities. Timeliness is important to protect the users of the financial statements from outdated information.

UNDERSTANDABILITY Information should be understandable through appropriate classification, characterisation and presentation of information. Some financial transactions are inherently complex and difficult to understand, but to omit such information would not give a fair representation of the financial statements. It is therefore important that the format and layout of the financial statements, the accounting policies applied, the terminology used, and other statements made within the financial statements are clear and concise

Question 16

What is the going concern concept?

Answer 16

The entity will continue in operation for the foreseeable future.

Question 17

What are the accounting definitions for asset, liability, equity, income and expenses

Answer 17

Assets - 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 future economic benefits.

Liabilities - A liability is a present obligation or duty of responsibility of the entity to transfer an economic resource as a result of past transactions or events that the entity has no practical ability to avoid.

Equity - This is the ‘residual interest’ in the assets of the entity after deducting all its liabilities.

Income - Income is increases in assets or decreases in liabilities that result in an increase in equity, other than those relating to contributions from holders of equity claims.

Expenses - Expenses are decreases in assets or increases in liabilities that result in a decrease in equity, other than those relating to distributions to holders of equity claims.

Question 18

Outline recognition

Answer 18

An item needs to meet the definition of an asset, a liability or equity to be recognised in the statement of financial position.

Likewise, an item needs to meet the definition of income or expenses to be recognised in the statement of profit or loss and OCI.

In addition to meeting the definition of an element, items are only recognised when their recognition provides users of financial statements with information that is both relevant and a faithful representation of the element being represented

Question 19

Outline decogntition

Answer 19

Derecognition is the removal of all or part of a recognised asset or liability from an entity’s statement of financial position.

Asset: derecognition of an asset occurs when the entity loses control of all or part of the recognised asset.

Liability: derecognition of a liability occurs when the entity no longer has a present obligation for all or part of the recognised liability.

Question 20

Explain the term ‘substance over form’

Answer 20

Substance over form is the concept that the financial statements and accompanying disclosures of a business should reflect the underlying realities of accounting transactions. Conversely, the information appearing in the financial statements should not merely comply with the legal form in which they appear.

Question 21

What is historical costs and what standards include guidelines for initial recognition of assets?

Answer 21

HISTORICAL COST OF AN ASSET IS THE PRICE PAID OR COST INCURRED TO ACQUIRE OR CREATE THE ASSET .​
​
THE HISTORICAL COST OF AN ASSET IS REDUCED TO SHOW ANY CONSUMPTION OF THE ASSET OR ANY IMPAIRMENT TO THE VALUE. ​

STANDARDS INCLUDING GUIDELINES FOR INITIAL RECOGNITION OF ASSETS:​
​
* IAS 16 * IAS 38 * IAS 40​

Question 22

What is current value basis in relation to assets?

Answer 22

Current value accounting is the concept that assets and liabilities be measured at the current value at which they could be sold or settled as of the current date.

This varies from the historically-used method of only recording assets and liabilities at the amounts at which they were originally acquired or incurred (which represents a more conservative viewpoint).

Both Generally Accepted Accounting Principles and International Financial Reporting Standards have been moving in the direction of requiring more current value accounting, so that fewer assets and liabilities are still recorded on the balance sheet at their original costs.

Question 23

What does fair value mean in relation to current value basis of assets and what standard provides info. around this?

Answer 23

Fair value of an asset: market participants’ current expectation of the amount to be received in a sale in an orderly transaction. ​

Fair value of a liability: market participants’ current expectation of the amount to be paid to transfer a liability in an orderly transaction. ​

IFRS 13

Question 24

What are the concepts of capital maintenance?

Answer 24

1. Financial concepts of capital maintenance
2. Physical concepts of capital maintenance

FINANCIAL

Capital is linked to the NET ASSETS of the company.​
Net Assets = Assets - Liabilities So Net Assets = Equity​
Profit is earned only if ……​
Money financial capital maintenance ​
Real financial capital maintenance

PHYSICAL
Capital is regarded as its production capacity.​
Profit is earned only if the production capacity at the end of the year exceeds the production capacity at the beginning of the year excluding any distributions to or contributions from the owners.

Question 25

Explain the need for a regulatory framework for Financial Reporting.

Answer 25

To facilitate the development of International Financial Reporting Standards, to provide quality cross-border financial information by providing a platform for global financial reporting.

Question 26

Explain the role of any financial reporting standard.

Answer 26

To improve the transparency of financial reporting and make financial information reliable, relevant and easier to understand.

To reduce the risk of creative accounting.

To make the financial statements of different period or of different entities comparable.

To increase the credibility of financial statements by improving the uniformity of accounting treatment between companies; and

To provide quality financial reports and accounting information which can be relied upon for consistency, commonality and overall transparency.

Question 27

Briefly discuss the two main approaches to regulatory framework.

Answer 27

Rule Based Regulatory System – every eventuality is covered by precise and inflexible rules which deal with the accounting treatment of that eventuality.

Principles Based Regulatory System – a conceptual framework is used which provides an underlying set of principles within which standards are developed to deal with the treatment of accounting issues.

Question 28

What is the role of financial and accounting standards in the preparation of the accounting statements?

Answer 28

Ensuring transparency in financial reporting through standardisation, harmonisation and convergence of accounting regulation.

Ensuring quality financial reports and accounting information meeting the requirements of institutions for global capital movement.

Compelling companies to disclose the accounting policies they have adopted as well as additional information that they might not disclose if the standards did not exist.

Question 29

List the key objectives of the financial and accounting standards.

Answer 29

improving the transparency of financial reporting and make financial information reliable, relevant and easier to understand.

reducing the risk of creative accounting.

making the financial statements of different period or of different entities comparable.

increasing the credibility of financial statements by improving the uniformity of accounting treatment between companies; and

providing quality financial reports and accounting information which can be relied upon for consistency, commonality and overall transparency.

Question 30

What are the arguments against accounting regulation?

Answer 30

A rigid accounting regulation could have a detrimental effect in the long term. The influence of political, economic and cultural climates of different countries is often ignored. One reporting regulation may not fit all countries when considering disclosure regulation.

• Frameworks apply to entities from various industries and the tendency to enforce standardisation may not be suitable for those on the margins. The choices provided by accounting standard setters, such as on the valuation of inventories, can be arbitrary. There would be considerable disagreement as to the method to be used, which could distort the comparability of companies’ financial statements.
• There is a concern amongst some professionals that standards tend to remove the need for accountants to exercise their judgement. However, others argue there is still plenty of scope for this.
• A key criticism of standardisation is that it gives an illusion of precision and comparability. This is debatable and arguably not fully justified in view of the wide range of subjective decisions that have to be made.
• There are simply too many standards of increasing complexity.

Question 31

Define a traded company, a quoted company and a public company.

Answer 31

Traded Company: A company with securities traded on a regulated market, such as the London Stock Exchange’s main market.

Quoted Company: A company whose equity share capital is listed on a stock exchange such as the London Stock Exchange. AIM companies are not quoted.

Public Company: A company whose certificate of incorporation states that it is a public company.