Unit Chapter One: Development of Accounting Principles & Professional

Practices

Introduction
Accounting is the universal language of business. The essential characteristics of accounting are (1)
identification, measurement and communication of financial information about (2) economic entities to
(3) interested parties. Financial and management accounting are the two widely known branches of
accounting. Financial accounting is the process that culminates in the preparation of financial reports
on the enterprise for use by both internal and external parties. Users of these financial reports include
investors, creditors, managers, unions and government agencies. In contrast, managerial accounting is
the process of identifying, measuring, analyzing and communicating financial information needed by
management to plan, control and evaluate a company’s operations.

Users of accounting information

 External users : Investors, creditors, suppliers , government , shareholders, etc
 Internal users: Lower, middle and top level managers

Areas of Differences between Financial Accounting & Management Accounting

Items of Difference Financial Accounting Management Accounting
Primary users  External decision makers such as Internal decision makers such as
investors, creditors, suppliers, low, middle and top level
government, shareholders, etc managers
 But organizational managers can
also be users of the information
Sources of data Internal source Both internal and external
sources
Publications Financial accounting statements are Management accounting
published information are not published
Delineation of activities More sharply defined Less sharply defined
Time span Less flexible Flexible
Time orientation Past oriented Future oriented
Precision Precision of information is required No emphasis is given to actual
figures. Approximate figures are
considered useful than exact
figures
Freedom of choice Must follow IFRS Need not follow IFRS
Reporting entity Organization as a whole. That is , only Detailed segment reports about
summarized data for the entire Departments , segments ,
organization are presented divisions, customers, and
employees are prepared
C0mpulsion Mandatory for external users Not mandatory
Descriptions Monetary Both monetary & non-monetary

From the above table, the distinction between financial accounting and Management accounting
becomes quite clear. Although many differences exist between them, they are similar in at least two
ways
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 1. Both rely of the same accounting information system: It would be a waste of money to have two
different data collecting systems existing side by side .One part of the overall accounting system is
the cost accounting system which accumulates cost data for used in both management and
financial accounting. For example, production cost data typically are used in helping managers set
prices, which is a management accounting use. However, production cost data also are used to
value inventory on a manufacturer’s balance sheet, which is a financial accounting use.
2. Both rely heavily on the concept of responsibility, or stewardship: Financial accounting is
concerned with stewardship over the company as a whole; management accounting is concerned
with stewardship over its parts, and this concern extends to the last person in an organization who
has any responsibility over cost.

The Environment of Financial Accounting

The discipline of accounting is commonly divided into the following areas or subsets: financial
accounting, managerial (cost) accounting, tax accounting, and not- for- profit (public sector) accounting.
Financial accounting has been characterized as “that branch of accounting concerned with the
classification, recording, analysis, and interpretation of the overall financial position and operating
results of an organization. Financial accounting encompasses the process and decisions that culminate in
the preparation of financial statements relative to the enterprise as a whole for use by parties both
internal and external to the enterprise. These statements provide a continual history qualified in money
terms of economic resources and obligations of a business enterprise and of economic activities that
change these resources and obligations. The following four environmental factors, although not as basic
as the three aspects described in environmental factors that influence accounting, shape financial
accounting to a significant extent:

 The many users and uses that accounting serves

 The nature of economic activity
 The economic activity in individual business enterprises
 The means of measuring economic activity.

Users of Accounting Information

The users of accounting information may be divided into two broad groups: internal users and external
users.

Internal users include all the management personnel of a business enterprise who use accounting
information either for planning and controlling current operations or for formulating long-range plans
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and making major business decisions. The term managerial accounting relates to internal measurements
and reporting; it includes the development of detailed current information helpful to all levels of
management in decision making designed to achieve the goals of the enterprise.

External users of accounting information include stock-holders, bondholders, potential investors,

bankers and other creditors, financial analysts, economists, labor unions, and numerous government
agencies. The field of financial accounting is directly related to external reporting because it provides
investors and other outsiders with the financial information they need for decision making.

