Financial Reporting

Contents
IFRS Framework........................................................................................................................... 2
RECOGNITION RULES ............................................................................................................... 2
DERECOGNITION RULES .......................................................................................................... 2
MEASUREMENT RULES ............................................................................................................ 2
Fair Value Measurement ............................................................................................................. 5
STANDARDS REFERRING TO FAIR VALUE................................................................................. 5
IFRS 13 ..................................................................................................................................... 5
FRAMEWORK FOR APPLYING THE DEFINITION ....................................................................... 6
MEASUREMENT OF FAIR VALUE .............................................................................................. 6
VALUATION TECHNIQUES ........................................................................................................ 6
HIERARCHY OF INPUTS ............................................................................................................ 6
IFRS 10 Consolidated Financial Statements - Module 1 ............................................................. 8
PRINCIPLES OF CONSOLIDATION: ............................................................................................ 8
IFRS 10 Consolidated Financial Statements - Module 2 ........................................................... 10
EXEMPTIONS FROM CONSOLIDATION: ................................................................................. 10

1
IFRS Framework
RECOGNITION RULES

Recognition is appropriate if it results in both relevant information about assets, liabilities,

equity, income and expenses and a faithful representation of those items, because the aim is to
provide information that is useful to investors, lenders and other creditors.

The revised recognition criteria refer explicitly to the qualitative characteristics of useful
information.

DERECOGNITION RULES

Asset: when the entity loses control of all or part of the recognised asset

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

MEASUREMENT RULES

Measurement is the process by which monetary values of the various financial statements'
elements are determined. It is at these monetary values that the elements are recognised and
carried in the statement of financial position and statement of comprehensive income.

The framework identifies following measurement bases, which are used to a different degree
and in varying combinations in financial statements:

1. Historical cost , where the basis for computing the carrying amount of an asset is the amount
of cash paid to acquire it in the first place. It has some very clear advantages over the other
approaches:

a. It is easy to calculate and comprehend;

b. It is relatively objective and free from bias, especially if the historical cost at
which an item was acquired is known;

c. It facilitates easy forecasting of future carrying amounts, as the assumptions

used in applying the historical cost approach are relatively insensitive to current
market conditions;

2
 d. Historical cost is easy to verify using transaction-related documents such as
invoices. The main disadvantage is that it does not reflect the current value of
assets or liabilities, where such information would obviously be considered
more useful by readers of financial statements.

2. Current value measurement bases, current value provides information updated to reflect
conditions at the measurement date. current value measurement bases include:

− 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

₋ Reflects market participants’ current expectations about the amount, timing and
uncertainty of future cash flows

− Value in use (for assets) / Fulfilment value (for liabilities):

₋ Reflects entity-specific current expectations about the amount, timing and uncertainty
of future cash flows

− Current cost

₋ Reflects the current amount that would be:

₋ paid to acquire an equivalent asset

₋ received to take on an equivalent liability

Key advantage of CCA: It provides users of financial statements with more relevant
information, which reflects the current state and performance of the company. However, it is
not free from drawbacks, the most important of which are:

− Current cost accounting is typically more subjective and less reliable than the historical cost
approach;

− Applying it may prove a complex task, and it is definitely less familiar to users of financial
information;

− Monetary items are still carried at their historical cost, which might not be relevant under
current market conditions;

3
− It may sometimes be difficult to obtain appropriate current cost values for all non-current
assets, especially if no market for such assets exists.

4
Fair Value Measurement
STANDARDS REFERRING TO FAIR VALUE

− IAS 16: Property, plant and equipment

− IAS 40: Investment property

− IAS 41: Agriculture

− IFRS 9: Financial instruments

− IFRS 13: Fair value measurement

IFRS 13

− IFRS 13 provides a set of measurement rules which must be applied whenever fair value is
required or permitted by another standard.

− It allows for consistency and comparability of fair value measurements used across
different lines within the statement of financial position.

− Where ‘Fair Value’:

− Is defined 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.

− Should be thought of as an exit price.

− Should be determined independent of the reporting entity’s intent or ability to actually

sell the asset or transfer the liability.

− Is a market-based measure, not an entity-specific measure.

− Where ‘Orderly Transaction’:

− Assumes adequate exposure to the market for a period before the measurement date to
provide market participants the ability to obtain awareness and knowledge of the asset
or liability beingvalued.

− Assumes involvement of market participants who are not forced to carry out the
transaction.

5
FRAMEWORK FOR APPLYING THE DEFINITION

The standard states that we must identify the following:

− The particular asset or liability being measured;

− In the case of non-financial assets, the highest and best use of the specified asset;

− The principal, or in some cases, the most advantageous, market for the asset or liability;
and

− The valuation technique appropriate for the actual measurement.

MEASUREMENT OF FAIR VALUE

The standard insists that the measurement of fair value should be based on an orderly
transaction to sell the asset or transfer the liability in either:

− The principal market (market which has the highest volume or level of activity) for the asset
or liability; or

− In the absence of a principal market, the most advantageous market (market which
maximises the amount which would be received to sell the asset or minimises the amount
that would have to be paid to transfer a liability).

VALUATION TECHNIQUES

− The market approach: based on market transactions involving identical or similar assets or
liabilities.

− The income approach: based on future amounts, typically cash flows or income, that are
discounted to their present value.

− The cost approach: links fair value to the amount required to replace an asset in its current
condition.

HIERARCHY OF INPUTS

− Level 1: involve unadjusted quoted prices from active markets for identical assets or
liabilities.

6
− Level 2: inputs comprise of:

− Quoted prices coming from non-active markets, or from active markets but for assets or
liabilities which are similar, instead of identical;

− Observable inputs other than quoted prices; and

− Inputs that are not directly observable but are supported by observable market data.

