SAKLAYEN 1

Applied Accounting Theory (506)

According to Prof. Dr. Syed Zabid Hossain

1. Discuss IFAC code of ethics for professional accountants relating to integrity and
objectivity, resolution of ethical conflicts. professional competence, confidentiality.
publicity, and independence .

This Code of Ethics for Professional Accountants establishes ethical requirements for professional
accountants. A member body of IFAC or firm may not apply less stringent standards than those
stated in this Code. However, if a member body or firm is prohibited from complying with certain
parts of this Code by law or regulation, they should comply with all other parts of this Code. A
professional accountant is required to comply with the following fundamental principles:

(i) Integrity
A professional accountant should be straightforward and honest in all professional and business
relationships.
• The principle of integrity imposes an obligation on all professional accountants to be
straightforward and honest in all professional and business relationships. Integrity also implies
fair dealing and truthfulness.
• A professional accountant shall not knowingly be associated with reports, returns,
communications or other information where the professional accountant believes that the
information:
o Contains a materially false or misleading statement;
o Contains statements or information furnished recklessly; or
o Omits or obscures information required to be included where such omission or obscurity
would be misleading

(ii) Objectivity
A professional accountant should not allow bias, conflict of interest or undue influence of others
to override professional or business judgments. The principle of objectivity imposes an obligation
on all professional accountants not to compromise their professional or business judgment because
of bias, conflict of interest or the undue influence of others.
A professional accountant may be exposed to situations that may impair objectivity. It is
impracticable to define and prescribe all such situations

(iii) Professional Competence and Due Care

A professional accountant has a continuing duty to maintain professional knowledge and skill at
the level required to ensure that a client or employer receives competent professional service
based on current developments in practice, legislation and techniques. A professional accountant
should act diligently and in accordance with applicable technical and professional standards when
providing professional services.
• The principle of professional competence and due care imposes the following obligations on all
professional accountants:
(a) To maintain professional knowledge and skill at the level required to ensure that clients or
employers receive competent professional service; and
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(b) To act diligently in accordance with applicable technical and professional standards when
providing professional services.
• The maintenance of professional competence requires a continuing awareness and an
understanding of relevant technical, professional and business developments.

(iv) Confidentiality
A professional accountant should respect the confidentiality of information acquired as a result of
professional and business relationships and should not disclose any such information to third
parties without proper and specific authority unless there is a legal or professional right or duty to
disclose. Confidential information acquired as a result of professional and business relationships
should not be used for the personal advantage of the professional accountant or third parties.

• The principle of confidentiality imposes an obligation on all professional accountants to refrain

from:
o (a) Disclosing outside the firm or employing organization confidential information acquired
as a result of professional and business relationships without proper and specific authority
or unless there is a legal or professional right or duty to disclose; and
o (b) Using confidential information acquired as a result of professional and business
relationships to their personal advantage or the advantage of third parties.
• A professional accountant shall maintain confidentiality, including in a social environment, being
alert to the possibility of inadvertent disclosure, particularly to a close business associate or a
close or immediate family member.
• A professional accountant shall maintain confidentiality of information disclosed by a
prospective client or employer.
• A professional accountant shall maintain confidentiality of information within the firm or
employing organization.

(v) Professional Behavior

A professional accountant should comply with relevant laws and regulations and should avoid any
action that discredits the profession. The principle of professional behavior imposes an obligation
on all professional accountants to comply with relevant laws and regulations and avoid any action
that the professional accountant knows or should know may discredit the profession. This includes
actions that a reasonable and informed third party, weighing all the specific facts and
circumstances available to the professional accountant at that time, would be likely to conclude
adversely affects the good reputation of the profession.

(vi) Ethical Conflict Resolution

A professional accountant may be required to resolve a conflict in complying with the fundamental
principles. When initiating either a formal or informal conflict resolution process, the following
factors, either individually or together with other factors, may be relevant to the resolution process:
(a) Relevant facts;
(b) Ethical issues involved;
(c) Fundamental principles related to the matter in question;
(d) Established internal procedures; and
(e) Alternative courses of action.
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Having considered the relevant factors, a professional accountant shall determine the appropriate
course of action, weighing the consequences of each possible course of action. If the matter
remains unresolved, the professional accountant may wish to consult with other appropriate
persons within the firm or employing organization for help in obtaining resolution.