Financial Reporting Standards in Ethiopia

In Ethiopia, the financial reporting proclamation 847/2014 was enacted in 2014. The proclamation, with
its pronouncements has prescribed International |financial reporting Standards and International
Financial reporting Standard for Small and Medium Entities as the only standards to be applied by
reporting entities in Ethiopia. Following the proclamation, regulation number 332/2015 was issued
which form the basis for the establishment of Accounting and Auditing Board of Ethiopia (AABE).
AABE was given power to decide on the manner and form of IFRS adoption and implementation. AABE,
following the deliberation of board members, has announced that it has chosen to follow a full adoption
policy, meaning that Ethiopia Adopts and applies IFRS as Issued by IASB.

The adoption of standards that require high quality, transparent, and comparable information is
welcomed by investors, creditors, financial analysts, and other users of financial statements.

The IASB and its governance structure

From 1973 until 2001, the body in charge of setting the international standards was the International
Accounting Standards Committee (IASC). The principal significance of IASC was to encourage national
accounting standard setters around the world to improve and harmonize national accounting standards.
Its objectives, as stated in its Constitution, were to formulate and publish in the public interest
accounting standards to be observed in the presentation of financial statements and to promote their
worldwide acceptance and observance. Work generally for the improvement and harmonization of
regulations, accounting standards, and procedures relating to the presentation of financial statements.

In its early years, IASC focused its efforts on developing a set of basic accounting standards. These
standards usually were worded broadly and contained several alternative treatments to accommodate
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the existence of different accounting practices around the world. Later these standards came to be
criticized for being too broad and having too many options.

Beginning in 1987, IASC initiated work to improve its standards, reduce the number of choices, and
specify preferred accounting treatments in order to allow greater comparability in financial statements.
This work took on further importance as securities regulators worldwide started to take an active
interest in the international accounting standard-setting process.

During its existence, IASC issued 41 numbered Standards, known as International Accounting Standards
(IAS), as well as a Framework for the Preparation and Presentation of Financial Statements. While some
of the Standards issued by the IASC have been withdrawn, many are still in force. In addition, some of
the Interpretations issued by the IASC‘s interpretive body, the so-called Standing Interpretations
Committee (SIC), are still in force.

In 2001, fundamental changes were made to strengthen the independence, legitimacy, and quality of
the international accounting standard-setting process. In particular, the IASC was replaced by the
International Accounting Standards Board (IASB) as the body in charge of setting the international
standards.

The objectives of IASB

The objectives of the IASB, as stated in its Constitution, are to
1. Develop, 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 statements and other financial reporting to help participants in the various capital
markets of the world and other users of the information to make economic decisions;
2. Promote the use and rigorous application of those standards; and
3. Work actively with national standard setters to bring about convergence of national accounting
standards and International Financial Reporting Standards to high-quality solutions.

The governance of IASB rests with the Trustees of the International Accounting Standards Committee
Foundation (the IASC Foundation Trustees‖ or, simply, the Trustees). The Trustees have no involvement

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in IASB‘s standard-setting activities. Instead, the Trustees are responsible for broad strategic issues,
budget, and operating procedures, as well as for appointing the members of IASB.

The ISAB Board is responsible for all standard-setting activities, including the development and adoption
of IFRS. The Board has 14 members from around the world who are selected by the Trustees based on
technical skills and relevant business and market experience. The Board, which usually meets once a
month, has 12 full-time members and 2 part-time members. The Board members are from a mix of
backgrounds, including auditors, preparers of financial statements, users of financial statements, and
academics.

IASB is advised by the Standards Advisory Council (SAC). It has about 40 members appointed by the
Trustees and provides a forum for organizations and individuals with an interest in international
financial reporting to provide advice on IASB agenda decisions and priorities. Members currently include
chief financial and accounting officers from some of the world‘s largest corporations and international
organizations, leading financial analysts and academics, regulators, accounting standard setters, and
partners from leading accounting firms.

IASB‘s interpretive body, International Financial Reporting Interpretations Committee (IFRIC), is in

charge of developing interpretive guidance on accounting issues that are not specifically dealt with in
IFRSs or that are likely to receive divergent or unacceptable interpretations in the absence of
authoritative guidance. IFRIC members are appointed by the Trustees.

