FACR – ICMAP ML2 (S-21) Ch # 02 – FR Frameworks

REGULATORY FRAMEWORK
Need of Regulatory Framework:
A regulatory framework exists to ensure that the accounting standards are prepared to meet the needs of
users.

Standard Setting Bodies Regulatory Authorities

 Private sector, self-regulated organizations.
 Board members are experienced accountants,
auditors, analysts and academics.
 Examples are:
o International Accounting Standards Board
(IASB)
o Financial Accounting Standards Board
(FASB)
 Set standards but don’t have the authority to
enforce.
 Country specific government entities like
Securities and Exchange Commission of
Pakistan.
 Authority to enforce financial reporting
regulations.
 Can over-rule private sector standard setting
bodies and establish standards in their
jurisdictions.
 Regulate capital markets in general as their
larger mandate.

Brief Historical Perspective - Harmonization of Accounting Regulations:

In June 1973, developed nations formed IASC (International Accounting Standard Committee) and given
it the task of harmonization of accounting regulation in order to facilitate cross-border investment. This
decision was made because accounting regulations of one country were materially different than that of
being following in another country; therefore, investors face a lot of difficulties in making resource
allocation decision.

IASC had two subordinated bodies:

1. SAC – Standard Advisory Council.
2. SIC – Standards Interpretation Committee.
This structure remained till year 2001 and issues 41 IAS (International Accounting Standard) and 32
Interpretations (for detailed explanations of an issue).

In 2001, with the joining of US, IASC was renamed as IASCF(International Accounting Standard
Committee Foundation) and today, this body is called IFRS Foundation and formed a body called IASB
(International Accounting Standards Board) which is responsible for developing IFRS. The subordinated
bodies of IASC have are now subordinated to IASB. In the initial structural meetings, IASB has decided to
adopt all previously issued IASs and Interpretations as it is. Consequently, further standards will be called
as IFRS and Interpretations will be called IFRICs.

In Short, collectively IFRS = IFRSs + IFRICs + IASs + SICs

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FACR – ICMAP ML2 (S-21) Ch # 02 – FR Frameworks

With the process of refinements, IASs and SICs will be converted into IFRSs and IFRICs.

Note: Visit www.ifrs.org for more information.

Why IFRS:
Financial information is the lifeblood of financial markets. Cross-border transactions are increasing day
by day – increasing the need for efficient and effective information management. International investors
need financial information they can trust in making informed capital resource allocation decisions. IFRS
(International Financial Reporting Standards) provide the global language of financial reporting. Since
all decision making is relative (inter/intra), people need comparable information. Over 100 countries
require their corporations to use IFRS when reporting their financial position and performance. Investors
around the world trust IFRS because they bring three key benefits to the world economy:

1. Transparency 2. Accountability 3. Efficiency

By providing high quality and By helping to reduce the By having single trusted global
comparable information. This information gap between standards. It lowers the
helps investors make more insiders and the outsiders. information processing and
informed decisions. This helps owners to hold reporting costs.
company to account.
Contributing global economy by giving trust, growth and long-term financial stability.

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FACR – ICMAP ML2 (S-21) Ch # 02 – FR Frameworks

What is IFRS? – Principles or Framework Bases Regulations

It is a single set of high quality, understandable and enforceable global accounting standards developed
and maintained by IASB – International Accounting Standards Board.

Role of IASB:
The objectives of IASB as set out in its Constitution are as under:
a) Developing: To formulate and publish in the public interest a single set of high quality,
understandable and enforceable global accounting standards that require high quality, transparent
and comparable information in financial statement and other financial reporting to help participants in
the various capital markets of the world & other users of the information to make economic decisions.
b) Monitoring: To promote the use and rigorous application of those standards.
c) Coordinating: To work actively with national standard-setters to bring about convergence of national
accounting standards & IFRSs to high quality like Companies Act 2017, SBP Prudential Regulations.

Scope of IFRS:
1. IFRSs are applicable on material and essential financial information.
2. IFRSs are prospective in nature, unless otherwise specially mentioned as retrospective.
3. IFRS will only be applicable and enforceable if and only if local regulatory bodies adopt it and become
part of local laws. For example, section 225 of Companies Act, 2017 states that “The Companies that
intend to make unreserved compliance with IFRS issued by IASB for financial statements, will be
allowed to do so.”