Where a matter involves a conflict with, or within, an organization, a professional accountant shall
determine whether to consult with those charged with governance of the organization, such as the
board of directors or the audit committee.

2. Requirement to present Basic and Diluted EPS based on IAS 33

IAS 33 Earnings Per Share sets out how to calculate both basic earnings per share (EPS) and
diluted EPS. The calculation of Basic EPS is based on the weighted average number of ordinary
shares outstanding during the period, whereas diluted EPS also includes dilutive potential ordinary
shares (such as options and convertible instruments) if they meet certain criteria.

IAS 33 was reissued in December 2003 and applies to annual periods beginning on or after 1
January 2005.

Requirement to present EPS

An entity whose securities are publicly traded (or that is in process of public issuance) must
present, on the face of the statement of comprehensive income, basic and diluted EPS for: [IAS
33.66]

Profit or loss from continuing operations attributable to the ordinary equity holders of the parent
entity; and profit or loss attributable to the ordinary equity holders of the parent entity for the
period for each class of ordinary shares that has a different right to share in profit for the period.
If an entity presents the components of profit or loss in a separate income statement, it presents
EPS only in that separate statement. [IAS 33.4A]

Basic and diluted EPS must be presented with equal prominence for all periods presented. [IAS
33.66]
Basic and diluted EPS must be presented even if the amounts are negative (that is, a loss per
share). [IAS 33.69]

If an entity reports a discontinued operation, basic and diluted amounts per share must be
disclosed for the discontinued operation either on the face of the of comprehensive income (or
separate income statement if presented) or in the notes to the financial statements. [IAS 33.68
and 68A]

Basic EPS
Basic EPS is calculated by dividing profit or loss attributable to ordinary equity holders of the parent
entity (the numerator) by the weighted average number of ordinary shares outstanding (the
denominator) during the period. [IAS 33.10]
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The earnings numerators (profit or loss from continuing operations and net profit or loss) used for
the calculation should be after deducting all expenses including taxes, minority interests, and
preference dividends. [IAS 33.12]

The denominator (number of shares) is calculated by adjusting the shares in issue at the beginning
of the period by the number of shares bought back or issued during the period, multiplied by a
time-weighting factor. IAS 33 includes guidance on appropriate recognition dates for shares issued
in various circumstances. [IAS 33.20-21]

Contingently issuable shares are included in the basic EPS denominator when the contingency has
been met. [IAS 33.24]

Diluted EPS
Diluted EPS is calculated by adjusting the earnings and number of shares for the effects of dilutive
options and other dilutive potential ordinary shares. [IAS 33.31] The effects of anti-dilutive
potential ordinary shares are ignored in calculating diluted EPS. [IAS 33.41]

4. Explain the two main categories of disclosures required by IFRS 7

IFRS 7 Financial Instruments: Disclosures requires disclosure of information about the significance
of financial instruments to an entity, and the nature and extent of risks arising from those financial
instruments, both in qualitative and quantitative terms. Specific disclosures are required in relation
to transferred financial assets and a number of other matters.

Disclosure requirements of IFRS 7

IFRS requires certain disclosures to be presented by category of instrument based on the IAS 39
measurement categories. Certain other disclosures are required by class of financial instrument.
For those disclosures an entity must group its financial instruments into classes of similar
instruments as appropriate to the nature of the information presented. [IFRS 7.6]

The two main categories of disclosures required by IFRS 7 are:

Information about the significance of financial instruments. information about the nature and
extent of risks arising from financial instruments. Nature and extent of exposure to risks arising
from financial instruments.

