Accounting (Basics) - Lecture 1
Concepts and principles


Contents
nObjective of financial statements of SME
nQualitative characteristics of information in financial statements
nFinancial position
nPerformance
nRecognition and measurement of assets, liabilities, income and expenses. Accrual basis
nRecognition in financial statements
nInitial and subsequent measurement in financial statements
nOffsetting
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Objective of financial statements of SME
nThe objective of financial statements of SME is to provide information about the financial
position, performance and cash flows of the entity that is useful for economic decision-making by a
broad range of users who are not in a position to demand reports tailored to meet their particular
information needs. Financial statements also show the results of the stewardship of management,
that is, the accountability of management for the resources entrusted to it.
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Qualitative characteristics of info in financial statements
nUnderstandability – the information provided in financial statements should be presented in a way
that makes it comprehensible by users who have a reasonable knowledge of business and economic
activities and accounting and a willingness to study the information with reasonable diligence.
nRelevance – the information provided in financial statements must be relevant to the
decision-making needs of users. Information has the quality of relevance when it is capable of
influencing the economic decisions of users by helping them evaluate past, present or future events
or confirming, or correcting, their past evaluations.
nMateriality – information is material - and therefore has relevance - if its omission or
misstatement could influence the economic decisions of users made on the basis of the financial
statements.
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Qualitative characteristics of info in financial statements
nReliability – the information provided in financial statements must be reliable, that is, it
should be free from material error and bias and represents faithfully that which it either purports
to represent or could reasonably be expected to represent.
nSubstance over form – transactions and other events and conditions should be accounted for and
presented in accordance with their substance and not merely their legal form. This enhances the
reliability of financial statements.
nPrudence – it is the inclusion of a degree of caution in the exercise of the judgements needed in
making the estimates required under conditions of uncertainty, such that assets or income are not
overstated and liabilities or expenses are not understated.
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Qualitative characteristics of info in financial statements
nCompleteness – to be reliable, the information in financial statements must be complete within the
bounds of materiality and cost. An omission can cause information to be false or misleading and
thus unreliable and deficient in terms of its relevance.
nComparability – users must be able to compare the financial statements of an entity through time
to identify trends in its financial position and performance. Users must also be able to compare
the financial statements of different entities to evaluate their relative financial position,
performance and cash flows.
nTimeliness – providing the information within the decision time frame. If there is undue delay in
the reporting of information it may lose its relevance.
nBalance between benefit and cost – the benefits derived from information should exceed the cost of
providing it.
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Financial position
nThe financial position of an entity is the relationship of its assets, liabilities and equity as
of a specific date as presented in the statement of financial position. These are defined as
follows:
a)Asset is a resource controlled by the entity as a result of past events and from which future
economic benefits are expected to flow to the entity.
b)Liability is a present obligation of the entity arising from past events, settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits.
c)Equity is the residual interest in the assets of the entity after deducting all its liabilities.
nThe expectation that future economic benefits will flow to or from an entity must be sufficiently
certain to meet the probability criterion before an asset or liability is recognized.
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Financial position
nIFRS for SMEs guidance for assets to be recognized as assets:
a)The future economic benefit of an asset is its potential to contribute, directly or indirectly,
to the flow of cash and cash equivalents to the entity. Those cash flows may come from using the
asset or from disposing of it.
b)Many assets, for example property, plant and equipment, have a physical form. However, physical
form is not essential to the existence of an asset. Some assets are intangible.
c)In determining the existence of an asset, the right of ownership is not essential. Thus, for
example, property held on a lease is an asset if the entity controls the benefits that are expected
to flow from the property.
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Financial position
nIFRS for SMEs guidance for liabilities to be recognized as liabilities:
a)An essential characteristic of a liability is that the entity has a present obligation to act or
perform in a particular way. The obligation may be either a legal obligation or a constructive
obligation:
i.A legal obligation is legally enforceable as a consequence of a binding contract or statutory
requirement.
ii.A constructive obligation is an obligation that derives from an entity’s actions when by an
established pattern of past practice, published policies or a sufficiently specific current
statement, the entity has indicated to other parties that it will accept particular
responsibilities, and, as a result, the entity has created a valid expectation on the part of those
other parties that it will discharge (fulfill) those responsibilities.
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Financial position
b)The settlement of a present obligation usually involves the payment of cash, transfer of other
assets, provision of services, the replacement of that obligation with another obligation, or
conversion of the obligation to equity. An obligation may also be extinguished by other means, such
as a creditor waiving or forfeiting its rights.
nIFRS for SMEs guidance for equity to be recognized as equity:
a)Equity is the residual of recognized assets minus recognized liabilities.
b)It may be subclassified in the statement of financial position. For example, in a corporate
entity, subclassifications may include funds contributed by shareholders, retained earnings and
gains or losses recognized directly in equity.
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Performance
nPerformance is the relationship of the income and expenses of an entity during a reporting period.
IFRS for SMEs permits entities to present performance in a single financial statement (a statement
of comprehensive income) or in two financial statements (an income statement and a statement of
comprehensive income).
nTotal comprehensive income and profit or loss are frequently used as measures of performance or as
the basis for other measures, such as return on investment or earnings per share.
nIFRS for SMEs defines income and expenses as follows:
a)Income is increases in economic benefits during the reporting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in increases in equity, other than
those relating to contributions from equity investors. The definition of income encompasses both
revenue and gains:
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Performance
i.Revenue is income that arises in the course of the ordinary activities of an entity and is
referred to by a variety of names including sales, fees, interest, dividends, royalties and rent.
ii.Gains are other items that meet the definition of income but are not revenue. When gains are
recognized in the statement of comprehensive income, they are usually displayed separately because
knowledge of them is useful for making economic decisions.
b)Expenses are decreases in economic benefits during the reporting period in the form of outflows
or depletions of assets or incurrences of liabilities that result in decreases in equity, other
than those relating to distributions to equity investors. The definition of expenses encompasses
losses as well as those expenses that arise in the course of the ordinary activities of the entity.
