International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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ability of users both to understand the transactions, other events and conditions that
have occurred and to assess the entity’s future cash flows. It clarifies, though, that
measuring assets net of valuation allowances – for example, obsolescence allowances
on inventories and doubtful debts allowances on receivables – is not offsetting. [IAS 1.33].
Accordingly, IAS 1 requires that assets and liabilities, and income and expenses, should
not be offset unless required or permitted by an IFRS. [IAS 1.32].
Just what constitutes offsetting, particularly given the rider noted above of ‘reflecting
the substance of the transaction’, is not always obvious. IAS 1 expands on its meaning as
follows. It notes that:
Presentation of financial statements and accounting policies 153
(a) IFRS
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– Revenue from Contracts with Customers – defines revenue from
contracts with customers and requires it to be measured at the amount of
consideration to which the entity expects to be entitled in exchange for
transferring promised goods or services, taking into account the amount of any
trade discounts and volume rebates allowed by the entity – in other words a
notional ‘gross’ revenue and a discount should not be shown separately, but should
be ‘offset’. Revenue from contracts with customers is discussed in Chapter 28;
(b) entities can undertake, in the course of their ordinary activities, other transactions
that do not generate revenue but are incidental to the main revenue-generating
activities. The results of such transactions should be presented, when this
presentation reflects the substance of the transaction or other event, by netting any
income with related expenses arising on the same transaction. For example:
(i) gains and losses on the disposal of non-current assets, including investments
and operating assets, should be reported by deducting from the proceeds on
disposal the carrying amount of the asset and related selling expenses; and
(ii) expenditure related to a provision that is recognised in accordance with
IAS 37 – Provisions, Contingent Liabilities and Contingent Assets – and
reimbursed under a contractual arrangement with a third party (for example,
a supplier’s warranty agreement) may be netted against the related
reimbursement; [IAS 1.34] and
(c) gains and losses arising from a group of similar transactions should be reported on
a net basis, for example, foreign exchange gains and losses or gains and losses
arising on financial instruments held for trading. However, such gains and losses
should be reported separately if they are material. [IAS 1.35].
4.1.6
Profit or loss for the period
The final provision of IAS 1 which we term a general principle is a very important one.
It is that, unless an IFRS requires or permits otherwise, all items of income and expense
recognised in a period should be included in profit or loss. [IAS 1.88]. This is the case
whether one combined statement of comprehensive income is presented or whether a
separate statement of profit or loss is presented (discussed at 3.2.1 above).
Income and expense are not defined by the standard, but they are defined by the
Conceptual Framework as follows:
(a) income is increases in assets, or decreases in liabilities, that result in increases in
equity, other than those relating to contributions from holders of equity claims; and
(b) expenses are decreases in assets, or increases in liabilities, that result in decreases
in equity, other than those relating to distributions to holders of equity claims.
[CF 4.68, 4.49].
Strictly speaking, the two definitions above apply for accounting periods beginning on
or after 1 January 2020 as a result of the revisions to the Framework published in 2018
(discussed in Chapter 2). [IAS 1.139S]. However, the definitions are essentially the same as
those in the earlier version (which are not further discussed here).
These definitions clearly suggest to us that the terms do not have what many would
consider their natural meaning, as they encompass all gains and losses (for example,
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capital appreciation in a non-current asset like property). There is a somewhat awkward
compromise with various gains and losses either required or permitted to bypass profit
or loss and be reported instead in ‘other comprehensive income’. Importantly, as
discussed at 3.2.1 above, profit and loss, and other comprehensive income may each be
reported as a separate statement.
