PRACTICE QUESTIONS & ANSWERS 2

PAPER 2.1 - FINANCIAL REPORTING

TOPIC
CONCEPTUAL, REGULATORY, & ETHICAL
FRAMEWORK OF ACCOUNTING

COMIPLED BY:
ROBERT AMPONSAH-GODWYLL, CA

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CONCEPTUAL, REGULATORY, & ETHICAL FRAMEWORK OF ACCOUNTING
Question 1

Explain the fundamental qualitative Characteristics of financial statements

1. Relevance

Relevant financial information is capable of making a difference in the decisions made by

users. Information may be capable of making a difference in a decision even if some users
choose not to take advantage of it or are already aware of it from other sources. Financial
information is capable of making a difference in decisions if it has predictive value,
confirmatory value or both.
2. Faithful representation

Financial reports represent economic phenomena in words and numbers. To be useful,

financial information must not only represent relevant phenomena, but it must also faithfully
represent the phenomena that it purports to represent. To be a perfectly faithful
representation, a depiction would have three characteristics. It would be complete, neutral
and free from error. Of course, perfection is seldom, if ever, achievable.

3. Materiality

Information is material if omitting it or misstating it could influence decisions that users

make on the basis of financial information about a specific reporting entity. In other words,
materiality is an entity-specific aspect of relevance based on the nature or magnitude, or both,
of the items to which the information relates in the context of an individual entity’s financial
report.
An item may be material in amount or by nature. Materiality “by amount” is influenced by
the size of the company. What may be material in big company may be immaterial in a small
companies.

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Question 2

Explain the enhancing the qualitative characteristics of financial statements

Answer

1. Understandability

Classifying, characterizing and presenting information clearly and concisely makes it

understandable. Some phenomena are inherently complex and cannot be made easy to
understand. Excluding information about those phenomena from financial reports might
make the information in those financial reports easier to understand. However, those reports
would be incomplete and therefore potentially misleading. Financial reports are prepared for
users who have a reasonable knowledge of business and economic activities and who review
and analyse the information diligently. At times, even well-informed and diligent users may
need to seek the aid of an adviser to understand information about complex economic
phenomena.
2. Verifiability

Verifiability helps assure users that information faithfully represents the economic
phenomena it purports to represent. Verifiability means that different knowledgeable and
independent observers could reach consensus, although not necessarily complete agreement,
that a particular depiction is a faithful representation. Quantified information need not be a
single point estimate to be verifiable. A range of possible amounts and the related
probabilities can also be verified.

3. Comparability
Users’ decisions involve choosing between alternatives, for example, selling or holding an
investment, or investing in one reporting entity or another. Consequently, information about
a reporting entity is more useful if it can be compared with similar information about other
entities and with similar information about the same entity for another period or another date
Comparability is the qualitative characteristic that enables users to identify and understand
similarities in, and differences among, items. Unlike the other qualitative characteristics,
comparability does not relate to a single item. A comparison requires at least two items.

4. 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 is.
However, some information may continue to be timely long after the end of a reporting
period because, for example, some users may need to identify and assess trends.

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Question 3

Explain the objectives/Purpose of the Conceptual framework

Answer

Purpose of Conceptual Framework

1. Assist the IASB in the development of future accounting standards and its review of existing
accounting standards.
2. Assist the IASB by providing a basis for reducing the number of alternative accounting
treatments
3. Assist national standard-setting bodies in developing national standards
4. Assist accountants in forming an opinion as to whether financial statements and in dealing
with topics that do not form the subject of International accounting standard;
5. Assist accountants in forming an opinion as to whether financial statements conform with
relevant accounting standards;
6. Assist users of financial statements in interpreting the information, contained in financial
statements prepared in conformity with International Accounting Standards

Question 4

Explain the main Assumption under the Conceptual Framework

Answer

Going concern
The financial statements are normally prepared on the assumption that an entity is a going
concern and will continue in operation for the foreseeable future. Hence, it is assumed that the
entity has neither the intention nor the need to liquidate or curtail materially the scale of its
operations; if such an intention or need exists, the financial statements may have to be prepared
on a different basis and, if so, the basis used is disclosed.