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Performance
i.Expenses that arise in the course of the ordinary activities of the entity include, for example,
cost of sales, wages and depreciation. They usually take the form of an outflow or depletion of
assets such as cash and cash equivalents, inventory, or property, plant and equipment.
ii.Losses are other items that meet the definition of expenses and may arise in the course of the
ordinary activities of the entity. When losses are recognized in the statement of comprehensive
income, they are usually presented separately because knowledge of them is useful for making
economic decisions.
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Recognition and measurement of assets, liabilities, income and expenses. Accrual basis
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nRecognition is the process of incorporating in the financial statements an item that meets the
definition of an asset, liability, income or expense and satisfies the following criteria:
a)it is probable that any future economic benefit associated with the item will flow to or from the
entity
b)the item has a cost or value that can be measured reliably
nMeasurement is the process of determining the monetary amounts at which an entity measures assets,
liabilities, income and expenses in its financial statements. Measurement involves the selection of
a basis of measurement. Two common measurement bases are:
a)Historical cost:
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Recognition and measurement of assets, liabilities, income and expenses. Accrual basis
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i.
i.for assets - it is the amount of cash or cash equivalents paid or the fair value of the
consideration given to acquire the asset at the time of its acquisition.
ii.for liabilities - it is the amount of proceeds of cash or cash equivalents received or the fair
value of non-cash assets received in exchange for the obligation at the time the obligation is
incurred, or in some circumstances (for example, income tax) the amounts of cash or cash
equivalents expected to be paid to settle the liability in the normal course of business.
nAmortized historical cost is the historical cost of an asset or liability plus or minus that
portion of its historical cost previously recognized as expense or income.
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Recognition and measurement of assets, liabilities, income and expenses. Accrual basis
b)
b)
b)Fair value – it is the amount for which an asset could be exchanged, or a liability settled,
between knowledgeable, willing parties in an arm’s length transaction.
nAn entity shall prepare its financial statements, except for cash flow information, using the
accrual basis of accounting. On the accrual basis, items are recognized as assets, liabilities,
equity, income or expenses when they satisfy the definitions and recognition criteria for those
items.
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Recognition in financial statements
nAn entity shall recognize an asset in the statement of financial position when it is probable that
the future economic benefits will flow to the entity and the asset has a cost or value that can be
measured reliably. An asset is not recognized when expenditure has been incurred for which it is
considered not probable that economic benefits will flow to the entity beyond the current reporting
period. Instead such a transaction results in the recognition of an expense in the statement of
comprehensive income.
nAn entity shall not recognize a contingent asset as an asset. However, when the flow of future
economic benefits to the entity is virtually certain, then the related asset is not a contingent
asset, and its recognition is appropriate.
nAn entity shall recognize a liability in the statement of financial position when:
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Recognition in financial statements
a)the entity has an obligation at the end of the reporting period as a result of a past event,
b)it is probable that the entity will be required to transfer resources embodying economic benefits
in settlement, and
c)the settlement amount can be measured reliably.
nA contingent liability is either a possible but uncertain obligation or a present obligation that
is not recognized because it fails to meet one or both of recognition conditions.
nThe recognition of income results directly from the recognition and measurement of assets and
liabilities. An entity shall recognize income in the statement of comprehensive income when an
increase in future economic benefits related to an increase in an asset or a decrease of a
liability has arisen that can be measured reliably.
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Recognition in financial statements
nThe recognition of expenses results directly from the recognition and measurement of assets and
liabilities. An entity shall recognize expenses in the statement of comprehensive income when a
decrease in future economic benefits related to a decrease in an asset or an increase of a
liability has arisen that can be measured reliably.
nTotal comprehensive income is the arithmetical difference between income and expenses. It is not a
separate element of financial statements, and a separate recognition principle is not needed for
it.
nProfit or loss is the arithmetical difference between income and expenses other than those items
of income and expense that IFRS for SMEs classifies as items of other comprehensive income. It is
not a separate element of financial statements, and a separate recognition principle is not needed
for it.
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Initial and subsequent measurement in financial statements
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nAt initial recognition an entity shall measure assets and liabilities at historical cost.
nDuring subsequent measurement it is necessary to distinguish between financial and non-financial
assets and liabilities. Basic financial assets and basic financial liabilities are subsequently
measured at amortized cost less impairment. An entity generally measures all other financial assets
and financial liabilities at fair value, with changes in fair value recognized in profit or loss.
nMost non-financial assets that an entity initially recognized at historical cost are subsequently
measured on other measurement bases. For example:
a)An entity measures property, plant and equipment at the lower of depreciated cost and recoverable
amount.
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Initial and subsequent measurement in financial statements. Offsetting
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b)An entity measures inventories at the lower of cost and selling price less costs to complete and
sell.
c)An entity recognizes an impairment loss relating to non-financial assets that are in use or held
for sale.
nMeasurement of assets at those lower amounts is intended to ensure that an asset is not measured
at an amount greater than the entity expects to recover from the sale or use of that asset.
nMost liabilities other than financial liabilities are measured at the best estimate of the amount
that would be required to settle the obligation at the reporting date.
nAn entity shall not offset assets and liabilities, or income and expenses, unless required or
permitted by IFRS for SMEs.
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