Qualitative disclosures [IFRS 7.33]

The qualitative disclosures describe:
Risk exposures for each type of financial instrument management's objectives, policies, and
processes for managing those risks changes from the prior period

Quantitative disclosures
The quantitative disclosures provide information about the extent to which the entity is exposed
to risk, based on information provided internally to the entity's key management personnel.
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These disclosures include: [IFRS 7.34]

Summary quantitative data about exposure to each risk at the reporting date disclosures about
credit risk, liquidity risk, and market risk and how these risks are managed as further described
below concentrations of risk.

Credit risk
Credit risk is the risk that one party to a financial instrument will cause a loss for the other party
by failing to pay for its obligation. [IFRS 7. Appendix A] Disclosures about credit risk include: [IFRS
7.36-38]
• maximum amount of exposure (before deducting the value of collateral), description of
collateral,
• information about credit quality of financial assets that are neither past due nor impaired,
and
• information about credit quality of financial assets whose terms have been renegotiated for
financial assets that are past due or impaired, analytical disclosures are required [IFRS
7.37] information about collateral or other credit enhancements obtained or called [IFRS
7.38]

Liquidity risk
Liquidity risk is the risk that an entity will have difficulties in paying its financial liabilities. [IFRS 7.
Appendix A] Disclosures about liquidity risk include: [IFRS 7.39]
• a maturity analysis of financial liabilities description of approach to risk management

Market risk [IFRS 7.40-42]

Market risk is the risk that the fair value or cash flows of a financial instrument will fluctuate due
to changes in market prices. Market risk reflects interest rate risk, currency risk and other price
risks. [IFRS 7. Appendix A]

5. Write an essay on financial reporting framework and profession bodies in

Bangladesh.

Legal framework
The Companies Act of 1994 provides basic requirements for financial reporting by all companies
in Bangladesh. It is silent about either Bangladesh Financial Reporting Standards (BFRS/BAS) or
International Financial Reporting Standards (IASs/IFRSs).

• Listed companies.
The Securities and Exchange Commission of Bangladesh regulates financial reporting by listed
companies. SER 1987 requires compliance with IASs/IFRSs as adopted in Bangladesh (these are
known as Bangladesh Financial Reporting Standards and include Bangladesh Accounting
Standards). Banks. The Bank Company Act of 1991 mandates reporting formats and disclosures
based on BAS 30, which is similar to IAS 30. The Act is silent about other BAS/BFRS, and
compliance with BAS/BFRS by banks is mixed.
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• Insurance companies.
The Insurance Act 1938 does not mandate compliance with BAS/BFRS. In practice, insurance
companies often do not follow BAS/BFRS.

• Other companies.
Neither the law nor the by-laws of the Institute of Chartered Accountants of Bangladesh mandates
compliance with BAS/BFRS by unlisted companies. Actual compliance varies widely and the ICAB
has published the Bangladesh Financial Reporting Standard for Small and Medium-sized Entities
(BFRS for SMEs) (see below).

Profession bodies in Bangladesh

The Financial Reporting Council (FRC)
The Financial Reporting Council (FRC), an independent government regulatory body under
the Financial Reporting Act (FRA) 2015. It is an organization under the aegis of the Ministry
of Finance. The FRC will regulate accounting, reporting, auditing and actuarial professions in
Bangladesh.

The Council main objects as defined in the FRA 2015 are:

• to promote the provision of high-quality reporting of financial and non-financial
information by public interest entities.
• to promote the highest standards among licensed auditors
• to enhance the credibility of financial reporting and
• to improve the quality of accountancy and audit services

The Institute of Chartered Accountants of Bangladesh (ICAB)

The major objectives of the Institute are to:
• Regulate the Accountancy Profession and matters connected therewith
• Ensure professional ethics and code of conduct
• Provide specialized and professional training in Accounting, Auditing, Taxation, Corporate
Laws, Management Consultancy, Information Technology and related subjects.
• Impart Continuing Professional Development (CPD) to members.
• Keep abreast of the latest developments in Accounting techniques, Audit methodology,
Information technology, Management consultancy and related fields and
• Liaise with international and regional organizations to strengthen mutual cooperation.