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Question 5

Briefly explain the content of the Conceptual Framework

Answer:
The specific topics discussed under the framework are as follows:
1. The objectives of financial statements;
2. User groups
3. Assumptions underlying financial statements preparation;
4. Qualitative Characteristics of financial statement ;
5. The elements of financial statements; their recognition and their measurement
6. The concepts of capital maintenance

(Briefly explain the point listed above giving preference to the marks allocated to the question)

Question 6

Briefly explain the objectives of International Accounting Standard Board (IASB).

Answer

Objectives / the role of IASB

1. To develop a set of global accounting standards which are of high quality, are understandable
and are enforceable.
2. To develop IAS which requires high quality, transparent and comparable information in
financial statements to help those in the world’s capital markets and other users make
economic decisions.
3. To promote the use and rigorous application of accounting standards.
4. To promote and facilitate the adoption of IFRSs, being the standards and interpretations
issued by the IASB, through the convergence of national accounting standards and IFRSs.

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Question 7

It is widely argued that global harmonisation of financial reporting standards will bring about
uniformity in financial reporting and ensure consistency and comparability in published financial
information by enterprises. However there are some barriers to global harmonization.

Briefly explain

a) the advantages of Global/International harmonization of accounting standards

b) the barriers to Global/International harmonization of financial reporting standards.

Solution

a) Advantages of International Harmonization

1. To achieve comparability in financial statements

Due to different set of financial reporting standards, the way financial statements prepared and
presented are different from each other which make it complicated to compare them. This is even
more noticeable in multinational companies when they operate in more than just one country. If
international harmonization is achieved, the achieved, the level of international comparability
also increases making it easier for companies to prepare the financial statements under one set of
rules; investors who understand the financial statements due to the nature of IFRS and make well
thought investment decisions.

2. International Expansion

Moving to a single set of global financial standards would also ease barriers to expansion for
companies. If companies wish to expand overseas today, they need to consider international
costs of compliance, which could mean adopting a completely new set of accounting records to
meet statutory requirements in the new country. In some cases, this would nearly double the
company’s accounting costs. For many small business, even the large rewards of moving
overseas are dwarfed by these expansion cost.

3. Central Authoritative Body

From a policy-making standpoint, moving to a single set of global standards puts rule making
into the hands of one body. Currently, accounting standards are set within each country by
each standard-setting body, as well as by an international group. One set of standards would
reduce disagreement between countries and international regulators, and it might also cut
costs. In some countries, businesses are required to pay reporting fees that go to fund these
standard-setting bodies. While the costs may not affect large companies, they can have a
huge impact on a small business. Moving to a central authoritative body could reduce these
costs drastically.

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4. Increased auditing efficiency and money saving

There will be increased auditing efficiency and money saving as companies has to use only
one set of reporting standards. This also serves to reduce trade barriers among countries
allowing more access to International capital markets

5. Helps to achieve consistency to be achieved under IFRS

Another advantages worth noting is the consistency to be achieved under IFRS as it was one
of the objectives of IFRS as single reporting standard. The consistency also contributes to
better understanding between investors, lenders and other business as there will be the nature
of predictability in place. Moreover, companies operating in different countries also can use
their expertise and systems in all countries they are operating due to consistency of the
reporting standards. Another benefit that derives from consistency is the time scale needed to
implement in new countries as there will be no need to learn and adapt to new country
specific rules expert minor adjustments.

Disadvantages/Barriers of Harmonization

1. Cultural Differences

One of the criticisms of harmonized accounting standards is that the IASB has failed to fully take
into account the cultural, political, and social differences between countries. This is particularly
relevant to their implementation in developing countries, where language barriers, attitudes
toward accounting and other socio-cultural aspects may affect their interpretation and
application. For example, when the harmonized standards were implemented in Jordan, they
were first translated into Arabic. Even though technical accounting terms have been well-defined
in Arabic, challenges arose when the English terminology was hard to interpret or used
inconsistently and, therefore, difficult to translate accurately.