List of IASB pronouncements

The IASB issues three major types of pronouncements:
1. International Financial Reporting Standards.
2. Conceptual Framework for Financial Reporting.
3. International Financial Reporting Standards Interpretations.

International Financial Reporting Standards

Financial accounting standards issued by the IASB are referred to as International Financial Reporting
Standards (IFRS). The IASB has issued 17 of these standards to date, covering such subjects as business
combinations, share-based payments, lease, insurance and many others.
Prior to the IASB (formed in 2001), standard-setting on the international level was done by the
International Accounting Standards Committee, which issued International Accounting Standards (IAS).
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The committee issued 41 IASs, many of which have been amended or superseded by the IASB. Those still
remaining (24 Standards) are considered under the umbrella of IFRS.

Conceptual Framework for Financial Reporting

As part of a long-range effort to move away from the problem by problem approach, the IASB uses an
IFRS conceptual framework. This Conceptual Framework for Financial Reporting sets forth the
fundamental objective and concepts that the Board uses in developing future standards of financial
reporting. The intent of the document is to form a cohesive set of interrelated concepts a conceptual
framework that will serve as tools for solving existing and emerging problems in a consistent manner.

The Conceptual Framework and any changes to it pass through the same due process (preliminary
views, public hearing, exposure draft, etc.) as an IFRS. However, this Conceptual Framework is not an
IFRS and hence does not define standards for any particular measurement or disclosure issue. Nothing in
this Conceptual Framework overrides any specific international accounting standard.

International Financial Reporting Standards Interpretations

Interpretations issued by the IFRS Interpretations Committee are also considered authoritative and must
be followed. These interpretations cover
A. Newly identified financial reporting issues not specifically dealt with in IFRS and
B. Issues where unsatisfactory or conflicting interpretations have developed, or seem likely to
develop, in the absence of authoritative guidance.
The IFRS Interpretations Committee applies a principles based approach in providing interpretative
guidance. To this end, the IFRS Interpretations Committee looks first to the Conceptual Framework as
the foundation for formulating a consensus. It then looks to the principles articulated in the applicable
standard, if any, to develop its interpretative guidance and to determine that the proposed guidance
does not conflict with provisions in IFRS. So far the IFRS Interpretations Committee has issued over 23 of
these interpretations.

Conceptual Framework for Financial Accounting Reporting

 Conceptual framework is a coherent system of concepts that flow from an objective. The objective
identifies the purpose of financial reporting
 A conceptual framework establishes the concepts that underlie financial reporting. A conceptual
framework is a coherent system of concepts that flow from an objective. The objective identifies
the purpose of financial reporting. The other concepts provide guidance on (1) identifying the
boundaries of financial reporting; (2) selecting the transactions, other events, and circumstances

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 to be represented; (3) how they should be recognized and measured; and (4) how they should be
summarized and reported

Need for a conceptual frame work:

 Why do we need a conceptual framework? First, to be useful, rule-making should build on and
relate to an established body of concepts. A soundly developed conceptual framework thus
enables the IASB to issue more useful and consistent pronouncements over time, and a coherent
set of standards should result. Indeed, without the guidance provided by a soundly developed
framework, standard-setting ends up being based on individual concepts developed by each
member of the standard-setting body.

Development of a Conceptual Framework

 The IASB issued “Conceptual Framework for Financial Reporting 2010” (the Conceptual Framework)
in 2010. The Conceptual Framework is a work in progress in that the IASB has not yet completed
updating the previous version of it.

Overview of the conceptual framework

 Comprises three levels :
1st level: Identifies the objectives of financial reporting i.e. Purposes of financial reporting
2nd level: Provides the qualitative characteristics that make accounting information useful and the
elements of financial statements
3rd level: Identifies the recognition, measurement, & disclosure concepts used in establishing and
applying accounting standards & the specific concepts to implement the objectives.

First Level: Basic Objectives

 The objectives of financial reporting is the foundation of the conceptual framework
 The objectives of general purpose financial reporting is to provide financial information about the
reporting entity that is useful to present and potential equity 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
selling loans and other forms of credit.
 General purpose financial report help users who lack the ability to demand all the financial
information they need from an entity and therefore must rely, at least partly, on the information
provided in financial reporting.