The Institute of Cost and Management Accountants of Bangladesh (ICMAB)

The major objectives of the Institute are to:

• Regulate and develop the Cost and Management Accounting (CMA) profession in
Bangladesh
• Provide and confer the highest professional degree in Cost and Management Accounting
• Formulate, adopt and implement Cost Accounting and Auditing Standards (CAAS) in
Bangladesh and international arena.
• Implement statutory Cost Audit as provided in the Companies Act, 1994
• Conduct research in the field of Cost and Management Accounting to promote and develop
the profession to meet the requirement of the time
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6. Discuss the conceptual framework for the financial reporting giving emphasis on
the main objective of general purpose financial reporting, qualitative characteristics
of useful financial information, and financial statements.

➢ Objective of general-purpose financial reporting.

The main objective of general-purpose financial reports is to provide the financial

information about the reporting entity that is useful to existing and potential:

• Investors,
• Lenders, and
• Other creditors

To help them make various decisions (e.g., about trading with debt or equity instruments of a
reporting entity).
General-purpose reports that should contain the following information about the reporting entity:

• Economic resources and claims (this refer to the financial position);

• The changes in economic resources and claims resulting from entity’s financial performance
and from other events.

Its an emphasis on accrual accounting to reflect the financial performance of an entity. It means
that the events should be reflected in the reports in the periods when the effects of transactions
occur, regardless the related cash flows.
However, the information about past cash flows is very important to assess management’s ability
to generate future cash flows.

➢ Discuss the qualitative characteristics of the financial statements.

Qualitative characteristics of financial statements In deciding which information to include in

financial statements, when to include it and how to present it, the aim is to ensure that the
information is useful to users of the financial statements in making economic decisions. The
attributes that make information useful are known as qualitative characteristics and are described
in terms of understandability, relevance, reliability and comparability in the context of the
preparation of financial statements. [Framework 24]

Relevance
Information is relevant if it has the ability to influence the economic decisions of users and is
provided in time to influence those decisions. Relevance has two characteristics: a predictive value
and a confirmatory value. Users can make a reasoned evaluation of how management might react
to certain future events, whilst information about past events will help them to confirm or adjust
their previous assessments.
Information about an entity’s financial position and past performance is often used as the basis
for making predictions about its future performance. It is therefore important how information is
presented. For example, unusual and infrequent items of income and expense should be disclosed
separately.
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Reliability
Information may be relevant, but unless it is reliable as well it is of little use. Information is
considered to be reliable if it does not contain substantial errors that would affect the economic
decisions of users and if it represents faithfully the entity’s transactions.
Faithful representation requires that transactions are accounted for, and presented in accordance
with, their substance and economic reality, even where this is different from their legal form.
Management should present information which is neutral, i.e. free from bias. To be reliable,
information should also be complete.

Comparability
For financial information to be useful, it is important that it can be compared with similar
information of previous periods or to that produced by another entity. For information to be
comparable, it should be consistently prepared; this can be achieved by an entity adopting the
same accounting policies from one period to the next as explained in IAS 8 Accounting policies,
changes in accounting estimates and errors.

Understandability
Information in financial statements should be understandable to users. This will, in part, depend
on the way in which information is presented. Financial statements cannot realistically be
understandable to everyone, and therefore it is assumed that users have:
• a reasonable knowledge of business and accounting; and
• a willingness to study with reasonable diligence the information provided.

➢ Discuss the qualitative characteristics of useful financial information.

The Framework describes 2 types of characteristics for financial information to be useful:

1. Fundamental, and
2. Enhancing.

Fundamental qualitative characteristics

• Relevance: capable of making a difference in the users’ decisions. The financial information
is relevant when it has predictive value, confirmatory value, or both. Materiality is closely
related to relevance.
• Faithful representation: The information is faithfully represented when it is complete,
neutral and free from error.

