CIMA F1

Financial Operations

Student Notes

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Contents

CIMA F1 ........................................................................................................................................................................1

Topic 6 – The Regulatory Environment ........................................................................................................................2

International Financial Reporting Standards (IFRSs) ................................................................................................5

Topic 7: The Conceptual Framework ............................................................................................................................7

Topic 8: External Audit............................................................................................................................................... 16

Topic 9: Code of ethics .............................................................................................................................................. 25

Topic 10: Corporate Governance............................................................................................................................... 33

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A1a: Explain the need for the regulation of the financial reporting information of

incorporated entities and the key elements of an ethical regulatory environment

for such information

A1b: Explain the roles and structures of the key bodies involved in the regulation of

financial reporting information.

Need for regulation

Because of the importance of published accounts giving a fair presentation to the users of these accounts, they

need to be regulated. Without such regulation consistency of accounts preparation is undermined.

Regulatory bodies

The IFRS

Foundation

22 Trustees

IFRS Advisory

Council

International

Accounting

Standards Board

IFRS

Interpretations

Committee

Appoints members

Advises

Reports

Topic 6 – The Regulatory Environment

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IFRS Advisory Council

The IFRS Advisory Council (formally called the SAC) provides a forum for organisations and individuals to

participate in the standard-setting process.

It is way the IASB consults with the outside world.

The objectives of the IFRS Advisory Council Care:

� To give advice to the IASB on agenda decisions and priorities in its work;

� To inform the IASB of the views of organisations and individuals on the Council on major standard-setting

projects;

� To give other advice to the Board or to the Trustees.

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IFRS Interpretations Committee (IFRS IC)

The IFRS Interpretations Committee (formally known as the International Financial Reporting Interpretations

committee or IFRIC) was originally established in 2002. They provide guidance on specific practical issues in the

interpretation of IFRS. Note that despite the name change. Interpretations issued by the IFRS Interpretations

Committee are still known as IFRIC interpretations. In your exam, you may see the IFRS Interpretations

Committee referred to as the IFRS IC.

The responsibilities of the IFRS IC:

1. To review on a timely basis , newly identified financial reporting issues not specifically addressed in IFRSs

2. To clarify issues where unsatisfactory or conflicting interpretations have developed, or seem likely to

develop in the absence of authoritative guidance, with a view to reaching a consensus on the appropriate

treatment.

Apply Your Knowledge 1

What is the role of the IFRS Interpretations committee?

A. To develop and issue a set of globally accepted international financial reporting standards

B. To clarify issues in the application of IFRS s where unsatisfactory or conflicting interpretations has

developed

C. To take account of the financial reporting needs of small and medium sized entities

D. To provide a forum for the IASB to consult with the national accounting standard setters, academics and

other interested parties

Apply Your Knowledge 2

Which of the following is responsible for developing and issuing IFRSs (International Financial Reporting

Standards)?

A. IFRS Foundation

B. IFRS Interpretations committee

C. International Accounting Standards Board (IASB)

D. IFRS Advisory Council

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A1c: Explain the scope of IFRS and how they are developed.

There are currently 41 IASs and 13 IFRSs in issue.

The use and application of FRSs

PLEASE NOTE THROUGHOUT THIS COURSE WE WILL USE THE ABBREVIATION IFRSs TO INCLUDE BOTH IFRSs

AND IASs.

The IFRSs have helped to improve and harmonise financial reporting around the world. The standards are used in

the following ways:

1. As national requirements

2. As the basis for all or some national requirements

3. As an international benchmark for those counties which develop their own requirements

4. By regulatory authorities for domestic and foreign companies

5. By companies themselves

In the UK the consolidated accounts of listed companies have had to be produced in accordance with IFRSs since

January 2005.

Standard-setting process

The IASB prepares IFRSs in accordance with due process.

� Establishment of a consultative group to give advice on the issues arising on the project. The IASB will consult

with this committee and IFRS advisory council throughout the process.

� On acceptance of a project a steering committee is set up (chaired by board members);

� On major projects, the IASB develops and publishes a Discussion Document for public comment;

� Following the receipt and review of comments, an Exposure Draft is produced for public comment;

� Following the receipt and review of comments, the final IFRS will be issued.

International Financial Reporting Standards (IFRSs)

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Scope and application of IFRSs

Any limitation of the applicability of a specific IFRS is made clear within that standard. IFRSs are not intended to

be applied to immaterial items, nor are they retrospective.

Within each individual country local regulations will govern, to a greater or lesser degree.