NOTE: The regulatory framework for financial reporting of Pakistan is enforced by Companies Act 2017
and SECP regulations. IFRS will become part of this framework upon adoption. Moreover, in case of
contradictions between local laws and IFRSs, local laws would prevail.

Standard setting process:

Possible results of in research proposal for an issue:
1. Issue is already covered in an existing IFRS and clarified – no need for new standard.
2. Interim solution is provided by issuing IFRIC until the issue is covered in a comprehensive
development phase.
3. Issue is new & relevant; there is a need to amend an existing standard of issue entirely new IFRS.

Refer “IFRS Tutorial Videos” in shared folder.

Additional documents accompanying IFRS:

a. Bases of conclusion – comments in favor.
b. Dissenting opinions – comments against.
c. Illustrative examples.
d. Implementation / application guidelines.

NOTE: Originally IFRS are published in English language but may be translated in other languages.

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FACR – ICMAP ML2 (S-21) Ch # 02 – FR Frameworks

COMPONENTS OF IFRS:
1 2 3 4 5 6

Scope Recognition De-recognition Presentation &

Definitions Measurement
(Applicability) Criteria criteria Disclosures

CONCEPTUAL FRAMEWORK
Financial statements are one of the most important sources of information available to a financial analyst;
therefore, it is imperative to have a sound understanding of financial reports and accompanying notes.

Financial Reporting Financial Statements Analysis

Information about: Information provided by “Financial Reporting” plus
a) Financial Performance. other information is analyzed to evaluate “past” and
b) Financial Position. “present” to predict the “future” on the following:
c) Changes in Financial Position. a) Profitability.
b) Liquidity.
c) Solvency.

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FACR – ICMAP ML2 (S-21) Ch # 02 – FR Frameworks

EXAMPLE: ESTIMATES IN FINANCIAL REPORTING

To facilitate comparisons across companies (cross sectional analysis) and overtime for a single company
(time series analysis), it is important that accounting methods are comparable and consistently applied.
However, accounting standards must be flexible enough to recognize that differences exist in the
underlying economics between businesses.

Suppose two companies buy the same model of machinery to be used in their respective businesses.
The machine is expected to last for several years. Financial reporting standards typically require that both
companies account for this equipment by initially recording the cost of the machinery as an asset. Without
such a standard, the companies could report the purchase of the equipment differently. For example, one
company might record the purchase as an asset and the other might record the purchase as an expense.
An accounting standard ensures that both companies should record the transaction in a similar manner.

Accounting standards typically require the cost of the machine to be apportioned over the estimated
useful life of an asset as an expense called depreciation. Because the two companies may be operating
the machinery differently, financial reporting standards must retain some flexibility. One company might
operate the machinery only a few days per week, whereas the other company operates the equipment
continuously throughout the week. Given the difference in usage, it would not be appropriate to require
the two companies to report an identical amount of depreciation expense each period. Financial reporting
standards must allow for some discretion such that management can match their financial reporting
choices to the underlying economics of their business while ensuring that similar transactions are
recorded in a similar manner between companies.

Financial statements of two companies with identical transactions in the fiscal year, prepared in
accordance with the same set of financial reporting standards,
are most likely to be:

a) identical.
b) consistent.
c) comparable.
[Answer: “c”]

OBJECTIVE OF FINANCIAL REPORTING:

The objective of general-purpose financial reporting is to provide financial information about the reporting
entity that is useful to existing and potential investors, lenders, and other creditors in making decisions
about providing resources to the entity. Those decisions involve buying, selling or holding equity and debt
instruments, and providing or settling loans and other forms of credit.

INTRODUCTION:
The IASB Framework provides the underlying rules, conventions and definitions that underpin the
preparation of all financial statements prepared under International Financial Reporting Standards (IFRS).
• Ensures standards developed within a conceptual framework. (consistent basis)
• Provide guidance on areas where no standard exists.
• Aids process to improve existing standards.
• Ensures financial statements contain information that is useful to users.
• Helps prevent creative accounting / fraudulent financial reporting.

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FACR – ICMAP ML2 (S-21) Ch # 02 – FR Frameworks

OBJECTIVE OF FRAMEWORK:
It is a theoretical set of principles which provides the basis for the preparation of IFRS. It helps different
stakeholders as per their requirements as under:

1. IASB:
a. Developing new IFRSs.
b. Reviewing / improving existing IFRSs.

2. National Accounting Bodies:

Developing national standards and pronouncements.

