CHAPTER ONE

The environment of Accounting

LEARNING OBJECTIVES

After studying this chapter, you should be able to:

 Overviews of Financial Accounting

 Requirements of financial reporting
 The IASB and its governance structure
 Major similarities and difference of GAAP and IFRS

Accounting is a systematic process of measuring the economic activity of a business to provide

useful information to economic decisions makers.

Accounting has been described as the process of identifying, measuring, recording

and communicating economic information to permit informed judgment and decision by users of
information.

Fair presentation of financial affairs is the essence of accounting theory and

practice.

Responsibilities of accountants are greater today than ever before because of the following
reasons:

 Increase in size and complexity of business enterprise

 Increasing economic role of government.

Financial statements and reports prepared by accountants are vital:

To the success of working society

 Economists
 Investors
 Managers
 Bankers and government officials
Classes of Accounting

Accounting information can be divided in two broad categories, according to the type of decision
makers who use it.

I. Management accounting - is the information accumulation, processing, and

communicating system designed to meet the decision making information needs of internal
users.

II. Financial accounting (FA) - is the information accumulation, processing and

communication system designed to satisfy the investment and credit decision-making
information needs to external users.

Users of Accounting Information

The users of accounting information can be classified as either external or internal.

a) External Users: are those who lack direct access to the information generated by the internal
operation of the company.

Examples:

 Shareholders and potential investors

 Suppliers and creditors
 Customers
 Competitors
 Financial analysts
 Tax and regulatory authorities

b) Internal Users: Internal users include all the management personnel of a business enterprise
who use accounting information either for planning, and controlling current operations or for
formulating long range plans and making major business decisions.

Financial reporting requirements

Objective: Provide financial information about the reporting entity that is useful to
  present and potential equity investors,
 lenders, and
 Other creditors in making decisions about providing resources to the entity.
 Proclamation No. 847/2014

The proclamation requires:

 Commercial organizations to follow

 International Financial Reporting Standards (IFRS), or
 International Financial Reporting Standards for Small and Medium Enterprises (IFRS for
SME)
 Charities and societies to follow International Public Sector Accounting Standards
(IPSAS)
 Public auditors to follow International Standards for Auditing.
 Public interest entity (PIE) should use the full IFRS.

The IASB and its governance structure

The International Accounting Standards Board (IASB) is the independent, accounting standard-
setting body of the IFRS Foundation. The IASB was founded on April 1, 2001, as the
successor to the International Accounting Standards Committee (IASC). It is responsible for
developing International Financial Reporting Standards (IFRS Standards), previously known as
International Accounting Standards (IAS) and promoting the use and application of these
standards

The international accounting standard board (IASB) composed of four organizations. These are:

►IFRS Foundation

►International Accounting Standards Board (IASB)

►IFRS Advisory Council

► IFRS Interpretations Committee.

List of IASB pronouncements

► International Financial Reporting Standards.

► Conceptual Framework for Financial Reporting.

► International Financial Reporting Standards Interpretations.

 Most agree that there is a need for one set of international accounting standards. Here is why:

•Multinational corporations

•Mergers and acquisitions

•Information technology

•Financial markets

 The following are the key similarities and differences between U.S. GAAP and IFRS related
to the financial reporting environment.

Similarities

•Generally accepted accounting principles (GAAP) for U.S. companies are developed by the
Financial Accounting Standards Board (FASB). The FASB is a private organization. The IASB
is also a private organization.

•Both the IASB and the FASB have essentially the same governance structure, that is, a
Foundation that provides oversight, a Board, an Advisory Council, and an Interpretations
Committee.

Differences

1. Rules vs. Principles

GAAP tends to be more rules-based, while IFRS tends to be more principles-based. Under
GAAP, companies may have industry-specific rules and guidelines to follow, while IFRS has
principles that require judgment and interpretation to determine how they are to be applied in a
given situation.

2. Inventory Methods
Both GAAP and IFRS allow First In, First out (FIFO), weighted-average cost, and specific
identification methods for valuing inventories. However, GAAP also allows the Last In, First out
(LIFO) method, which is not allowed under IFRS. Using the LIFO method may result in
artificially low net income and may not reflect the actual flow of inventory items through a
company.

3. Fair Value Revaluations

IFRS allows revaluation of the following assets to fair value if fair value can be measured
reliably: inventories, property, plant & equipment, intangible assets, and investments in
marketable securities. This revaluation may be either an increase or a decrease to the asset’s
value. Under GAAP, revaluation is prohibited except for marketable securities.

4. Impairment Losses

Both standards allow for the recognition of impairment losses on long-lived assets when the
market value of an asset declines. When conditions change, IFRS allows impairment losses to be
reversed for all types of assets except goodwill. GAAP takes a more conservative approach and
prohibits reversals of impairment losses for all types of assets.

 Impairment loss is the amount by which the carrying amount of an asset or a cash-generating
unit exceeds its recoverable amount.
 Impairment loss = carrying cost - recoverable amount
 An impairment loss is recognized when the carrying amount of an asset exceeds its fair
value.
5. Fixed Assets

GAAP requires that long-lived assets, such as buildings, furniture and equipment, be valued at
historic cost and depreciated appropriately. Under IFRS, these same assets are initially valued at
cost, but can later be revalued up or down to market value. Any separate components of an asset
with different useful lives are required to be depreciated separately under IFRS. GAAP allows
for component depreciation, but it is not required.
Example1: January 2022 XYZ Company purchased a machine that

Cost = 1 million

Useful life = 10 years

Carrying value = 200,000

Fair value (recoverable amount) = 100,000

Depreciation method = straight-line

Required

1. Determine the annual depreciation expense and Calculate impairment loss

Solution1. Straight line depreciation = (cost of the asset – estimated carrying value) ÷ estimated
useful life of an asset. 80,000 (1m – 200,000)/10

Impairment loss =?

Impairment loss = carrying cost - recoverable amount = 200,000- 100,000 = 100,000