Second Level: Fundamental Concepts

 Explain qualitative characteristics of accounting information and define elements of financial
statement.
 A bridge between the why of accounting ( objective) and the how of accounting ( recognition ,
measurement and financial statement presentation )

Qualitative Characteristics of Accounting Information

 IASB (International Accounting Standard Board) identified the qualitative characteristics of
accounting information to disclose, and the format in which useful information that distinguish
better ( more useful information from inferior ( less useful ) information for decision making
purposes.

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  There are two qualitative characteristics : Primary and Enhancing qualities

Primary (Fundamental) qualities include:

1. Relevance
2. Faithful representation

Fundamental Quality: Relevance

 Refers to how helpful the information is for financial decision making processes
 To be relevant accounting information must be capable of making a difference in a decision
 Financial information is capable of making a difference when it has predictive value , confirmatory
value or both
 Ingredients of relevance are:
1. Predictive value
2. Confirmatory ( Feedback value)
3. Materiality

Predictive value: Financial information has predictive value if it has value as an input to predictive
processes used by investors to form their own expectations about the future. Confirmatory value:
Financial information has confirmatory value if it helps users confirm or correct prior expectations.
Materiality: It is a company specific aspect of relevance. Information is material if omitting it or
misstating could influence decisions that users make on the basis of the reported financial information.
Information is immaterial and therefore irrelevant, if it would have no impact on a decision –maker. In
short, it must make a difference or a company need not disclose it.

Fundamental Quality: Faithful Representation

 Faithful representation means that the numbers and descriptions match what really existed or
happened
 Faithful representation is a necessity because most users have neither the time nor the expertise to
evaluate the factual content of the information
 To be a faithful representation, information must be complete, neutral and free of material error.
 Ingredients of faithful representation:

1. Completeness
 Financial statement should not exclude any transaction
 It means that all the information that is necessary for faithful representation is provided
 An omission can cause information to be false or misleading and thus not be helpful to the
users of financial reporting
2. Neutrality
 The degree to which information is free from bias
 It means that a company cannot select information to favor one set of interested parties
over another
 If financial information is biased (rigged) the public will lose confidence and no longer use it
3. Free from material error
 The degree to which information is free from material error
 An information item that is free from error will be a more accurate (faithful) representation
of a financial item

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  However, faithful representation does not apply total freedom from error. This is because
most financial reporting measures involve estimates of various type that incorporate
management judgment

Enhancing (Secondary) Qualities

 Are complementary to the fundamental qualitative characteristics
 These characteristics distinguish more useful information from less useful information.
Enhancing qualities ingredients are :
1. Comparability
2. Verifiability
3. Timeliness
4. Understandability

Comparability
 It is the degree to which accounting standards and policies are consistently applied from one period
to another
 Information that is measured and reported in a similar manner for different companies is considered
comparable. It enables users to identify the real similarities and difference in economic events
between companies. Investors can only make valid evaluations if comparable information is
available
 Another type of comparability, consistency, is presented when a company applies the same
accounting treatment to similar events from period to period.
 The idea of consistency does not mean, however, that companies cannot switch from one
accounting method to another. A company can change methods, but it must first demonstrate that
the newly adopted method s preferable to the old.
 If approved, the company must then disclose the nature and effect of the accounting change, as well
as the justification for it , in the financial statement for the period in which it made the change .

Verifiability
 It is extent to which information is reproducible given the same data and assumption
 Receipts and invoices make accounting information verifiable.
 It occurs when independent measurers , using the same methods , obtain similar results:
Example:
1) Two independent auditors must count inventory and arrive at the same physical quantity
amount for inventory
2) Two independent auditors compute inventory value at the end of the year using the FIFO
method of inventory valuation

Timeliness
 It is how quickly information is available to users of accounting information. The less timely ( old)
,the less useful the information is for decision making.
 It means having relevant information available sooner can enhance its capacity to influence
decisions and a lack of timeliness can rob information of its usefulness.