IAS 1 notes that some IFRSs specify circumstances when an entity recognises particular
items outside profit or loss, including the effect of changes in accounting policies and
error corrections (discussed at 4.4 and 4.6 below). [IAS 1.89]. Other IFRSs deal with items
that may meet the Framework’s definitions of income or expense but are usually
excluded from profit or loss. Examples include:
(a) changes in revaluation surplus relating to property, plant and equipment and
intangible assets;
(b) remeasurements on defined benefit plans in accordance with IAS 19;
(c) gains and losses arising from translating the financial statements of a foreign
operation;
(d) gains and losses from investments in equity instruments designated at fair value
through other comprehensive income;
(e) gains and losses on financial assets measured at fair value through other
comprehensive income;
(f) the effective portion of gains and losses on hedging instruments in a cash flow
hedge and the gains and losses on hedging instruments that hedge investments in
equity instruments measured at fair value through other comprehensive income;
(g) for particular liabilities designated as at fair value through profit and loss, fair value
changes attributable to changes in the liability’s credit risk;
(h) changes in the value of the time value of options when separating the intrinsic
value and time value of an option contract and designating as the hedging
instrument only the changes in the intrinsic value;
(i)
changes in the value of the forward elements of forward contracts when separating
the forward element and spot element of a forward contract and designating as the
hedging instrument only the changes in the spot element, and changes in the value
of the foreign currency basis spread of a financial instrument when excluding it
from the designation of that financial instrument as the hedging instrument; and
(j) insurance finance income and expenses related to insurance or reinsurance
contracts which is excluded from profit or loss in certain circumstances in
accordance with IFRS 17 – Insurance Contracts. [IAS 1.7, 89].
4.1.7
Practice Statement 2 – Making Materiality Judgements
In September 2017 the IASB published Practice Statement 2 – Making Materiality
Judgements (Statement 2). This is a non-mandatory statement and does not form part of
IFRS, its application is not, therefore, required to state compliance with IFRS. [PS 2.2].
Notwithstanding the above, preparers of financial statements may wish to consider the
practice statement and an overview of it is given below.
Statem
ent 2 addresses three main areas:
Presentation of financial statements and accounting policies 155
• the general characteristics of materiality;
• a four-step process that may be applied in making materiality judgements when
preparing financial statements (the ‘materiality process’); and
• guidance on how to make materiality judgements in relation to the following:
• prior period information,
• errors,
• information about covenants; and
• interim reporting.
There is also a discussion of the interaction between the materiality and local laws and
regulations. Local laws and regulations may specify additional requirements that can
affect the information included in the financial statements. IFRS permits the disclosure
of such additional information in order to meet local legal or regulatory requirements,
although not material from an IFRS perspective, as long as it does not obscure
information that is material (see 4.1.5.A above). [PS 2.28, IAS 1.30A, BC30F].
4.1.7.A
General characteristics of materiality
The Practice Statement explores materiality by considering the following characteristics:
• Definition of material[PS 2.5-7].
The objective of financial statements is to provide financial information about the
reporting entity that is useful to primary users. An entity identifies the information
necessary to meet the objective by making appropriate materiality judgements.
The definition of material is discussed at 4.1.5.A above.
• Materiality judgements are pervasive[PS 2.8-10].
Materiality judgements are pervasive to the preparation of financial statements.
Entities make materiality judgements in decisions about recognition and measurement
as well as presentation and disclosure. Requirements in IFRS only need to be applied
if their effect is material to the complete set of financial statements. However, it is
inappropriate to make, or leave uncorrected, immaterial departures from IFRS to
achieve a particular presentation. The Practice Statement reiterates that, as discussed
at 4.1.5.A above, an entity does not need to provide a disclosure specified by IFRS if
the information resulting from that disclosure is not material, even if IFRS contains a
list of specific disclosure requirements or describes them as minimum requirements.
• Judgement
Materiality judgements require consideration of both the entity’s circumstances
(and how they have changed compared to prior periods) and how the information
responds to the information needs of its primary users. [PS 2.11-12].
• Primary users and their information needs
When making materiality judgements, an entity needs to take into account how
information could reasonably be expected to influence the primary users of its
financial statements and what decisions they make on the basis of the financial
statements. Primary users are existing and potential investors, existing and
potential lenders and existing and potential other creditors. They are expected to
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have a reasonable knowledge of business and economic activities and to review
and analyse the information included in the financial statements diligently. Since
financial statements cannot provide all the information that primary users need,
entities aim to meet the common information needs of their primary users and not,
therefore, needs that are unique to particular users or to niche groups. [PS 2.13-23].
• Impact of publicly-available information
Financial statements must be capable of standing-alone. Therefore, entities make
the materiality assessment regardless of whether information is publicly available
from another source. [PS 2.24-26].
