Accounting Theory Practice, International Accounting Standard - Essay Example

ACCOUNTING THEORY PRACTICE International Accounting Standard has been revised again on 6 September 2007. This revision has brought the IAS almoston the level of US Financial Accounting Standard Board (FASB) statement no. 130 ‘Reporting Comprehensive Income’. In fact FASB decided earlier that it would not publish an exposure draft requiring changes at this phase of changes in IAS 1. As per Ernst & Young (September 2007)1, ‘The main revision to IAS 1 arises from the IASB’s consideration of the US Standard SFAS 130 Reporting Comprehensive Income. The IASB has also taken the opportunity to improve the structure and wording of IAS1” This revised IAS 1 is applicable to all entities whether those are profit oriented or not- for profit entities. ‘Not- for profits entities in both the public and private sectors can apply this standard, however they may need to change the description used for particular line items within their financial statements and for the financial statements themselves. This standard applies to those entities that present consolidated financial statements and those that present financial statements as defined in IAS 27: Consolidated and Separate Financial Statements. It does not apply to the structure and contents of condensed interim financial statements prepared in accordance with IAS 34: Interim Financial Reporting.’ (Barry and Jermakowicz, page 22)2. In other words IAS 1 is applicable to all financial statements that cater general purpose needs. ‘General purpose financial statements are those intended to meet the needs of users who are not in a position to demand reports tailored to meet their specific information needs. They include statements presented separately or those within another public document, such as annual report or prospectus.’(David Alexander and Simon Archer, 3.04)3 IAS 1 revised in September 2007, issued by International Accounting Standard Board (IASB), is the first of the series of expected revisions on the standard. While issuing the revised IAS 1, IASB (2007)4 stated in the press release that ‘the changes made are to require information in financial statements to be aggregated on the basis of shared characteristics and to introduce a statement of comprehensive income. This will enable the readers to analyze changes in a company’s equity resulting from transactions with owners (such as dividend and share purchase) separately from non- owner changes (such as transactions with third parties)’. This indicates that the basic objective of changes is to present each financial statement in such a fashion that reflects the financial position and performance of the entity in such an organized manner so that the financial information about business activities should be separated from other activities, and also from transactions relating to owners of the entity. This objectivity of revised standard will provide users of financial statements a comprehensive report not only on business performances of the entity but also a detailed report on other activities as well as activities of the ownership of the entity. Explaining this objectivity of the board, Barry, Epstein and Jermakowicz (2008, p.22)5 has stated that ‘IASB and FASB have decided that financial statement should present information in a manner that reflects a cohesive financial picture of an entity and which separates an entity’s financing activities from its business and other activities as well transactions with owners. Additionally, financing activities should be separated into transactions with owners and all other financing activities.’ Though changes brought in by IASB in IAS 1 on September 6, 2007 is the first phase of changes in the standard concerned with presentation of financial statements, the published overall main objectives for bringing changes in IAS 1 as stated by International Accounting Standard Board (2007, page 781)6 are as under: “ a) To provide framework within which an entity assesses how to present fairly the effects of transactions and other events, and assess whether the result of complying with the requirements of a standard or an interpretation would be so misleading that it would not give a fair presentation.; b) To base the criteria for classifying liabilities as current or non current solely on the conditions existed at the date of balance sheet; c) To prohibit the presentation of items of income and expense as ‘extraordinary items’; d) To specify disclosures about the judgments management has made in the process of applying the entity’s accounting policies, apart from those involving estimation, that have the most significant effect on the amounts recognized in the financial statements; e) To specify disclosures about key sources of estimation uncertainty at the balance sheet date that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year.” Broadly speaking, the revision of IAS 1 in September 2007 has brought in the following two new requirements for compliance by the entities: “ a) Requirement to disclose reclassification adjustments relating to components of other comprehensive income. Reclassification adjustments are amounts reclassified to profit or loss in the current period that were recognized in other comprehensive in income in previous period. The purpose is to provide users with information to assess the effects of such reclassification on profit or loss. b) Requirement to disclose income tax relating to each component of other comprehensive income. The purpose is to provide users with tax information relating to these components because these components often have rates different from those applied to profit or loss.” (EFRAG, May 2008)7 In a comprehensive manner Mirza, Orrell, and Holt (2008, page 24)8 have listed the significant changes brought out by revised IAS 1 as under: There is a new requirement to include a “statement of financial Position” at the beginning of earliest comparative period presented whenever an entity applies a change in accounting policy retrospectively, or makes a retrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements; All items of income and expense (including those accounted for directly in equity) must, after the revision become effective, be presented either in a single statement (a “statement of comprehensive income”) or in two statements (with a separate “income statement” and a “statement of comprehensive income”); Entities are no loner permitted to present items of “other comprehensive income” (e.g., gains or losses on revaluation of property, plant and equipment) separately in “statement of changes in equity” ( “such non- owner movements must now be presented in a statement of comprehensive income”); Entities are no longer permitted to present