3. Preparers of Financial Statements:

a. Applying existing IFRSs.
b. Guiding about accounting treatments which have not addressed by any IFRS.

4. Auditors:
Helping auditors form an opinion on the following matters:
a. True / Fair View.
b. Free from Material Misstatement.
c. Compliance of IFRSs.

Disclaimer: This is NOT an IFRS. In case of conflict with any IFRS, the IFRS would prevail.

CHAPTER 01: OBJECTIVE OF GENERAL-PURPOSE FINANCIAL REPORTING:

The objective of financial reporting is to provide financial information that is useful to users in making
decisions relating to providing resources to the entity – investment and financing decisions.

To provide Information about the following:

• Economic resources and claims (assets & liabilities i.e. financial position);
• Efficiency and effectiveness of management. (revenues & expenses i.e. financial performance)
• The changes in economic resources and claims. (SOCIE)
• Past cash flows are to assess management’s ability to generate future cash flows.
Prepared by: M. Umar Munir (Gold Medalist), FCMA, MS Finance
FACR – ICMAP ML2 (S-21) Ch # 02 – FR Frameworks

CHAPTER 02: QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION

CHAPTER 03: FINANCIAL STATEMENTS &REPORTING ENTITY:

Complete Set of Financial Statements:

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FACR – ICMAP ML2 (S-21) Ch # 02 – FR Frameworks

FINANCIAL REPORTING ASSUMPTIONS:

Financial statements are always prepared for a specified period of time, or the reporting period.Normally,
the financial statements are prepared on following two assumptions:

1. Going concern:

It is assumed that the entity has neither (a) the intention nor (b) the need to liquidate or curtail
materially the scale of its operations; if such an intention or need exists, the financial statements may
have to be prepared on a different basis and, if so, the basis used is disclosed in notes.

Examples when entity CANNOT be regarded as going concern:

• An inability by the entity to pay dividends to shareholders.
• Major losses or cash flow difficulties that have arisen since the reporting date.
• Adverse key financial ratios i.e. ROI, D/E, TIE, GPM etc.
• Indications of withdrawal of financial support from the bank or other financial institutions.
• Negative operating cash flows.
• Major debt repayments falling due which the entity will not be able to meet.
• Pending legal or regulatory proceedings against the reporting entity that may result in claims that
are unlikely to be satisfied.

2. Accrual:
Accrual basis relate to recognition of revenues and expenses:
a) Revenues are reported on the income statement when they are earned. When the revenues are
earned but cash is not received, the asset accounts receivable will be recorded.
b) Expenses are reported on the income statement when they are incurred and matched-up with
the revenues being reported, or when a cost has no future benefit that can be measured. When
an expense occurs and cash has not yet been paid, a liability account will also be recorded

REPORTING ENTITY:
Reporting entity is an entity who must or chooses to prepare the financial statements. It can be:
• A single entity – for example, one company;
• A portion of an entity – for example, a division of one company;
• More than one entities – for example, a parent and its subsidiaries reporting as a group.

As a result, we have a few types of financial statements:

• Consolidated: a parent and subsidiaries report as a single reporting entity;
• Unconsolidated / separate: e.g. a parent alone provides reports, or

CHAPTEER 04: DEFINITIONS OF ELEMENTS OF FINANCIAL STATEMENTS

Asset: Liability: Equity:
• A present economic • A present obligation of Equity is the
resource controlled by the entity to transfer an residual interest
the entity as a result of economic resource as a in the assets of
past events. result of past events. the entity after
deducting all its
• An economic resource • An obligation is a duty liabilities.
FINANCIAL is a right that has the or responsibility that the
“Also called Net
POSITION expected potential to entity has no practical
Assets.”
produce economic ability to avoid. (No
benefits. rescue without affecting Contributed + Reserves.
interparty relationship) (Revenue & Capital)

• Asset could be tangible Appropriated & Un-

appropriated
or intangible. Could be legal or
•
constructive. (IAS-37)
Current and non-current distinction need to be made.