Enhancing qualitative characteristics

• Comparability: Information should be comparable between different entities or time periods;

• Verifiability: Independent and knowledgeable observers are able to verify the information;
• Timeliness: Information is available in time to influence the decisions of users;
• Understandability: Information shall be classified, presented clearly and concisely.
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7. a) Define operating segments based on IFRS 8

FRS 8 defines an operating segment as follows. An operating segment is a component of an

entity:

• that engages in business activities from which it may earn revenues and incur expenses
(including revenues and expenses relating to transactions with other components of the same
entity);
• whose operating results are reviewed regularly by the entity’s chief operating decision maker
to make decisions about resources to be allocated to the segment and assess its performance;
and
• for which discrete financial information is available. Not all operations of an entity will
necessarily be an operating segment (nor part of one).For example, the corporate
headquarters or some functional departments may not earn revenues or they may earn
revenues that are only incidental to the activities of the entity. These would not be operating
segments. In addition, IFRS 8 states specifically that an entity’s post-retirement benefit plans
are not operating segments.

7. b) Discuss quantitative thresholds and aggregation of reportable segment

Segment information is required to be disclosed about any operating segment that meets any of
the following quantitative thresholds:

• its reported revenue, from both external customers and intersegment sales or transfers, is10
per cent or more of the combined revenue, internal and external, of all operating segments;
or
• the absolute measure of its reported profit or loss is 10 per cent or more of the greater, in
absolute amount, of (i) the combined reported profit of all operating segments that did not
report a loss and (ii) the combined reported loss of all operating segments that reported a
loss; or
• its assets are 10 per cent or more of the combined assets of all operating segments. If the
total external revenue reported by operating segments constitutes less than 75 per cent of
the entity’s revenue, additional operating segments must be identified as reportable segments
(even if they do not meet the quantitative thresholds set out above) until at least75 per cent
of the entity’s revenue is included in reportable segments.

IFRS 8 has detailed guidance about when operating segments may be combined to create a
reportable segment. This guidance is generally consistent with the aggregation criteria in IAS 14.

7. c) State the main features of IFRS 8 Operating Segments .

The core principle of IFRS 8 is that an entity shall disclose information to enable users of its
financial statements to evaluate the nature and financial effects of the business activities in which
it engages and the economic environments in which it operates. The main features are:
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• An operating segment is a component of an entity:

o that engages in business activities from which it may earn revenues and incur expenses
(including revenues and expenses relating to transactions with other components of the
same entity);
o whose operating results are regularly reviewed by the entity’s chief operating decision
maker to make decisions about resources to be allocated to the segment and assess its
performance; and
o for which discrete financial information is available.

• Guidance is provided on which operating segments are reportable (generally 10%

thresholds). At least 75% of the entity’s revenue must be included in reportable segments.
• IFRS 8 does not define segment revenue, segment expense, segment result, segment assets
and segment liabilities, nor does it require segment information to be prepared in conformity
with the accounting policies adopted for the entity’s financial statements.
• Entity-wide disclosures are required even when an entity has only one reportable segment.
These include information about each product and service or groups of products and services.
Analyses of revenues and certain non-current assets by geographical area are also required
– with an expanded requirement to disclose revenues/assets by individual foreign country (if
material), irrespective of the entity’s organization. Finally, there is a requirement to disclose
information about transactions with major external customers (10% or more of the entity’s
revenue).

7. d) Write the key differences between IFRS 8 and IAS 14.

The main differences between IAS 14 and IFRS 8 are as follows:

• IFRS 8 adopts a ‘through the eyes of management approach’, which means that the operating
segments for accounting purposes should be the same as those used for internal management
purposes. The same accounting policies should be used in the IFRS segment report as in the
internal reporting system. Many companies seem to have applied IAS 14 in such a way that
the reporting segments are very close to their internal management organization.
Commentators have however different views as to the impact of the requirement to use
internal accounting policies..
• IAS 14 requires an analysis by geographical segment, but it can be limited if it is designated
as only secondary segmental information. IFRS 8 requires a geographic analysis if designated
as an operating segment. Otherwise, IFRS 8 will require information at entity-wide level on
revenue and certain non-current assets (if the disclosure information is available or not
burdensome to collect). Information required on the entity-wide level by IFRS 8 and on
secondary segment by IAS 14 is in many cases quite similar.
• The information to be provided by business segment is different under IAS 14 and IFRS 8.
Under IAS 14, revenue, result, assets, liabilities, and cost of new property, plant or equipment
(PPE) and intangible assets acquired all needed to be shown by business segment when
designated as primary segmental information. Under IFRS 8, more detailed information has
to be provided, but only to the extent that it is regularly provided to the chief operating
decision-maker.
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• Because of changes made to IAS 34 Interim Financial Reporting by IFRS 8, more segment
information is now required in interims than it was the case before.