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A1a: Explain the need for the regulation of the financial reporting information of

incorporated entities and the key elements of an ethical regulatory environment

for such information

Purpose and status of the conceptual Framework

The IASB’s Framework for the Preparation and Presentation of Financial Statements sets out the concepts

underlying the preparation and presentation of financial statements for external users.

In detail, the intended role of the Framework is to:

� assist the IASB in its development of future accounting standards and in its review of existing

accounting standards

� assist the IASB by providing a basis for reducing the number of alternative accounting treatments

permitted by law and accounting standards

� assist preparers of financial statements in applying accounting standards and in dealing with topics

that do not form the subject of an accounting standard

� assist auditors in forming an opinion as to whether financial statements conform with accounting

standards

� help users of financial statements to interpret the information contained in financial statements

prepared in conformity with accounting standards

� provide those who are interested in the work of the IASB with information about its approach to the

formulation of accounting standards.

The Framework is not itself an accounting standard nor can it override the requirements of any existing

accounting standard.

The objective general purpose financial reporting

You must learn the objective of financial statements, the qualitative characteristics of financial statements and

the underlying assumptions. These are a ‘need to learn’.

At the user

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.

These decisions involve buying, selling or holding investments in shares or debt instruments, and providing or

settling loans and other forms of credit.

Topic 7: The Conceptual Framework

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Decisions made by users depend upon the returns that they expect to receive, for example dividend income,

principal and interest payments or market price increases. Consequently users need information that helps them

assess the prospects for future net cash inflows to an entity.

To assess the entity's prospects for future net cash inflows users need information about:

� the resources of the entity

� claims against the entity

� how efficiently and effectively the entity's management and governing board have discharged their

responsibilities to use the entity's resources.

Many existing and potential investors, lenders and other creditors cannot require reporting entities to provide

information directly to them and must rely upon general purpose financial reports for much of the financial

information they need. Consequently they are the primary users to whom general purpose financial reports are

directed.

Underlying assumption

Going concern

Going concern is the underlying assumption adopted whenever we are preparing financial statements. You will

have learnt about this from your first introduction to double-entry bookkeeping.

Although the accruals concept is no longer considered to be an underlying assumption it is still covered by the

Conceptual Framework as an important concept of financial accounting. The accruals concept states events

should be dealt with in the accounting period they occur, rather than the period they are paid.

Fundamental qualitative characteristics of financial statements The framework splits qualitative characteristics into two categories:

(i) Fundamental qualitative characteristics

- Relevance

- Faithfull representation

(ii) Enhancing qualitative characteristics:

- Comparability

- Verifiability

- Timeliness

- Understandability

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Relevance

Relevance – to be useful, information must be relevant to the decision making needs of the user. Information is

relevant when it influences the economic decisions of users by helping them to evaluate past, present or future

events or confirming or correcting their past evaluations.

The relevance of information is affected by its nature and materiality. (Information is material if its omission or

misstatement could influence the economic decisions of users taken on the basis of the financial statements)

Faithful representation

Faithful representation – a transaction or other event is faithfully represented if the way in which it is recognised,

measured or presented in the financial statements corresponds closely to the effect of that transaction or event.

Substance over form – the economic substance of a transaction should be recorded rather than simply its legal

form.

Example: A company acquired a non-current asset under a hire purchase agreement; the legal position is that

ownership does not pass until the final instalment has been paid. However, substance of the transaction is that

the company is purchasing an asset and taking out a loan to pay for it. Therefore, the asset and the loan are

recorded in the accounts.

Neutrality (objectivity) – information is not neutral if it has been selected or presented in such a way as to

influence the making of a decision or judgement in order to achieve a predetermined result or outcome.

Free from error – Within the bounds of materiality information must be free from error. This does not mean

perfectly accurate. Estimates are acceptable but must be described clearly as such.

Completeness- Financial information must be complete, within the restrictions of materiality and cost, to be

reliable. Omission may cause information to be misleading.

Enhancing qualitative characteristics of financial statements

Comparability, verifiability, timeliness and understandability are qualitative characteristics that enhance the

usefulness of information that is relevant and faithfully represented. The enhancing qualitative characteristics

may also help determine which of two ways should be used to depict a phenomenon if both are considered

equally relevant and faithfully represented.

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Comparability

Users must be able to compare financial statements over a period of time in order to identify trends in financial

position and performance. Users must also be able to compare financial statements of different entities to be

able to assess their relative financial position and performance.

In order to achieve comparability, similar items should be treated in a consistent manner from one period to the

next and from one entity to another. However, it is not appropriate for an entity to continue accounting for

transactions in a certain manner if alternative treatments exist that would be more relevant and reliable.