4.1.7.B
Making materiality judgements
The Practice Statement sets out a four-step process to help preparers making materiality
judgements. This process describes how an entity may assess whether information is
material for the purposes of recognition, measurement, presentation and disclosure.
The materiality process considers potential omissions and misstatements as well as
unnecessary inclusion of immaterial information. In all cases, an entity focuses on how
the information could reasonably be expected to influence the decisions of users of
financial statements. [PS 2.29-32].
The steps are as follows.
• Step 1 – Identify
Identify information about transactions, other events and conditions that has the
potential to be material considering the requirements of IFRS and the entity’s
knowledge of its primary users’ common information needs. [PS 2.35-39].
• Step 2 – Assess
Determine whether the information identified in Step 1 is material considering
quantitative (size of the impact of the information against measures of the financial
statements) and qualitative (characteristics of the information making it more likely
to influence decisions of the primary users) factors in the context of the financial
statements as a whole. [PS 2.40-55].
• Step 3 – Organise
Organise material information within the draft financial statements in a way that
communicates the information clearly and concisely (for example, by emphasising
material matters, tailoring information to the entity’s own circumstances,
highlighting relationships between different pieces of information). [PS 2.56-59].
• Step 4 – Review
Review the draft financial statements to determine whether all material
information has been identified and consider the information provided from a
wider perspective and in aggregate, on the basis of the complete set of financial
statements. [PS 2.60-65].
4.1.7.C Specific
topics
The Practice Statement provides guidance on how to make materiality judgements in
the following specific circumstances:
Presentation of financial statements and accounting policies 157
• Prior period information
Entities are required to provide prior period information if it is relevant to
understand the current period financial statements, regardless of whether it was
included in the prior period financial statements (discussed at 2.4 above). This
might lead an entity to include prior period information that was not previously
provided (if necessary to understand the current period financial statements) or to
summarise prior period information, retaining only the information necessary to
understand the current period financial statements. [PS 2.66-71].
• Errors
An entity assesses the materiality of an error (omissions or misstatements or both)
on an individual and collective basis and corrects all material errors, as well as any
immaterial financial reporting errors made intentionally to achieve a particular
presentation of its financial statements (discussed at 4.6 below). When assessing
whether cumulative errors (that is, errors that have accumulated over several
periods) have become material an entity considers whether its circumstances have
changed or further accumulation of a current period error has occurred.
Cumulative errors must be corrected if they have become material to the current-
/>
period financial statements. [PS 2.72-80].
• Loan covenants
When assessing whether information about a covenant in a loan agreement is
material, an entity considers the impact of a potential covenant breach on the
financial statements and the likelihood of the covenant breach occurring.
[PS 2.81-83].
• Materiality judgements for interim reporting
An entity considers the same materiality factors for the interim report as in its annual
assessment. However, it takes into consideration that the time period and the
purpose of interim financial statements (that is, to provide an update on the latest
complete set of annual financial statements) differ from those of the annual financial
statements. Interim financial statements are discussed in Chapter 37. [PS 2.84-88].
4.2
The distinction between accounting policies and accounting
estimates
IAS 8 defines accounting policies as ‘the specific principles, bases, conventions, rules
and practices applied by an entity in preparing and presenting financial statements.’
[IAS 8.5]. In particular, IAS 8 considers a change in ‘measurement basis’ to be a change in
accounting policy (rather than a change in estimate – see 6.2.1 below for information
about the Board’s proposals in these areas). [IAS 8.35]. Although not a defined term, IAS 1
(when requiring disclosure of them) gives examples of measurement bases as follows:
• historical cost;
• current cost;
• net realisable value;
• fair value; and
• recoverable amount. [IAS 1.118].
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‘Accounting estimates’ is not a term defined directly by the standards. However, it is
indirectly defined by the definition in IAS 8 of a change in an accounting estimate as
follows. A change in accounting estimate is an adjustment of the carrying amount of an
asset or a liability, or the amount of the periodic consumption of an asset, that results
from the assessment of the present status of, and expected future benefits and
obligations associated with, assets and liabilities. Changes in accounting estimates result
from new information or new developments and, accordingly, are not corrections of
errors. [IAS 8.5]. Examples given by the IASB are estimates of bad debts and the estimated