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Subject 3. The International Financial Reporting Standards Framework
#cfa #cfa-level-1 #financial-reporting-and-analysis #financial-reporting-standards
The IFRS Framework sets forth the concepts that underlie the preparation and presentation of financial statements for external end-users, provides further guidance on the elements from which financial statements are constructed, and discusses the concepts of capital and capital maintenance.

Objectives of Financial Statements

The Framework identifies the central objective of financial statements as providing information about a company that is useful in making economic decisions. Financial statements prepared for this purpose will meet the needs of most end-users. Users generally want information about a company's financial performance, financial position, cash flows, and ability to adapt to changes in the economic environment in which it operates.

The Framework identifies end-users as investors and potential investors, employees, lenders, suppliers, creditors, customers, governments, and the public at large.

Qualitative Characteristics of Financial Statements

The Framework prescribes a number of qualitative characteristics of financial statements. The key characteristics are relevance and reliability. Preparers can face a dilemma in satisfying both criteria at once. For example, information about the outcome of a lawsuit may be relevant, but the financial impact cannot be measured reliably.

Financial information is relevant if it has the capacity to influence an end-user's economic decisions. Relevant information will help users evaluate the past, present, and most importantly, future events in a company.

To be reliable, financial information must represent faithfully the effects of the transactions and events that it reflects. The true impact of transactions and events can be compromised by the difficulty of measuring transactions reliably.

  • Financial information faithfully represents transactions and events when accounted for in accordance with their substance and economic realityand not merely their legal form. Commonly, a legal agreement will purport that a company has "sold" assets to a third party. However, an analysis of the substance of the arrangement indicates that the company retains control over the future economic benefits and risks embodied in the asset, and should continue to recognize it on its own balance sheet.
  • Financial information is reliable if it is free from material error and is complete. Information is material if its omission or misstatement could influence decisions that end-users make on the basis of the financial statements. Information is reliable when it is neutral or free from bias and prudence. A degree of prudence when preparing financial information enhances its reliability. However, a company should not use prudence as the basis for the recognition of, for example, excessive provisions.

Financial information must be easily understandable in addition to being relevant and reliable. Preparers should assume that end-users have a reasonable knowledge of business and economic activities, and an ability to comprehend complex financial matters.

End-users must be able to compare a company's financial statements through time in order to identify trends in financial performance (comparability). Hence, policies on recognition, measurement, and disclosure must be applied consistently over time. Where a company changes its accounting for the recognition or measurement of transactions, it should disclose the change in the Basis of Accounting section of its financial statements and follow the guidance set out in IFRS.

The application of qualitative characteristics and accounting standards usually results in financial statements that show a true and fair view, or fairly present a company's financial position and performance.

The Elements of Financial Statements

The Framework outlines definition and recognition criteria for assets, liabilities, equity, revenues and expenses as the elements of financial statements.

Valuation of elements is based on:

  • Historical costs

    • Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition.
    • Liabilities are recorded at the amount of proceeds received in exchange for the obligation.

  • Current costs

    • Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same asset was acquired currently.
    • Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently.

  • Realizable (settlement) value

    • Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal.
    • Liabilities are carried at their settlement values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.

  • Present value

    • Assets are carried at the present discounted value of the future cash inflows that the item is expected to generate in the normal course of business.
    • Liabilities are carried at the present discounted value of the future net cash outflows that are expected to be required to settle the liabilities in the normal course of business.

  • Fair value

    This is the amount at which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction, which may involve either market measures or present-value measures.

Constraints and Assumptions

There are three inherent constraints.

  • Timeliness. To be relevant, information must be timely; however, it takes time to get reliable information. How to balance between relevance and reliability?

  • Benefit versus cost. Does the cost of providing financial information exceed the benefits derived from the information?

  • Balance between qualitative characteristics. For example, should financial statements omit non-quantifiable information, such as work force creativity which can result in superior financial performance?

Underlying assumptions:

  • Accrual basis. Financial statements shall be prepared on the accrual basis of accounting. No effects of payments are to be considered. All activities are reported to the financial statements of the periods to which they relate.
  • Going concern principle. Financial statements are normally prepared on the assumption that a company is a going concern and will continue in operation for the foreseeable future. There is no intention or need to liquidate the company in the future. If those needs or intentions exist, the financial statements shall be prepared on another basis.


A company sells goods and gets the negotiated selling price. In terms of special circumstances, the company isn't able to determine the costs for the mentioned proceeds.

Revenue and costs from the same activity have to be recognized simultaneously. Therefore, the revenue from a sale shall be recognized when the costs incurred or to be incurred with respect to the transaction can be measured reliably. Revenues won't be able to be shown in this case.
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