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Objective of reporting standards and its contents

April 21, 2023

Background:
Lot of students from a commerce background faces a challenge in WHY and HOW to read an accounting standard or reporting standard under IFRS, IND AS or under any other GAAP (Generally Accepted Accounting Principles). Accounting standard or reporting standard is not a novel or a story which creates interest without relevance. One needs to understand the objective of reporting standards and which principles are enumerated in a reporting standard in order to have interest in the same. In this blog, with respect to a reporting standard, we will understand:

  1. Objectives of reading a reporting standard (Why to read a reporting standard?)
  2. Contents of a reporting standard
  3. Structure of the reporting standard under IFRS
  4. How to read it and interpret the same.

In this blog, we will evaluate the first two aspects of the above points i.e., why to read a reporting standard and contents of the reporting standard. This will help us to understand the overall content of the reporting standard and will bring the necessary context in reading of the reporting standard. In a subsequent blog, we will understand about the structure of the reporting standard and about how to interpret any accounting and reporting provision.

Objectives of reading a reporting standard (Why read a reporting standard?)

Accounting framework is the language of business. Thus, to understand the financial position and financial performance of an entity, it is important to understand the accounting framework in which the financial statements are prepared by that entity. Accounting framework sets out the accounting and reporting principles and financial statements are prepared and presented within the boundaries of the same. Different countries have different accounting frameworks and are popularly called as Generally Accepted Accounting Principles (GAAP). For e.g., accounting framework of India is called as Indian GAAP, of USA is called as US GAAP, of UK is called as UK GAAP etc. Each GAAP contains accounting and reporting principles for preparing financial statements of any entity within that geography.

Each GAAP contains reporting principles structured in the form of “reporting standards”, so that financial statements are prepared with certain qualitative characteristics. In order to understand / evaluate the financial statements (financial position and financial performance) of any entity located in any geography, requisite understanding of that specific GAAP i.e., reporting standards is necessary. Any reporting standards provide 5 reporting principles which help user to evaluate and understand the financial statements of a business entity.

In the next section we will understand which are these 5 most important principles that help the user of financial statements to read and understand financial statements. Knowing and understanding these principles is the first step towards reading a reporting standard with some objective and context.

Contents of the reporting standard (knowing accounting principles)

Reporting standard provides a guideline while preparing the financial statements with the help of five important principles. Every reporting standard mainly will provide guidance on accounting of an item of income, expenditure, asset, liability and equity with the help of principles mentioned below:

1. Recognition – By virtue of this principle, standard provides guidance on ‘when to record a particular transaction related to asset, liability, income or expenditure in the books of an entity’.

For e.g., When to recognise a revenue (income) transaction in the books? If an entity sells goods to its customer on the second last day of the year i.e., on 30 March and the customer receives the goods on 5 April. If shipping terms say that sale will be complete only once it is accepted by the customer, then Revenue cannot be recorded on 30 March, but it has to be recorded on 5 April. Revenue may not be recognised on the date of dispatch. This conclusion may change based on the shipping terms of the revenue contract. This principle of revenue recognition is discussed in the reporting standard related to revenue IFRS 15 – Revenue from contracts with customers.

Similarly, related to recognition of an asset, if an entity pays advance to purchase an asset, it does not mean it has assumed all the risks and rewards related to that asset by paying advance. Thus, on date of advance payment, entity may not be able to recognise asset in the books. Asset will be recognised in the books only upon assuming all the risks and rewards associated with that asset as per the recognition principles provided in the reporting standard related to asset i.e., IAS 16 – Property, plant and equipment.

2. Measurement – By virtue of this principle, standard provides us the guidance about what amount an item of asset, liability, income, or expenditure is to be measured initially when recognised for the first time in financial statements. This principle is “initial measurement principle”. For e.g., with respect to assets, while measuring factory assets initially, reporting standard provides that it will be measured initially “at cost”. It also explains which expenses incurred by an entity will be considered as a part of the cost and which expenses will not be considered as part of the cost.

With respect to assets and liabilities, respective standards provide guidance on how and what amount of that asset or liability is to be carried in the balance sheet in the subsequent years. This principle is “subsequent measurement principle”. For e.g., factory assets once measured at cost initially, subsequently may be measured at cost less depreciation and impairment or at revaluation less depreciation and impairment. Entity has a choice to select the subsequent measurement model.

3. Presentation – By virtue of this principle, standard will provide us the guidance on where an item of asset, liability, equity, income or expenditure is to be presented. For e.g., Revenue is an income from operating activities of an entity. Any other income which does not form part of operating activities is not Revenue. In the “Statement of profit and loss and other comprehensive income”, income from operating activities only can be presented as “Revenue” and income from activities other than operating activities is required to be presented under “Other income”.

Similarly, in the balance sheet in “Equity and liabilities” section, any funds obtained from third party are required to be presented either as equity or as liability depending on the substance of the contract. If the entity has an obligation towards repayment of funds obtained as per contractual terms, then such funds are presented as “liability”. Whereas, if there is no such obligation to repay the funds obtained and the investing party has residual interest in the net assets of the entity, it shall present the instrument under “equity”.

Further, reporting standards will also provide guidance with respect to whether an asset and a liability can be presented net of each other. For e.g., whether deferred tax asset (DTA) and deferred tax liability (DTL) can be presented separately or can be presented either Net DTL or Net DTA. Every such element (asset, liability, equity, income or expenditure) will be presented in the financial statements as per the guidance provided in the respective reporting standard.

4. Derecognition – By virtue of this principle, standard provides guidance as to timing to derecognize (remove) an item of an asset or a liability from the financial statements. Asset or liability cannot be derecognized from the balance sheet till the time entity is using the same actively in its business, even if its carrying value is zero. Thus, the timing of derecognising the asset or liability from the books is important from an accounting perspective. Standards with respect to asset or liability provide guidance as to derecognition of such asset or liability.

5. Disclosures – Not everything can be evaluated by the user of the financial statements from the face of the balance sheet or the statement of profit and loss or other statement like cash flows. Descriptive information with respect to the transactions is required for further analysis of the transaction or analysis of the financial statements. Every reporting standard will provide the additional disclosure requirements which are required to be followed by the entity while preparing the financial statements.

These 5 principles will remain constant across the different accounting frameworks. However, guidance provided underneath each principle may differ considering economic and other scenarios in each geography in the respective GAAP. Accounting / reporting standard must be read to evaluate these 5 principles to account for each element in the financial statements. Reporting standards may provide alternatives while selecting the accounting principles, generally called as “accounting policy choices”. However, once a particular policy is selected, it needs to be applied consistently in order maintain comparability in preparation and presentation of financial statements. Section of each principle is the most relevant section in a reporting standard which an accountant or other user of a financial statement must be aware of while preparing and evaluating the financial statements of any entity.

Finpro Consulting specializes in IFRS / Ind AS accounting and reporting and has helped many of their clients in resolving complex accounting issues including accounting for business combination transactions, preparing consolidated financial statements for complex group structures etc. For more information on the subject, you can get in touch with us at info@finproconsulting.in

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