• The Conceptual Framework for Financial Reporting implies that the two fundamental qualitative characteristics (relevance and faithful representation) are vital as, without them, financial statements would not be useful, in fact, they may be misleading. As the name suggests, the four enhancing qualitative characteristics (comparability, verifiability, timeliness and understandability) improve the usefulness of the financial information. Thus financial information which is not relevant or does not give a faithful representation is not useful (and worse, it may be misleading);
• Financial information which does not possess the enhancing characteristics can still be useful, but not as useful as if it did possess them. For financial statements to be useful to users (such as investors or loan providers), they must present financial information faithfully, i.e. financial information must faithfully represent the economic phenomena which it purports to represent (e.g. in some cases it may be necessary to treat a sale and repurchase agreement as an in-substance (secured) loan rather than as a sale and subsequent repurchase).
• Faithfully represented information should be complete, neutral and free from error. The substance is not identified as a separate characteristic because the IASB says it is implied in a faithful representation such that faithful representation is only possible if transactions and economic phenomena are accounted for according to their substance and economic reality.

Under the IASB Conceptual Framework, Network Bank Ltd should not recognise any asset or liability at the time it places the order, because the transaction has not taken place. There is no obligation arising from past events.
The Framework recognises purchase transactions when delivery takes place, and title passes. At this point the bank, and not the manufacturer, has assumed the risks and rewards of owning the ATM machine.

Nonetheless, the bank has made an important and irrevocable commitment. Generally, major capital spending commitments are disclosed in the notes to the financial statements

Criteria for recognition of asset or liability – 1.5 marks
Explanation of whether or not the Bank can be recognised – 1.5 marks

The definition of liability can help decide the accounting treatment of the situation. Under the conceptual framework a liability is 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 resources embodying economic benefits. In this case, the past event is the fall and injury to the pedestrian.

Present obligation depends on the probability of payment. The solicitors has advised that a GH¢17,000 loss is probable. Therefore appropriate accounting involves recognizing a liability for the probable payment. An expense would also be recognized.

(Criteria for recognition of liability – 2 marks)
(Explanation of whether or not the Bank can be recognized – 2 marks)

The conceptual framework defines equity as ‘the residual interest in the assets of the entity after deducting all its liabilities’.
Equity cannot be identified independently of the other elements in the statement of financial position/balance sheet. The characteristics of equity are that equity is a residual, i.e. something left over after the entity has determined its assets and liabilities. In other words: Equity = Assets –Liabilities.

There is no need for recognition criteria for equity as it is a residual, determined after recognition criteria are applied to the other elements. In other words, the recognition of assets and liabilities will lead to recognition of equity.
*Definition of equity – 2 marks
*Explanation of reason for equity recognition – 2 marks

The Framework addresses:

• the objective of general purpose financial reporting.
• qualitative characteristics of useful financial information.
• financial statements and the reporting entity.
• the elements of financial statements.
• recognition and derecognition.
• measurement.
• presentation and disclosure.
• concepts of capital and capital maintenance.                                                                                                   (Any 4)

i) Photographs of the company’s founders, which are of great sentimental value.
The asset definition is failed as the photographs do not represent future economic benefits (para. 49(a)). Future economic benefits constitute the potential to contribute, directly or indirectly, to the flow of cash and cash equivalents to an entity (para. 53).
Recognition criteria are thus irrelevant, as there is no asset to recognise.

ii) Donation of GH¢10,000.
The asset definition (para. 49(a)) is met as all 3 characteristics are present. –

• Past event: The receipt of the donation.
• Flow of future economic benefits: The donation represents an inflow of GH¢10, 000 cash into Tatale Ltd.
• Control over the future economic benefits: Tatale Ltd will benefit from this GH¢10, 000 cash inflow and can deny or regulate the access of others to this cash inflow
  Therefore, an asset of GH¢10 000 must be recognised.

The income definition (para. 70(a)) is met as all 3 characteristics are present.

• Increase in economic benefits during the period:
• In the form of an asset increase: Tatale Ltd now has additional cash of GH¢10 000.
• Results in an increase in equity: If assets increase and liabilities remain unchanged, equity increases.
  Therefore, income of GH¢10,000 must also be recognised. Note that in this case the recognition of an asset has resulted in the simultaneous recognition of income (para. 84 and 92).

iii) Obsolete plant now retired from use
The asset definition is failed as the plant no longer represents future economic benefits (para. 49(a)).
The plant must now be written off from the accounts.
Recognition criteria are thus irrelevant, as there is no asset to recognise.