Understandability
 It is degree to which information is understood. It is common for poorly performing companies to
use a lot of Jargon and difficult phrasing in its annual report in an attempt to disguise the under
performance
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  For information to be useful, there must be a connection (linkage) b/n users and the decision they
make. This link, understandability, is the quality of information that lets reasonably informed users
sees its significance.
 Understandability is enhanced when information is classified, characterized and presented clearly
and concisely.
 Users of financial reports are assumed to have a reasonable knowledge of business and economic
activities

Basic Elements of Financial statements

Assets: A resource controlled by the entity as a result of past events and from which future economic
benefits are expected to flow to entity.
Liability: 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.
Equity: The residual interest in the assets of the entity after deducting all its liabilities.
Income: Increase in economic benefits during the accounting 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 participants.
Expenses: Decreases in economic benefits during the accounting period in the form of outflows or
depletions of assets or incurrence of liabilities that result in decreases in equity other than those relating
to distributions to equity participants.

Third Level: Recognition, Measurement and Disclosure Concepts

 Consists of concepts that implement the basic objectives of level one. These concepts explain
how companies should recognize measure, and report financial elements and events
A. Basic Assumptions
1. Economic Entity Assumptions
 Entity is something that exist separately from other things and has its own identity
 Economic activity can be identified with a particular unit of accountability.
 A company keeps its activity separate and distinct from its owners and any other business unit.
 It dictates that the company’s financial activities are separate from those of its owners and
managers and any other business entities
 The entity concept does not necessarily refer to a legal entity. A parent and its subsidiaries are
separate legal entities, but merging their activities for accounting and reporting purpose does
not violate economic entity assumptions.
 A corporation and its shareholders are separate for accounting purposes. A sole proprietorship
and partnership are treated as separate from their owners for accounting purposes only , but
this does not hold true in the eyes of the law
 The accounting equation asset is equal to liability plus capital is justified because of this
assumption.
2. Going Concern Assumption
 It means that the company will have a long life. As a rule, we expect companies to last long
enough to fulfill their objectives and commitments.
 A business is established to operate for unlimited period of time (long life) at profit at least for
more than one year.
 Significant Implications of this assumption
1. Historical Cost principle

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 2. Depreciation, estimation of useful life and residual value
3. Amortization & Depletion
4. Current and non- current classification of assets & liabilities,
5. Preparation of financial statement , etc

3. Monetary Unit Assumption ( unit of measure assumption)

 Money is the common denominator of economic activity and provides appropriate basis for
accounting measurement and analysis i.e monetary unit is the most effective means of
expressing changes in capital and exchange of goods and services to interested parties.
 Accounting generally ignores price level changes ( inflation & deflation) & assumes that the unit
of measure ( i.e Euros, Dollar, Yen , pound ) remains reasonably stable
 Use of Monetary Unit Assumption
 To justify adding 1985 pounds to 2019 pounds without any adjustment.
 Limitations of this assumption
 It does not consider the change in price level
 Some accounting events cannot be measured in monetary terms. For example
competence , morale of Management and employees
4. Periodicity Assumption ( Time period assumption )
 To measure the results of a company’s activity accurately, we would need to wait until it
liquidates
 Decision makers, however, cannot wait that long for such information.
 Users need to know a company’s performance and economic status on a timely basis so
that they can evaluate and compare companies and take appropriate actions
 It implies that a company can divide its economic activities into artificial time periods. ie
monthly, quarterly , semiannually and yearly.
 The shorter the time period , the inflation is more relevant and less reliable (
representational faithful)
 The longer the time period , the information is more reliable and less relevant
 There is a trade- off b/n relevance and faithful representation in preparing financial data.
 Use of time period assumption
 Adjusting entries for accruals , deferrals and other adjusting entry items
5. Accrual Basis of accounting
 It means that transactions that change a company’s financial statement are recorded in the
periods in which the events occur. Ie Revenue is recognized when it is probable that future
economic benefits will flow to the company and reliable measurement is possible (revenue
recognition principle). Expense is recognized when incurred ( the expense recognition
principle ) rather than when paid
 An alternative to the accrual basis is the cash basis. Under cash basis accounting revenue is
recorded only when cash is received and expense is recorded only when cash is paid. Cash
basis is prohibited under IFRS.