2. Worldwide Acceptance

National accounting standards are high politicized and there is often a natural tendency to place
the interests of the national economy ahead of those of the global economy. Private sector
businesses, and professional accounting bodies also have a vested interest in accounting practices
and financial reporting. Pressure from these groups to change or reject certain standards can
carry a lot of weight with political decision makers. Adopting international financial standards is
met with additional challenges in developing countries. They often lack the resources and
infrastructure to adapt national legal and legislative framework in which to house the standards,
making proper implementation difficult.

3. International Enforcement

The success of harmonized financial reporting depends on individual governments enforcing

adherence to the international standards once they have been implemented. In 2008, the French

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authorities allowed the bank Societe Generale to transfer some of its losses from 2008 to 2007,
meaning its financial statement for 2008 looked much better than the reality. This provoked an
international outcry, not the least from the IASB. When exceptions are made, it undermines the
integrity of the whole system and renders it ineffective.

4. Training and Retraining

When a country decides to harmonize with the international standards, its companies,
accountants and auditors need to be retrained in the new standards and reporting procedures for
financial statements. College and university programs in this field also have to undergo
significant changes in order to educate new people entering the profession. Before any of this can
happen, trainers and professors will require training so they can instruct professionals and
students. This will require the development of new learning materials and curricula, new
examinations for professional licensing and new accounting software and reporting systems. To
further complicate matters, the adoption of harmonized standards has to be phased in, so for
number of years, two different systems are in operation. Such a complex transition requires a lot
of safety mechanisms to ensure it achieves uniform results.

5. Different economic environment

Another disadvantage of harmonisation is when there exists different economic environment as

harmonization could be considered useless. If a particular country has its own practice in place,
and even though they adapt to use one of the international reporting standards, it could be more
harmful to the country rather than make anything good. This is because the irrelevant element of
the new reporting standard may be of no use and therefore may even introduce ambiguity and
complication to that country’s reporting standards.

NB: Other points (Barriers) which could be explained

1. Different purposes of financial reporting

2. Different legal system
3. Different user groups
4. Needs of developing countries
5. The lack of strong accountancy bodies.

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Question 8

Explain the benefit Ghana has derived from the adoption of the International Financial Reporting
Standard (IFRS).

Solution

1. Financial statement are used by a wide range of users, investors, lenders, customers, etc., and
therefore it must be useful to all these users
2. It aids in comparing financial statements
3. It assist in the preparation of financial statement to provide at least some basic information
4. It increases users’ understanding of, and confidence in financial statement
5. It regulates the behaviour of companies towards their investors.

Question 9– Watch out

There are two different approaches to developing accounting standards: principle-based, and rule
based.

Required:
a) Explain the rule based and the principle based approaches
b) Explain the advantages of the rule based and the principle based approaches.

Solution
a) A principle based system works within a set of defined principles. A principle based system
is therefore of accounting is a system which is based on a conceptual framework. It requires
preparers to use judgement in order to develop accounting policies to report specific types of
transactions and events. A principle based system would therefore contain more general
requirement.

Rule based system regulates for issues as they arise. A rule based system requires preparers
to understand and apply detailed rule to report specific transactions. A rule-based accounting
standards often need to contain complex definitions scope exceptions.

b) Advantages of principle based system

1. In theory, it is more likely than a rigid-rules based system to result in financial statements
that show a true and fair view/give a fair presentation;
2. It encourages the use of professional judgement
3. It is less open to creative accounting abuses as principles are harder to evade than rules
and
4. Arguably it is more flexible than a system of rules and can therefore cope better with a
rapidly changing business and economic

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 Advantages of Rule based system

1. In theory, it results in financial statements being comparable between entities (or between
entities in the same industry
2. It may reduce the volume of explanation necessary in financial statement (as in theory
there is only one allowed accounting treatment for each type of transaction or event).
3. It is suitable for large, complex economies
4. It provides the answers in almost all situation; preparers do not have to make judgement
and risk the consequences. (e.g litigation or reputational damage if a user makes a wrong
decision based on information in the financial statements)

Question 10

Explain the four bases of measurement used in the financial statements.

