Slide 2.1 Accounting and Reporting on an Accrual Accounting Basis Chapter 2

Slide 2.2 Objectives By the end of this chapter, you should be able to: explain the historical cost convention and accrual concept; adjust cash receipts and payments in accordance with IAS 18 Revenue; account for the amount of non-current assets used during the accounting period; prepare a statement of income and a statement of financial position; reconcile cash flow accounting and accrual accounting data.

Slide 2.3 Objective of financial statements To provide information about The financial position The financial performance Capability of an enterprise to adapt and Changes in the amount due to equity owners General purpose: Useful to a wide range of users in making economic decisions (IASB)

Slide 2.4 Common information needs for decision making All the information needs of all users cannot be met, but –Some needs are common to all users, for example some interest in the financial position, performance and adaptability of the enterprise as a whole. So, which user is the primary target? The IASB states that, as investors are providers of risk capital, financial statements that meet their needs would also meet the needs of other users.

Slide 2.5 Decision makers need to assess the ability to generate cash The IASB considers that economic decisions require an evaluation of  An enterprise’s ability to generate cash and  The timing and certainty of its generation It believes that users are better able to make the evaluation if they are provided with information that focuses on the financial position, performance and cash flow of an enterprise.

Slide 2.6 Financial information to evaluate the ability to generate cash differs from financial information on actual cash flows The IASB approach differs from the cash flow model used in Chapter 1, in that,  In addition to the cash flows and statement of financial position it includes within its definition of performance a reference to profit It states that this information is required to assess changes in the economic resources that the enterprise is likely to control in the future  This is useful in predicting the capacity of the enterprise to generate cash flows from its existing resource base.

Slide 2.7 A complete set of financial statements – IASB A statement of financial position as at the end of the period, or Balance Sheet A statement of comprehensive income for the period, or Income Statement A statement of changes in equity for the period A statement of cash flows for the period Notes, comprising a summary of significant accounting policies and other explanatory information.

Slide 2.8 HCA Accounting HCA = Historical cost accounting HCA is useful for stewardship purposes  Transactions reported at amount at date transaction occurred  Amounts are objective and verifiable  Basis for determining outcome of agency agreements, for example loan covenants However, may not be as useful as inflation adjusted data for decision making.

Slide 2.9 Accrual accounting Includes transactions affecting the current accounting period that have not yet involved the movement of cash – i.e: Adjusts the realised operating cash flows for transactions still not converted into cash at the end of the period Includes in period’s income, invoices issued but cash still not received Includes in the period’s expenses invoices received but cash still not paid out Regarded by the IASB as more useful than cash accounting in making economic decisions.

Slide 2.10 Subjective judgements – the matching principle Financial statements must include costs related to the achievement of the reported income  Payments made this period for expenses that relate to the next period are deducted from the cash paid to arrive at the expense for the period  Payments to be made in the next period for expenses incurred in the current period are added to the cash paid to arrive at the expense for the period.

Slide 2.11 Illustration – income statement adjusted See Fig 1.7, p.11 Figure 2.3 Statement of income for the 6 months ended 30 June 20X1

Slide 2.12 Illustration – financial position adjusted Figure 2.4 Statement of financial position adjusted to an accrual basis

Slide 2.13 Financial position applying IASB definitions An asset is defined as a resource –Controlled by the enterprise –As a result of a past event –From which future economic benefits are expected to flow Note that this definition is important and will be met throughout later chapters.

Slide 2.14 Financial position applying IASB definitions (Continued) A liability is defined as a present obligation  Arising from a past event  Whose settlement is expected to result in an outflow of resources Note that this definition will also be met throughout the text.

Slide 2.15 Statement of financial position applying the IASB definitions cont. next slide Figure 2.5 Reframed statement as at 30 June

Slide 2.16 Statement of financial position applying the IASB definitions (Continued) Figure 2.5 Reframed statement as at 30 June (Continued)

Slide 2.17 Treatment of non-current assets The Matching Principle approach is to: Estimate as revenue expenditure how much of initial cost of the asset has been consumed in the period – this is known as depreciation Apply IAS 16 Depreciation – this IAS will be discussed in detail in the PPE chapter.

Slide 2.18 IAS 16 states Depreciation is the systematic allocation of the depreciable amount over useful economic life Depreciable amount is the cost of an asset less its residual value (value remaining at the end of the asset’s useful life) The depreciation method used should reflect the pattern in which the asset’s economic benefits are consumed.

Slide 2.19 Non-current asset treatment in accrual accounting – the going concern assumption Assumes business will continue in operational existence for foreseeable future More relevant to use loss of service potential rather than change in net realisable value (NRV)  Service potential means the number of products that can be produced over life of the asset  NRV: The net asset value of an asset or investment if it were sold, less the estimated cost of the sale and the amount the seller would have to spend to bring the asset or investment to a state where it can be soldnet asset valueassetinvestmentsoldcostsaleseller Necessary to assess financial capital maintenance.

Slide 2.20 Income statement adjusted Figure 2.6 Statement of income for the 6 months ending 30 June

Slide 2.21 Statement of financial position Figure 2.7 Statement of financial position as at 30 June

Slide 2.22 Figure 2.7 Statement of financial position as at 30 June (Continued) Statement of financial position (Continued)

Slide 2.23 Reconcile the accrual accounting income figure with the net cash balance Figure 2.8 Reconciliation of income figure with net cash balance

Slide 2.24 Reconcile the accrual accounting data in more detail Figure 2.9 Statement of cash flow netting amounts that have not been converted to cash

Slide 2.25 Reconcile the accrual accounting data in more detail (Continued) Figure 2.9 Statement of cash flow netting amounts that have not been converted to cash (Continued)

Slide 2.26 Reconciliation in accordance with accounting standards Figure 2.10 Cash flow statement in accordance with IAS 7 Statement of cash flows

Slide 2.27 Reconciliation in accordance with accounting standards (Continued) Figure 2.10 Cash flow statement in accordance with IAS 7 Statement of cash flows (Continued)

Slide ‘Cash flow accounting and accrual accounting information are both required by a potential shareholder.’ Discuss. 2.‘The asset measurement basis applied in accrual accounting can lead to financial difficulties when assets are due for replacement.’ Discuss. Review questions

Slide ‘Accrual accounting is preferable to cash flow accounting because the information is more relevant to all users of financial statements.’ Discuss. 4.‘Information contained in a statement of income and a statement of financial position prepared under accrual accounting concepts is factual and objective.’ Discuss. Review questions (Continued)

Slide 2.30 Review questions (Continued) The Framework for the Preparation and Presentation of Financial Statements identified seven user groups: investors, employees, lenders, suppliers and other trade creditors, customers, government and the public. Discuss which of the financial statements illustrated in Chapters 1 and 2 would be most useful to each of these seven groups if they could only receive one statement. 5.

Slide The annual financial statements of companies are used by various parties for a wide variety of purposes. For each of the seven different ‘user groups’, explain their presumed interest with reference to the performance of the company and its financial position. Review questions (Continued)