Disclosure of accounting policies should also be made so that users can identify any changes in these policies or

differences between the policies of different entities.

Verifiability

Verification can be direct or indirect. Direct verification means verifying an amount or other representation

through direct observation i.e. counting cash. Indirect verification means checking the inputs to a model, formula

or other technique and recalculating the outputs using the same methodology i.e. recalculating inventory

amounts using the same cost flow assumption such as first-in, first-out method.

Timeliness

Timeliness means having information available to decision makers in time to be capable of influencing their

decisions. Generally, the older the information is the less useful it becomes.

Understandability

Information needs to be readily understandable by users. Information that may be relevant to decision making

should not be excluded on the grounds that it may be too difficult for certain users to understand.

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The elements of financial statements

Asset is a resource controlled by the enterprise as a result of past events and from which future economic

benefits are expected to flow to the enterprise.

Liabilities are an entity’s obligations to transfer economic benefits as a result of past transactions or events.

Equity is the residual amount found by deducting all liabilities of the entity from all of the entity’s assets.

Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of

assets or decreases in liabilities that result in increases in equity, other than those relating to contributions from

equity participants.

Expenses are decreases in economic benefits during the accounting 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 participants.

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Recognition of the elements of financial statements

In order to recognise anything in the statement of financial position and income statement it must meet all three

of the following criteria:

� Meet the definition of the element (as above)

� Probable future economic benefit will flow to or from the entity

� The item can be measured reliably

Measurement of the elements of financial statements

� Historical cost --- cash price or fair value at acquisition or obligation. Most commonly used but widely

criticised

� Current cost – what would be the cash price today

� Realisable value --- what could be realised/satisfied today

� Present value – discounted future cash flows

The Framework does not state which of the four should be used

Concepts of capital and capital maintenance.

The concept of capital maintenance is concerned with how an entity defines the capital that it seeks to

maintain. It provides the linkage between the concepts of capital and the concepts of profit because it

provides the point of reference by which profit is measured; it is a prerequisite for distinguishing between an

entity’s return on capital and its return of capital; only inflows of assets in excess of amounts needed to

maintain capital may be regarded as profit and therefore as a return on capital. Hence, profit is the residual

amount that remains after expenses (including capital maintenance adjustments, where appropriate) have

been deducted from income. If expenses exceed income the residual amount is a loss.

Financial capital maintenance is measured in either nominal monetary units or units of constant purchasing

power.

Physical capital maintenance requires the adoption of the current cost basis of measurement – an appreciation of

what it would cost to replace assets at current prices.

The main difference between the two is how they treat the effects of increases in prices of assets and liabilities.

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Apply Your Knowledge 1

Under the IASB’s Framework for the preparation and presentation of financial statements which of the following

is the ‘threshold quality’ of useful information.

A. Relevance

B. Reliability

C. Materiality

D. Understandability

Apply Your Knowledge 2

THE IASB’s Framework identifies qualitative characteristics

i. Relevance

ii. Comparability

iii. Verifiability

iv. Understandability

v. Faithful Representation

Which of the above are not listed as an enhancing characteristic?

A. (i), (iv) and (v)

B. (ii), (iii) and (iv)

C. (ii) and (iii)

D. (i) and (v)

Apply Your Knowledge 3

According to ‘The Framework’ what is the main objective of financial reporting?

Providing useful information to:

A. The government

B. The employees

C. The customers

D. The investors

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Apply Your Knowledge 4

Which THREE of the following are uses of financial statements as identified by ‘The Framework’?

A. The general public

B. Trade unions

C. Lenders

D. Analyst/ advisors

E. The European Union

F. Competitors

Apply Your Knowledge 5

Which are the THREE main financial statements as identified by ‘The Framework’?

A. The statement of liabilities

B. The statement of expenses

C. The income statement

D. The statement of financial position

E. The statement of cash flows

F. The statement of Obligations

Apply Your Knowledge 6

According to ’The Framework’ which qualitative characteristics enhance the usefulness of information that is:

A. Comparability, understandability, timeliness, completeness

B. Consistency, prudence, measureability, verifiability

C. Consistency, reliability, measurability, timeliness

D. Materiality, understandability, measureability, reliability

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Apply Your Knowledge 7

Which THREE of the following are qualitative characteristics of financial statements as identified by

A. Relevance

B. Materiality

C. Reliability

D. Timeliness

E. Measurability

F. Prudence

Apply Your Knowledge 8

Which THREE of the following are elements of financial statements as identified by ‘The Framework’

A. Revenue

B. Expenses

C. Profits

D. Losses

E. Capital

F. Obligations