− Level 3 – inputs that are unobservable.

7
IFRS 10 Consolidated Financial Statements - Module 1
PRINCIPLES OF CONSOLIDATION:

Basic idea: A company which controls one or more other entities is required to present
consolidated financial statements. The entity which exercises control over other businesses is
naturally the parent, whereas the companies over which control is exercised are its subsidiaries.

Although the parent and its subsidiaries remain legally separate, the consolidated financial
statements of the group which they constitute must be prepared as if those entities were, in
fact, a single business. This perspective on reporting the activities of a group is referred to as
the single economic unit concept.

This method of preparing consolidated financial statements involves replacing the cost of the
parent’s investment in subsidiaries with the individual assets and liabilities of those
subsidiaries, which when combined with the assets and liabilities of the parent, provide an
indication of the resources and obligations of the group as a whole.

A key feature of IFRS 10: It establishes the rules for assessing whether the relationship
between one entity and another may, in fact, be deemed to constitute control. An investor
controls an investee if it is exposed, or has rights, to variable returns from its involvement with
the investee and has the ability to affect those returns through its power over the investee.
Accordingly, an investor is deemed to exercise control over an investee if and only if that
investor has all of the following:

a) Power over the investee. This criterion relates to power. An investor has the power when
it has existing rights giving it the current ability to direct the relevant activities of the
investee. IFRS 10 defines relevant activities as those activities of the investee that
significantly affect the investee’s returns. The rights which give the investor the ability to
direct such activities, typically include voting rights, potential voting rights, which arise
from options over shares or instruments that are convertible into shares, or the rights to
appoint key management personnel;

b) Exposure, or rights, to variable returns from its involvement with the investee. Such
conditions are deemed to exist when the investor’s returns have the potential to vary as
a result of the investee’s performance;

c) The ability to use its power over the investee to affect a number of the investor’s
returns. IFRS 10

8
states that an investor who has power over an investee but cannot benefit from that power
does not exercise control. Similarly, an investor who has an exposure to variable returns from
its involvement with the investee, but cannot use its power to direct the activities that affect
the investee’s return, also cannot claim to control the investee.

Once the existence of control is established, IFRS 10 requires a parent to prepare consolidated
financial statements using uniform accounting policies for similar transactions and events.

If a member of the group uses accounting policies which differ from those adopted for the
purposes of preparing consolidated financial statements, appropriate adjustments are required
to ensure conformity with the policies followed by the group.

A potential problem also arises when the individual financial statements of the parent and its
subsidiaries which are used in the preparation of the consolidated financial statements are in
fact prepared as at different reporting dates. IFRS 10 states that if the end of the reporting
period of the parent is different from that of a subsidiary, the subsidiary must prepare, for
consolidation purposes, additional financial information as of the same date as the financial
statements of the parent, unless it is impracticable to so.

In the event that the subsidiary is unable to prepare such additional information, the parent
must use the most recent financial statements which have been prepared by the subsidiary.
These must be adjusted to reflect the effects of significant transactions or events that occurred
between the subsidiary’s reporting date and the date of the consolidated financial statements.
However, the difference between these dates cannot exceed three months.

9
IFRS 10 Consolidated Financial Statements - Module 2
EXEMPTIONS FROM CONSOLIDATION:

Let’s examine the circumstances which allow a parent company to not present consolidated
financial statements or to exclude a subsidiary from consolidation.

Providing exemptions from the requirement to consolidate controlled subsidiaries is potentially

risky and dangerous. The rules are, therefore, quite strict and considerably limit the
circumstances when this may occur.

IFRS 10 states that a parent entity may choose not to prepare consolidated financial statements
if all of the following conditions are met simultaneously:

− The parent itself is a wholly-owned subsidiary, in other words, it has a parent entity that
holds 100% of its shares, or is a partially-owned subsidiary of another entity and all of its
remaining owners have been informed about, and do not object to its intention not to
present consolidated financial statements;
− Its debt or equity instruments, in other words, its bonds or shares, are not traded in a
public market, where public market is to be understood broadly to mean a domestic or
foreign stock exchange or an over-the-counter market;
− It did not file, nor is in the process of filing, its financial statements with a securities
commission or other regulatory body for the purpose of issuing any class of financial
instruments in a public market;
− Its ultimate or any intermediate parent produces consolidated financial statements that are
available for public use and which comply with IFRS.
− A parent who wishes to take advantage of the IFRS 10 exemption from preparing
consolidated financial statements cannot conceal the fact that it exercises control over
other entities, and is, in fact, required to disclose the following information in its separate
financial statements:
− The fact that the exemption from consolidation has been used, and the name and principal
place of business of the company whose IFRS-compliant consolidated financial statements
have been produced for public use; - A list of its significant investments in subsidiaries, joint
ventures and associates;
− A description of the method used to account for the above investments in its separate
financial statements.

10
In addition to the exemption from preparing consolidated financial statements as provided by
IFRS 10, there are also two circumstances when an individual subsidiary may actually be
excluded altogether from consolidated financial statements that are nevertheless being
prepared by the parent entity in a group, or excluded from standard consolidation procedures:

1) The specific subsidiary may be deemed immaterial, and as you should already know,
International Financial Reporting Standards only apply to material items. An immaterial
subsidiary would therefore not require inclusion in the group’s consolidated financial
statements;

2) The second reason pertains to omitting a subsidiary from standard consolidation

procedures. This occurs when the company is acquired with the intention of reselling it in
the short term. In such cases, following guidance contained in IFRS 5, the subsidiary
would be reported under ‘assets held for sale’ within current assets and measured at the
lower of its carrying amount and fair value less costs to sell.

Note: In this case, the subsidiary would show up in the consolidated financial statements but its
treatment would be very different to the way in which other subsidiaries are reported and
measured.

11