8. a) Discuss an auditor's report for audit conducted in accordance with International

Standards on Auditing (ISA)

The auditor’s report when the audit has been conducted in accordance with the ISAs includes the
following elements:

(a) Title;

• The auditor’s report should have a title that clearly indicates that it is the report of an
independent auditor.
• A title indicating the report is the report of an independent auditor, for example,
“Independent Auditor’s Report,” affirms that the auditor has met all of the ethical
requirements, including that of independence and, therefore, distinguishes the auditor’s
report from reports issued by others.

(b) Addressee;

• The auditor’s report should be addressed as required by the circumstances of the

engagement.
• The auditor’s report is addressed to those for whom the report is prepared. National laws
or regulations often specify to whom the auditor’s report on general purpose financial
statements should be addressed in that particular jurisdiction.

(c) Introductory paragraph that identifies the financial statements audited;

The introductory paragraph in the auditor’s report should identify the entity whose financial
statements have been audited and should state that the financial statements have been audited.
The report should specifically identify the title of each of the financial statements that comprise
the complete set of general purpose financial statements, the date and period covered by those
financial statements, and refer to the related notes.

(d) A description of management’s responsibility for the preparation and the fair
presentation of the financial statements;

The auditor’s report should state that management is responsible for the preparation and the fair
presentation of the financial statements in accordance with the applicable financial reporting
framework and that this responsibility includes:

• Maintaining internal control relevant to the preparation of financial statements that are free
from material misstatement, whether due to fraud or error;
• Selecting and applying appropriate accounting policies that are consistent with the applicable
financial reporting framework; and
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• Making accounting estimates that are reasonable in the circumstances.

(e) A description of the auditor’s responsibility to express an opinion on the financial

statements and the scope of the audit, which includes: (i) A reference to the ISAs, and (ii) A
description of the work an auditor performs in an audit.

• The auditor’s report should include a statement that the responsibility of the auditor is to
express an opinion on the financial statements based on the audit.
• The auditor’s report states that the auditor’s responsibility is to express an opinion on the
financial statements based on the audit in order to contrast it to management’s
responsibility for the preparation and the fair presentation of the financial statements

(f) An opinion paragraph containing an expression of opinion on the financial statements and
a reference to the applicable financial reporting framework used to prepare the financial
statements (including identifying the country of origin4 of the financial reporting framework when
IFRS or International Public Sector Accounting Standards (IPSAS) are not used);

• An unqualified opinion should be expressed when the auditor concludes that the financial
statements give a true and fair view (or are presented fairly, in all material respects) in
accordance with the applicable financial reporting framework.
• An unqualified opinion indicates implicitly that any changes in accounting policies or in the
method of their application, and the effects thereof, have been properly determined and
disclosed in the financial statements.

(g) Where relevant, reporting on any other reporting responsibilities in addition to the
responsibility to report on the financial statements;

• When the auditor addresses other reporting responsibilities within the auditor’s report on
the financial statements, these other reporting responsibilities should be clearly identified
and distinguished from the auditor’s responsibilities for, and opinion on, the financial
statements.

(h) Date of the report

The auditor should date the report as of the date on which the auditor has obtained sufficient
appropriate audit evidence to support the auditor’s opinion.

(i) Auditor’s signature

• The auditor’s report should be signed.

• The auditor’s signature is either in the name of the audit firm, the personal name of the
auditor or both, as appropriate for the particular jurisdiction

(j) Auditor’s address

The report should name a specific location, ordinarily a city, in the jurisdiction where the auditor
practices.
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8. b) Explain Directors’ Report.

A directors’ report is a financial document that larger limited companies are required to file at
end of the financial year.