• Economic Reality is more important: In substance over form principle the economic reality of transaction is more important than legal form of the transaction. Thus the transaction are not recorded merely on the bases of legal reality and economic reality is more relevant for accounting for the transaction. This is an important characteristic of this principle.
• Portray Real Nature of Transaction: Another important characteristic of Substance over form principle is portraying the real picture of the transactions. This approach discourages the hiding the actual nature of transaction. This concept has been explained with few examples.
• Achieve Faithful Representation: Application of prudence concept helps in achieving the faithful representation of
  financial statements. Faithful representation of financial statements is an important accounting principle.
• It has become clear that any hard rule can be creatively circumvented by contriving transactions appropriately. This is because transactions are necessarily structured between parties as they wish, and to suit their business needs. Regulators cannot anticipate the needs of transacting parties, and rules by their nature always lag behind the transactions themselves. In other words, as regulators see a transaction that is not covered by the existing rules, they seek to “plug the gap”. This is not a satisfactory way to ensure that financial statements reflect truth and fairness.           (2 valid points for 4 marks)
  

There are some key tell-tale indicators that should alert the accountant to the possibility that substance and form issues may exist. Some of these are:

• If two or more transactions are executed together, and the combined effect of both taken together is different from the effect of each individually, this is worth investigating. For example a sale transaction selling an asset (possibly at a price in excess of market) and an agreement to lease back that same asset (possibly at an inflated rental).
• Business arrangements entered into which seem to disproportionately advantage one party over another. There is nothing legally wrong with entering into an arrangement that is not in your best interests, but rational business people tend not to do so unless there is a benefit elsewhere.
• Contrived option arrangements that serve to divert risk from where it might otherwise lie.
• Unusual terms in business agreements that might affect our assessment of the timing of revenues and costs.
• Transactions that may be structured to manipulate the reported results, for example by misreporting expenses as assets, or liabilities as revenue.                                                                                                                                                       (Any 4)

Financial capital maintenance: Under this concept, a profit is earned only if the financial (or money) amount of the net assets at the end of the period exceeds the financial (or money) amount of net assets at the beginning of the period, after excluding any distributions to, and contributions from owners during the period. Financial capital maintenance can be measured in either nominal monetary units or units of constraint purchasing power.
Physical capital maintenance: Under this concept, a profit is earned only if the physical productive capacity (or operating capability) of the entity (or the resources or funds needed to achieve that capacity) at the end of the period exceeds the physical productive capacity at the beginning of the period, after excluding any distributions to, and contributions from owners during the period.

• According to IAS 16 Property, Plant and Equipment all purchased items of property, plant and equipment are initially recognised at cost, after this an entity may choose to apply the cost model, where PPE is carried at cost less accumulated depreciation, or the revaluation model, where an item of PPE is carried at re-valued amount.
• If the revaluation model is used the entire class of PPE to which that asset belongs must be re-valued. The frequency of revaluation depends on the movements in the fair value of the items being re-valued, but where there are significant movements in fair value, annual revaluations may be required.
• The cost model is more objective as a cost is definite but is providing out of date information. The revaluation model could be considered more subjective as it relies on expert valuers to provide reliable measures of fair value. These measures will be more up to date but may lead to large revaluation gains and losses in the event of a booming property market followed by a crash, as is the case here. The cost model will be cheaper to apply as no expert opinions are required.
• Allowing two models leads to a lack of comparability across reporting entities, not just in the statement of financial position but also in the statement of profit or loss as the depreciation charges will be adjusted for revaluation.                         (Any 2)
  

• It fails to account for externalities. Backward looking, (Historic data) therefore information is of limited use. Decision usefulness to who? – Suppliers of capital (effectively shareholders) – limited accountability.
• Estimates and many areas of judgement – do accountants construct their reality of how the world is?
• Conceptual Framework supports the view that information on financial performance and position should be primarily for suppliers of capital.
• Narrow view of accountability/serves capitalist system – what about other key stakeholders?
• Contract an organization should have with society (e.g. Banks). Ethic of accountability.
• Need wider system of reporting (e.g. Environmental/sustainability/integrated reporting).
• Cost of preparing reports (e.g. separate sustainability report) for different users can be prohibitive.                           (Any 5)
  

• They reduce or eliminate confusing variations in the methods used to prepare financial statements.
• They provide a focal point for debate and discussions about accounting practice.
• They oblige companies to disclose the accounting policies used in preparation of accounts.
• They are a less rigid alternative to enforcing conformity by means of legislation.
• They have obliged companies to disclose more accounting information than they would otherwise have done if accounting standards did not exist.
  