Basic Accounting Principles (Guidelines)

 Four basic principles of accounting to record and report transactions are
1. Measurement principles
2. Revenue Recognition Principle
3. Expense Recognition principle
4. Full ( adequate) disclosure principle
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Measurement principles
 Two measurement principles: Historical cost and fair value
 Selection of which principle to follow generally reflects a trade- off between relevance and faithful
representation.
Historical Cost Principle
 IFRS requires that companies account for and report many assets and liabilities on the basis of
acquisition price
 Cost is determined by the exchange price agreed upon by the parties to the exchange and is
measured by the amount of cash to be given up in exchange for the resource received. If the
consideration up is something other than cash , cost is measured by the fair-value of what is given
or the fair value of asset or service received whichever is more clearly and objectively determined
 Cost has an important advantage over other valuations ie it generally through to be a faithful
representation of the amount paid for a given item
 Do companies account for liability on a cost basis? Yes. ie company issue liability such as bonds ,
notes and A/P in exchange for assets ( or services) for an agreed upon price. This price, established
by the exchange transaction, is the cost of the liability.
 Advantage of cost principle:
 It is more reliable ( faithful representation)
 Definite and verifiable
Fair Value Principle
 Fair value: It is the price that would be received to sell an asset or paid to transfer a liability in
orderly transaction between market participants at the measurement date. It is market based
measure
 At initial acquisition, historical cost equals fair value. In subsequent periods, as market and
economic conditions change, historical cost and fair value often diverge. Thus fair value measures
or estimates provide more relevant information about excepted future cash flow related to the
asset or liability.
 IASB believes that fair value information is more relevant to users than historical cost. Fair value
measurement provides better insight into the value of a company’s assets and liabilities
Revenue Recognition Principle
 It is in line with accrual basis of accounting
 When a company agrees to perform a service or sell a product to a customer, it has a performance
obligation. when the company satisfies this performance obligation , it recognized revenue
 Revenue recognition principle requires that company recognize revenue in the accounting period in
which the performance obligation is satisfied
Example: Assume that a cleaning shop cleans clothing on June 30 but customers do not claim and
pay for their clothes until the first week of July. When does the shop record revenue? ie which
month? The answer is in the month of June when it performed the service
Expense Recognition Principle (Let expenses follow the revenue)
 It is in line with accrual basis of accounting. Expense is recognized (recorded) when it is incurred. It
is incurred when cash is paid ( for immediate expenses), when asset is used up or when a liability is
incurred for the services received in the process of obtaining revenue
 Expenses are defined as outflow or other using up of assets or incurring of liability (or a
combination of both) during a period as a result of delivering or producing goods and /or rendering
services.

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  Companies charge some costs to the current period as expenses (or losses) simply because they
cannot determine a connection with revenue.
Types of costs Relationship Recognition
Product Costs Direct relationship Recognized in period
 Raw material between costs and of revenue (
 Labor revenue Matching)
 Overhead
Period Costs No direct relationship Expensed as
 Salaries between cost & incurred
 Administrative Costs revenue

Full Disclosure Principle

 Information that is important to influence the judgment and decisions of an informed user should
be disclosed ( ie should be known )
 Disclosure can be made :
1. Within the main body of financial statement
2. In the notes to those statements
3. As supplementary information
 Disclosure is not a substitute for proper accounting

Constraints: Cost Constraint

 In order to include financial information in the financial statement, the cost should not exceed the
benefit. Underlying cost benefit constraint is the expectation that the benefits derived by external
users of financial statement should exceed the costs incurred by the preparers of information
 Companies must weigh the costs of providing the information against the benefits that can be
derived from using it
 Rule making bodies and governmental agencies use cost – benefit analysis before making final their
informational requirements. Ie benefit should exceed its cost of preparation and reporting.
IFRS based financial statements (IAS 1)
IAS 1 prescribes the basis for presentation of general purpose financial statements to ensure
comparability both with the entity‘s financial statements of previous periods and with the financial
statements of other entities. It sets out overall requirements for the presentation of financial
statements, guidelines for their structure and minimum requirements for their content.