At the end of financial year, the directors draft a short statement on the overall activities of the
company which is called director’s report. This is attached to the company’s annual report. Such a
report indicates whether there had been any change in the company’s nature of business. It is an
instrument through which the Board describes the business performance during last financial year
and prospect in the years to come.

Contents of Directors Report

A director’s is attached to the annual report of a public limited company. Contents of such report
are governed by the Companies Act. According to the company’s act 1994 and The Dhaka Stock
Exchange Listing Regulations 1997, we can identify the following contents of director’s report:

• Addressing the shareholders

• The objectives of the company in general
• Statement of the company affairs
• Principal activities of the company and trend of activities including the range of
competition
• Indication to future developments and any significant shift in policy
• Allocation of profits in dividends, Reserves and in any other form
• Contribution to the national treasury
• Any big deal in the form of lease, loan or debenture
• Information about election, re-election or retirement of directors
• Employment policy, labor relations and the total number of employees at the end of the
year
• Names of the Directors during the last financial year

What is the purpose of a directors’ report?

The directors of a company are required to prepare a directors’ report at the end of each financial
year. This legislation is part of a general move towards greater corporate transparency.

The information provided by the directors’ report helps shareholders understand:

• Whether the company’s finances are in good health;

• Whether the company has the capacity to expand and grow;
• How well the company is performing within its market, and how well the market is
performing in general;
• How well the company is complying with financial regulations, accounting standards and
social responsibility requirements.

By knowing this information, shareholders can make better informed decisions and can hold the
directors of the company to greater account.
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9. a) State the Financial capital and Physical capital concepts of financial reporting
based on the framework.
This is carried forward from previous versions of Framework, so there’s nothing new here.
Let me recap shortly. The Framework explains two concepts of capital:

• Financial capital – this is 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.
The financial capital maintenance can be measured either in Nominal monetary units, or
Units of constant purchasing power.

• 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.

The main difference between these concepts is how the entity treats the effects of changes in
prices in assets and liabilities.

9. b) What is the meaning of Measurement? Discuss the measurement basis/ method

of qualifying monetary amount for elements in the financial statements.
Measurement means IN WHAT AMOUNT to recognize asset, liability, piece of equity, income or
expense in your financial statements. Thus, there need to select the measurement basis, or the
method of quantifying monetary amount for elements in the financial statements.
The Framework discusses two basic measurement basis:

1. Historical cost – this measurement is based on the transaction price at the time of
recognition of the element; A historical cost is a measure of value used in accounting in which
the value of an asset on the balance sheet is recorded at its original cost when acquired by
the company. The historical cost method is used for fixed assets in the United States under
generally accepted accounting principles (GAAP).
2. Current value – it measures the element updated to reflect the conditions at the
measurement date. Here, several methods are included:
• Fair value;
• Value in use;
• Current cost.

Other measurement basis:

1. Present Value - Present value (PV) is the current value of a future sum of money or stream
of cash flows given a specified rate of return. Future cash flows are discounted at the discount
rate, and the higher the discount rate, the lower the present value of the future cash flows.
Determining the appropriate discount rate is the key to properly valuing future cash flows,
whether they be earnings or debt obligations.
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2. Net Realizable Value - Net realizable value (NRV) is the value of an asset that can be
realized upon the sale of the asset, less a reasonable estimate of the costs associated with
the eventual sale or disposal of the asset. NRV is a common method used to evaluate an
asset's value for inventory accounting. NRV is a valuation method used in both Generally
Accepted Accounting Principles (GAAP) and International Financial Reporting Standards
(IFRS).

The Framework then gives guidance on how to select the appropriate measurement basis and
what factors to consider (especially relevance and faithful representation).

What we personally find really useful is the guidance on measurement of equity. The issue here
is that the equity is defined as “residual after deducting liabilities from assets” and therefore total
carrying amount of equity is not measured directly. Instead, it is measured exactly by the formula:

• Total carrying amount of all assets, less

• Total carrying amount of all liabilities.
The Framework points out that it can be appropriate to measure some components of equity
directly (e.g. share capital), but it is not possible to measure total equity directly.