Answer
The framework identifies four possible measurements bases:
i. Historical cost

Assets are recorded at the amount of cash and cash equivalents paid or the fair value of
the consideration given to acquire them at the time of acquisition. Liabilities are recorded
at the amount of proceeds received in exchange for the obligation
ii. Current cost

Assets are carried at the amount of cash or cash equivalents required to acquire them
currently. Liabilities are carried at the discounted amount currently required to settled
them.
iii. Realizable (Settlement) value

Assets are carried at the amount which could currently be obtained by an orderly
disposal. Liabilities are carried at their settlement value (i.e. the amount to be paid to
satisfy them in the normal course of business.
iv. Present value
Assets are carried at the present discounted value of the future net cash inflows that the
item is expected to generate in the normal course of business, and liabilities at the present
discounted valued of the expected outflows necessary to settle them.

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Question 11

As a new qualified accountant with The Institute of Chartered Accountants (Ghana), you are
asked to make a short presentation to the rest of the staff in the accounting and finance
department of your employer who are themselves yet to join ICAG as students about the
standard setting process adopted by the International Accounting Standards Board.

Required:

Discuss the standard setting process as adopted by the IASB to these junior staff.

Answer

1. IASB staff prepare an issue paper including the approach of national standard setters.
2. The IFRS Advisory committee is consulted about the advisability of adding the topic to the
IASB’s agenda.
3. A Discussion Document is then published for public comment.
4. An exposure draft is published for another public comments (after taking into consideration
the comments on the discussion document)
5. After considering all comment received, the new IFRS is approved by t 8 votes (out of the
total of 14) of the IASB. The final standard includes both a basis for conclusions and any
dissenting opinions.

Question 12

The functional currency according to IAS 21, the effect of changes in foreign exchange rates is
the currency of the primary economic environment where the entity operates.

Required:

Identify three factors in accordance with IAS 21 that an entity will consider in determining its
functional currency

Answer

1. The currency that mainly influences sales prices for goods and services
2. The currency of the country whose competitive forces and regulations mainly determine the
sales price of goods and services.
3. The currency that mainly influences labour, material and other costs of providing goods and
services.
4. The currency in which funding from issuing debt and Equity is generated.
5. The currency in which receipts from operating activities are usually retained.

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Question 13

Recognition in financial reporting is the process of incorporating into the financial statements an
item that meets the definition of an element of financial statements and satisfies specified
criteria.

Required:

State the criteria for recognition of an element of financial statements in financial reporting

Answer

Criteria for recognition

1. It is probable that future economic benefit associated with the item will flow to or from the
entity
2. The Item has a cost or value that can be measured with reliability.

Question 14

In accordance with IAS 1, Presentation of Financial Statements, explain;

a) The components of a complete set of financial statement and

b) The elements of Financial statement

Answer

a) Components of financial statements

A complete set of financial statements comprises:
1. a statement of financial position as at the end of the period;
2. a statement of comprehensive income for the period;
3. a statement of changes in equity for the period;
4. a statement of cash flows for the period;
5. notes, comprising a summary of significant accounting policies and other explanatory
information; and
6. a statement of financial position as at the beginning of the earliest comparative period when
an entity applies an accounting policy retrospectively or makes a retrospective restatement of
items in its financial statements, or when it reclassifies items in its financial statements.

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b) Elements of financial statements
The Conceptual Framework issued by International Accounting Standard Board (IASB)
identifies five main elements of financial statements as discussed below:
Assets
An Assets is an economic resource owned and controlled by an entity as a result of past event
from which future economic benefit is expected to flow to the entity.
Liability
A liability is a present obligation arising from past events, the settlement of which will result
in an outflow of economic resources embodying benefits.
Capital
Capital is the residual interest in an entity.
Income
Income refers to the increase in economic benefits resulting from an increase in assets or
reduction in liability
Expenses
An expense refers to the decrease in economic benefits resulting from an increase in liability
or decrease in assets.
Question 15

a) Explain the concept of “fair presentation” and compare it with “true & fair view”.
b) Explain the concept of “substance over-form” and its relationship to fair presentation
c) Explain the circumstances in which non-compliance with the detailed provisions of an
accounting standard would be justified.