transactions with owners in their capacity as owners in the notes to the financial statements (since now the “statement of changes in equity” must be presented as a separate financial statement); and New detailed requirements have been added regarding the presentation of items of “other comprehensive income.” These detailed requirements of presenting other comprehensive income include disclosure of income tax for each component of other comprehensive income. Further dividend and per share income may be disclosed wither on the face of changes in the statement of equity or in the notes to financial statements. The term ‘owners’ used above has been defined in the revision of IAS 1 as ‘the holders of instruments classified as equities. The major changes with regard to presentation of Income statement will affect the entities who were earlier presenting a separate statement of recognized income and expense. Now these entities will have to provide in addition a statement of changes in equities, that earlier they used to provide in notes to financial statements. In the opinion of Price Waterhouse Coopers (November 2007)9, “The amendment considers the alignment of comprehensive concept with FAS 130; however there are still some differences. For example FAS 130 permits a third option of displaying comprehensive income in a statement of changes in equity. IAS 1 revised does not permit this third option. There are other items required by one standard but not by the other. For example, the amendment of IAS 1 requires an entity to display the share of each item of associates’ other comprehensive income; FAS 130 does not provide explicit guidance.” It must be noted that now ‘income statement’ or ‘statement of comprehensive income’ will not now include the results of extraordinary items. Extraordinary items are items of income and expense that arise out of transactions not in ordinary course of activities of the entity. In fact the concept of ‘extraordinary items’ have now been completely eliminated from the presentation of financial statements. ‘Some respondents to the exposure draft argued that extraordinary items should be presented in a separate component of income statement because they are clearly distinct from all of the other items of income and expense and because such presentation highlights to the users of financial statements the items of income and expense to which the least attention should be given when predicting an entity’s future performance. The board decided that the items treated as extraordinary result from the normal business risks faced by an entity and do not warrant presentation in a separate component of income statement. The nature or function of a transaction or other event, rather its frequency, should determine its presentation within the income statement. Items currently classified as extraordinary are only a subset of the items of income and expense that may warrant disclosures to assist users in predicting an entity’s future performance. Eliminating the category of extraordinary items eliminates the need for arbitrary segregation of the effects of the related external events – some recurring and other not – on the profit or loss of an entity for a period. (IASB, 2007, page 813)10 Revision of IAS1 has changed the nomenclature of financial statements. Balance sheet will be known as ‘Statement of Financial Position’, income statement will be called ‘Statement of Comprehensive Income’ and the cash flow statement as ‘Statement of Cash flows’. Using these titles will be at the optional probably first to popularize them among the users of financial statements. It is a fact that a balance sheet by whatever name called will remain as balance sheet, but as per Feed Burner (Sep. 2007)11 a balance sheet prepared as per IFRS cannot be considered as ‘Statement of Financial Position’ because of the following reasons: “ Operating assets such as inventory, plant, equipment, and land are measured at historic cost. As past costs, they are no indicators of current ‘position’. They merely communicate that old investments will cover those costs that have not yet been expensed. Some assets are measured in terms of their current ‘position’ to generate future cash flows. But total assets is nothing more than a summation of apples and other things so dissimilar it would be kindness to call them oranges. The rule makers’ euphemism for a little of this and little of that is ‘multi- attribute- approach’ e.g., historic cost for inventory and PP &E, net realizable value for receivables, present value for some investments, random numbers for ‘hedged items’, and more. A statement of financial position should be reasonably complete, but for too many assets and liabilities excluded by extant accounting rules. What could you learn about a consulting firm’s most critical asset --- its collective brain power and experience, from its ‘statement of financial position’ prepared in accordance with IFRS ?” With the changes brought in by revised IAS 1, it is not now possible to present non- owners changes in equities in the statement of changes in equities. Income and expenses will be presented separately from owners changes in equity either in one statement (statement of comprehensive income) or two statements (statement of income and statement of comprehensive income) at the option of the entity. Comparative information in respect previous periods will be declared when financial statements are restated. The standard also provides a provision for a third statement of financial positions as at the beginning of earliest comparative period whenever entity changes accounting policies, or make retrospective restatement of items in the financial statements. The standard makes it mandatory to disclose reclassification adjustments relating to each component of other comprehensive income. Further income tax relating to each component of comprehensive income is required to be disclosed. Above all, dividend will now be recognized as distribution to owners and related per share amount will be presented either in statement of changes in equity or in the notes to financial statements. It is generally believed that revised IAS 1 will certainly improve the quality of financial statements and accordingly the information to be provided to the users of financial statements. The changes that will provide the real impact on improvement of financial statements are the changes relating to separation of owners changes in equity from non- owners changes, disclosure of reclassification of adjustments, and presentation of dividends and related per share amounts. It is believed that changes brought in by this revision of IAS 1 will overall improve the quality of accounting information available to users of financial statements. References: Read More