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FACR – ICMAP ML2 (S-21) Ch # 02 – FR Frameworks

Revenue:
Increases in assets, or decreases in
liabilities, that result in increases in
equity, other than those relating to
contributions from holders of equity
FINANCIAL
claims. (Share Premium is NOT
PERFORMANCE
revenue).It includes revenues &
gains.
The price for goods sold and services
rendered during a given accounting
period.
Expense:
Decreases in assets, or increases in
liabilities, that result in decreases in
equity, other than those relating to
distributions to holders of equity
claims. (Dividend / drawings is NOT
an expense).It includes expenses &
losses.
The costs of goods and services used
up in the process of earning revenue.

IFRSs are developed on balance sheet / statement of financial position approach. Revenues and
expenses are just relative terms and transferred eventually to equity, the residual. This is why recognition
/ de-recognition and measurement criteria are only defined for assets and liabilities.

CHAPTER 05: RECOGNITON AND DE-RECOGNITION CRITERIA:

RECOGNITION (Addition in F/S) DE-RECOGNITION (Removal from F/S)

Two criteria: Asset: Liability:
a) Probability of future economic benefits. When the entity loses When the entity no
(inflow for assets / outflow for liabilities) control to attain economic longer has a present
b) Reliability of measurement. benefits. obligation.

CHAPTER 06: MEASUREMENT BASES: “Determining the value”

Measurement bases need to be selected to quantify monetary amount for elements in the financial
statements.

a) Historical cost – this measurement is based on the transaction price at the time of recognition of the
element;
b) Current value – it measures the element updated to reflect the conditions at the measurement date
like, Net Realizable Value (IAS-02) , Value in Use (IAS-36), fair value (IFRS-13).

CHAPTER 07: PRESENTATION AND DISCLOSURE:

The main aim of presentation and disclosures is to provide an effective communication tool in the
financial statements. Effective communication of information in the financial statements requires:
• Focus on objectives and principles of presentation and disclosure, not on the rules;
• Group similar items and separate dissimilar items;
• Aggregate information.

NET ASSETS:
Net assets or equity can increase or decrease as a result of several things, for example:
• Shareholders contribute cash to the company
• Company makes a profit or loss
• Company buys own shares back from the market
• Company pays out the dividends to shareholders
• Company revalues certain assets.

The key to understand the difference between (a) profit or loss, (b) other comprehensive income and (c)
changes in equity is to understand where these changes are coming from.
We can classify changes in net assets or equity into 2 main categories:

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FACR – ICMAP ML2 (S-21) Ch # 02 – FR Frameworks

1. Capital changes – changes related to introduction and return of capital to shareholders, such as:
o Issuance of new shares
o Paying out of dividends to shareholders
o Buy-back of own shares from the market
All capital changes must be reported in the statement of changes in equity.

2. Performance changes – these are all changes coming from the activities of the company and not
from the shareholders. We can further divide this category into 2 subcategories:
a) Changes resulting from or related to primary performance or main revenue-producing
activities of the company that are reported in profit or loss. Here the following items fall:
• Revenue from sales of goods or services
• Expenses incurred to make sales of goods or services
• All other income and expenses, such as finance, administrative, marketing, personnel, etc.
• Gains related to primary performance (sale of property, plant and equipment, etc.)
IFRS standard does not permit recognition of these changes directly to equity.All these changes
are reported in profit or loss.

b) Changes resulting from other, non-primary or non-revenue producing activities of the

company that are not reported in profit or loss as required or permitted by other IFRS
standard. For example:
• Changes in revaluation surplus related to property, plant and equipment (IAS 16)
• Actuarial gains and losses (IAS 19)
• Gains & losses from translating the financial statements of a foreign operation (IAS 21)
All these changes are reported in other comprehensive income.

CHAPTER 08: CONCEPT OF CAPITAL AND CAPITAL MAINTENANCE

The Framework explains two concepts of capital:
1. Financial capital: – synonymous with the net assets or equity of the entity.
Under the financial maintenance concept, the profit is earned only when the amount of net assets at
the end of the period is greater than the amount of net assets in the beginning, after excluding
contributions from and distributions to equity holders.
2. Physical capital: –
This is the productive capacity of the entity based on, for example, units of output per day. Here the
profit is earned if physical productive capacity increases during the period, after excluding the
movements with equity holders.

Prepared by: M. Umar Munir (Gold Medalist), FCMA, MS Finance