Answer

a) Fair presentation and true and fair view

IAS 1 Presentation of Financial Statements describes the concept of fair presentation. Fair
presentation involves representing faithfully the effect of transactions, other events and
conditions in accordance with the definitions and recognition criteria in the IASB Framework.

This is developed by stating that the application of IFRS, interpretations and additional
disclosures will result in fair presentation.
The traditional UK approach required financial statements to comply with the Companies
Act (and therefore UK standards) and give a true and fair view. True could be approximated

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to ‘represent faithfully’ and fair to ‘fair presentation’. IAS 1 links them by stating that
compliance with standards will give a fair presentation. As a result there is unlikely to be any
difference between the two.

Whilst not dealing with the concepts directly, the IASSB Framework uses the descriptions of
fair presentation and true and fair view interchangeably in its discussion of the application of the
principal qualitative characteristics of financial information.

b) Substance over form and fair presentation

Most transactions are reasonably straightforward and their substance (their commercial
effect) is the same as their legal form. In some complex transactions the true substance may
not be readily apparent. Their legal form may not adequately express the true commercial
effect of such transactions.
Where this is the case, it may not be sufficient to account for them by merely recording their
form. The financial statements should represent commercial substance, not just legal form
(substance over form). If a transaction gives rise to an asset or liability (as defined in the
IASB Framework), it should be accounted for on this basis even if this is different from its
legal form. Applying the definitions of an asset and a liability identifies the appropriate
accounting treatment.
The IASB Framework identifies that if information is to represent faithfully the transactions
it purports to represent, then they should be accounted for in accordance with their substance
and economic reality and not merely their legal form. The substance may not be consistent
with the legal form of a transaction. An example is a sale and repurchase agreement.

c) Non-compliance with IFRS

IAS 1 allows non-compliance with a standard (or interpretation) only where management
concludes that compliance would be so misleading as to conflict with objectives of financial
statements set out in the IASB Framework. However this is only where the relevant
regulatory framework requires, or does not prohibit, such a departure.
The standard uses the phrase ‘where management concludes’ which may indicate that there a
margin for those preparing the financial statements to use this exception where they believe it
is appropriate. However, IAS 1 talks about this coming about ‘in extremely rare
circumstances’. To all intents and purposes, these circumstances will never occur.

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Question 16

Briefly state and describe five (5) main weaknesses of the Historical Cost Convention.

Solution

1. Return on Capital Employed (ROCE) can be distorted as result of profits being overstated in
real terms and assets such as fixed assets being understated.
2. Historical Cost Accounts may fail to show whether a company is earning sufficient funds to
enable it to maintain its capital real.
3. Also historical cost accounts may fail to show the extent to which funds can prudently be
distributed in the form of dividends.
4. Historical cost accounts can give misleading impression of growth and profitability.
5. It does not express in current prices all of the resources employed in a business.
6. Another possible weakness is the matching of current revenues expresses in current prices
with historical cost may result in inflated profits being reported.

Question 17

In accordance with IAS 1, explain the five (5) ways of identifying a financial statements.

Answer

Ways of identifying financial statements

1. The name of the reporting entity

2. The statement of financial position date
3. The presentation currency used
4. The level of rounding used
5. Whether the financial statement represent a single entity or a group

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Question 18

The IASB’s Framework for the Preparation and Presentation of Financial Statements requires
financial statements to be prepared on the basis that they comply with certain accounting
concepts (underlying assumptions) such as:

1. Matching / Accruals
2. Prudence
3. Comparability
4. Materiality

For most entities, applying the appropriate concepts/assumptions in Accounting for Inventories is
an important element in preparing their financial statements.

Required:

Illustrate with examples how each of the concepts/assumption listed above may affect accounting
for inventory.

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