IAS 1 provides guidelines for preparation and presentation of general purpose financial statements in
accordance with International Financial Reporting Standards (IFRSs). Other IFRSs set out the recognition,
measurement and disclosure requirements for specific transactions and other events. General purpose
financial statements are those intended to meet the needs of users who are not in a position to demand
reports that are tailored according to their information needs.

Types of financial statements according to IAS 1

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 1. Statement of financial position
2. Statement of profit or loss and other comprehensive income
3. Statement of change in equity
4. Statement of cash flow
5. Notes to the financial statements
Statement of Financial Position

 The statement of financial position also called balance sheet is a statement that present an entity’s
assets, liabilities and equity ( net asset) at a given point in time i.e as at a specific date
 It provides information concerning liquidity, solvency and financial flexibility of a company
 Under IFRS, assets and liabilities are recorded at cost or fair value at inception in the financial
statements, which for assets and liabilities are arising from arm’s length transactions, will generally
be equal to negotiated prices. Subsequent measurement is under the historical cost principle or fair
value , depending on the requirements of the standard and accounting policy election made by the
entity

Classification of assets

According to IAS 1, an asset should be classified as a current asset when it satisfies any one of the
following:

1. It is expected to be realized in , or is held for sale or consumption in the normal course of the
entity’s operating cycle
2. It is held primarily for trading purposes
3. It is excepted to be realized within 12 months of the end of the reporting period
4. It is cash or a cash equivalent asset, which is not restricted in its use

Classification of Liabilities

According to IAS1, a liability should be classified as current liability when:

1. It is expected to be settled in the normal course of business within the entity’s operating cycle
2. It is due to be settled within 12 months of the date of the statement of financial position
3. It is held primarily for the purpose of being traded ; or
4. The entity does not have an unconditional right to defer settlement beyond 12 months

Classification of Shareholders’ Equity

 Shareholders’ equity represents the interests of the owners in the net assets of a corporation. It
shows the cumulative net results of past transaction and other events affecting the entity since its
inception.
1. Share Capital: It consists of the par or nominal value of preference and ordinary shares
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2. Share premium : It is the difference between the market value of the share and its par value
3. Retained Earnings : It represents the accumulated earnings since the inception f the entity , less any
earnings distributed to owners in the form of dividends
4. Some elements of comprehensive income,
 These components of other comprehensive income include net changes in the fair values of
available for sale securities portfolios , and un realized gains or losses on translations of the financial
statements of subsidiaries denominated in foreign currency, net changes in revaluation surplus , etc

Statement of Profit or Loss and Other Comprehensive Income

 It presents all components all components of profit or loss and other comprehensive income in
single statement with net income being an intermediate caption.
 IAS 1 states that comprehensive income is the change in the equity’s net assets over the course of
the reporting period arising from non- owner sources
 Under IAS1, Other comprehensive income (OCI) includes items of income and expense (including
reclassification adjustments) that are not recognized in profit or loss as may be required or
permitted by other IFRS. The components of OCI include:
1. Changes in revaluation surplus ( ISA 16, and IAS 38)
2. Actuarial gains and losses on defined benefit plans ( IAS19)
3. Translation gains and losses of foreign operations ( IAS 21)
4. Gains and losses on re-measuring available for sale financial assets ( IAS 39)

Statement of cash flows

 It reports cash receipts , cash payments and net change in cash resulting from a company’s
operating , investing and financing activities during a period
 It classifies cash receipts and cash payments by operating , investing and financing activities
 The statement of cash flows can be prepared using two methods: the direct method and the
indirect method. Both methods organize cash flows into three activities: operating, investing, and
financing activities.
 The direct method reports cash flows from operating activities into categories such as cash from
customers, cash to suppliers, and cash to employees. The indirect method reports cash flows
from operating activities starting with net income/loss adjusted for any non-cash items, followed
by the changes in each of the working capital accounts (i.e., current assets and current liabilities
accounts).
 The total cash flows from the operating activities are the same for both methods. The investing
and financing activities are prepared the same way under both methods.

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