Advantages of Harmonization

• The first and most important advantage of harmonization of reporting standards is to achieve comparability in financial statements. Due to different sets of financial reporting standards, the way financial statements prepared and presented are different from each other which make it complicated to compare them. This is even more noticeable in multinational companies when they operate in more than just one country. If international harmonization is achieved, the level of international comparability also increases making it easier for companies to prepare the financial statements under one set of rules; investors who understand the financial statements due to the nature of IFRS and make well thought investment decisions.
• International Expansion
  Moving to a single set of global financial standards would also ease barriers to expansion for companies. If companies wish to expand overseas today, they need to consider international costs of compliance, which could mean adopting a completely new set of accounting records to meet statutory requirements in the new country. In some cases, this would nearly double the company’s accounting costs. For many small businesses, even the large rewards of moving overseas are dwarfed by these expansion costs.
• Central Authoritative Body
  From a policy-making standpoint, moving to a single set of global standards puts rule making into the hands of one body. Currently, accounting standards are set within each country by each standard-setting body, as well as by an international group. One set of standards would reduce disagreement between countries and international regulators, and it might also cut costs. In some countries, businesses are required to pay reporting fees that go to fund these standard-setting bodies. While the costs may not affect large companies, they can have a huge impact on a small business. Moving to a central authoritative body could reduce these costs drastically.
• There will be increased auditing efficiency and money saving as companies has to use only one set of reporting standards. This also serves to reduce trade barriers among countries allowing more access to international capital markets.
• Another advantage worth noting is the consistency to be achieved under IFRS as it was one of the objectives of IFRS as a single reporting standard. The consistency also contributes to better understanding between investors, lenders and other businesses as there will be the nature of predictability in place. Moreover, companies operating in different countries also can use their expertise and systems in all countries they are operating due to consistency of the reporting standards. Another benefit that derives from consistency is the time scale needed to implement in new countries as there will be no need to learn and adapt to new country specific rules except minor adjustments.                                                                     (Any 3)

Disadvantages of Harmonization

• Cultural Differences
  One of the criticisms of harmonized accounting standards is that the IASB has failed to fully take into account the cultural, political and social differences between countries. This is particularly relevant to their implementation in developing countries, where language barriers, attitudes toward accounting and other socio-cultural aspects may affect their interpretation and application. For example, when the harmonized standards were implemented in Jordan, they were first translated into Arabic. Even though technical accounting terms have been well-defined in Arabic, challenges arose when the English terminology was hard to interpret or used inconsistently and, therefore, difficult to translate accurately.
• Worldwide Acceptance
  National accounting standards are highly politicized and there is often a natural tendency to place the interests of the national economy ahead of those of the global economy. Private sector businesses and professional accounting bodies also have a vested interest in accounting practices and financial reporting. Pressure from these groups to change or reject certain standards can carry a lot of weight with political decision makers. Adopting international financial standards is met with additional challenges in developing countries. They often lack the resources and infrastructure to adapt national legal and legislative frameworks in which to house the standards, making proper implementation difficult.
• International Enforcement
  The success of harmonized financial reporting depends on individual governments enforcing adherence to the international standards once they have been implemented. In 2008, the French authorities allowed the bank Société Générale to transfer some of its losses from 2008 to 2007, meaning its financial statement for 2008 looked much better than the reality. This provoked an international outcry, not the least from the IASB. When exceptions are made, it undermines the integrity of the whole system and renders it ineffective.
• Training and Retraining
  When a country decides to harmonize with the international standards, its companies, accountants and auditors need to be retrained in the new standards and reporting procedures for financial statements. College and university programs in this field also have to undergo significant changes in order to educate new people entering the profession. Before any of this can happen, trainers and professors will require training so they can instruct professionals and students. This will require the development of new learning materials and curricula, new examinations for professional licensing and new accounting software and reporting systems. To further complicate matters, the adoption of harmonized standards has to be phased in, so for a number of years, two different systems are in operation. Such a complex transition requires a lot of safety mechanisms to ensure it achieves uniform results.
• Another disadvantage of harmonization is when there exists different economic environment as harmonization could be considered useless. If a particular country has its own practice in place, and even though they adapt to use one of the international reporting standards, it could be more harmful to the country rather than make anything good. This is because the irrelevant element of the new reporting standard may be of no use and therefore may even introduce ambiguity and complication to that country’s reporting standards.                                                                                       (Any 3)

• Historical cost is whereby assets are recorded at the amount of cash or cash equivalents paid or fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amounts of proceeds received in exchange for the obligation, or in some circumstances at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business..
• Current cost whereby assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently, and liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently.
• Realisable (settlement) value is the amount of cash or equivalents that could currently be obtained by selling an asset in an orderly disposal. Settlement value is the undiscounted amounts of cash and cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.
• Present value is the presented discounted value of the future net cash flows in the normal course of business.

The IASB Framework for the Preparation and Presentation of Financial Statements (IASB Framework) says that information is relevant ―when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations. For accounting information to be relevant, ―accounting information must be capable of making a difference in a decision by helping users to form predictions about the outcomes of past, present, and future events or to confirm or correct expectations, and goes on to define event and outcome.

CPP makes adjustments for general inflation whereas CCA allows for specific price movements (changes in the deprival value of assets).
Specific price changes (in CCA) enable a company to determine whether its operating capability has been maintained. The two concepts use different concepts of capital maintenance; namely operating capability with CCA and general purchasing power with CPP.

• It is probable that any future economic benefit associated with the item will flow to or from the entity.
• The item has a cost or value that can be measured with reliability.

• Different purposes of financial reporting
• Different legal system
• Different user groups
• Needs of developing countries
• Nationalism demonstrated in the unwillingness to accept another country’s standards
• Cultural differences resulting in different objectives for accounting systems
• Unique circumstances
• The lack of strong accountancy bodies                                                                                                                        (Any 3)