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Conceptual Framework for Financial Reporting - Essay Example

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The paper "Conceptual Framework for Financial Reporting" is a good example of a Finance & Accounting essay. The definition of an expense has not been met based on the principles in the conceptual framework. The conceptual framework defines expenses as consumptions or losses of future economic benefits in the form of reductions in assets or increases in liabilities of the entity…
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Running Header: Conceptual framework for financial reporting Conceptual framework for financial reporting Author’s Name Instructor’s Name Course Number Date of Submission 1. The definition of an expense has not been met based on the principles in the conceptual framework. The conceptual framework defines expenses as consumptions or losses of future economic benefits in the form of reductions in assets or increases in liabilities of the entity, other than those relating to distributions to owners that result in a decrease in equity during the reporting period. In this case, the $100,000 cannot be termed as consumption or loss of future economic benefit since it has not been used already but it is a provision to be used in future. In addition, the provision does not result in loss of assets as it has only been set aside. It has not been used to generate any income or to pay any debt but it has only been set aside probably from the company’s earnings to be used for future expansion (Aasb.gov.au, 2017). It also does not result in any increase in liabilities as it is not a debt but part of the company’s capital/internal resources to be used in future expansion. In other words, when it is eventually utilized in the expansion, it will add to the company’s assets while increasing the company’s equity. The provision is hence not an expense but an asset. It also does not result in a decrease in the owner’s equity but indeed if it is set aside from earnings, it will result in increased equity as it will increase the company’s earning potential and also prevent the company from incurring liabilities in a bid to expand. In this respect therefore, the definition of expenses has not been met. 2. The expenses recognition criteria has also not been met. This is because an expense should be recognized in the operating statement in the determination of the result for the operating period only when it is probable that the consumption or loss of future economic benefits resulting in a reduction in assets and/or an increase in liabilities has occurred. In this case, there has not been any reduction in assets or an increase in liabilities that has occurred as a result of the provision. In addition, in recognizing an expense, the consumption or loss of future economic benefits should be reliably measured (ifrs.org, 2015). This has not been the case since the provision has not resulted in any consumption or loss of future economic benefits. This is just a provision in the books and has not been as a result of a decrease in assets or an increase in liabilities. There is no reliable measurement of any consumption or loss of future economic benefits. When in future the expansion does take place, this will not be recognized as an expense since this investment is capital in nature and the expense that will be recognized is only in terms of depreciation but not in terms of the actual investment that has gone into the expansion. As such, the recognition criteria for expenses has also not been met. 3. The features of the preference shares are that they attract a fixed dividend of 3 percent every year whether or not profit is made since if no profit is made, the interest will still have to be paid in future years. In addition the preference shares will be bought back by the company in three years at their issue price. In my opinion, this is a debt as opposed to equity since it fulfils the features of a debt in line with the conceptual framework. One feature of a debt is that the issuer has an obligation to deliver either cash or other financial asset to the debt holder. In this case, the obligation arises from the requirement to repay the principal after three years by way of redeeming the shares as well as the interest obligation on the part of the company. On the other hand, they would be considered equity if they evidences a residual interest in the company’s assets after all the liabilities have been deducted. The fact that the preference shares has an obligation to deliver cash to the holders while specifying when the instrument will be settled makes this a debt. This is because the company has no discretion as to when to pay dividend or to redeem them but this has been set in the contractual document. Another reason why this should be considered liability is that there is specification on the amount of annual interest to pay at 3 percent annually (Masb.org.my, 2015). Other factors that make this to be considered a debt or liability is the fact that it will not be converted into ordinary shares eventually but will be redeemed after three years. This means there is limited life to the instrument hence making it debt as opposed to equity which has no fixed life but its life ends with that of the company. In addition, the redemption of the preference shares will be triggered by lapse of time in that it will happen after three years and this is beyond the control of the holder or the issuer of the preference shares. In addition, this is a debt since there is no discretion on when interest is to be paid but it must be paid at 3 percent whether or not the company makes profit. The critical factor that makes this a debt is the fact that the issuer has no unconditional right to avoid paying interest and paying the purchase price to redeem the shares after three years lapse (efrag.org, 2017). Thus, the preference shares have indeed fulfilled the definition of liability or debt based on the conceptual framework as well as the provisions of IAS 32. It is for this reason that these preference shares should be considered liability on the basis of the provisions of the conceptual framework. 4. Exposure draft 2016/1-Defination of a business and accounting for previously held interests-(Proposed amendments to IFRS 3 and IFRS 11) The exposure draft in question relates to amendments to IFRS3 and IFRS 11. The exposure draft is aimed at clarifying the guidance on the definition of a business in a bid to eliminate the difficulties caused by the current definition in practice. This is aimed at making the difference between accounting for a business combination and an asset purchase in a bid to facilitate recognition of deferred tax especially for transactions that are most likely to be affected by a concentration test including real estate’s acquisition as well as the extractive industries. For instance, can acquiring a single asset entity be termed as business and how is this accounted for? Thus, such amendments would make clear differences between asset and business acquisition which for instance arise in the capitalization of transaction costs as well as in treatment of contingent consideration. Through the amendments, concentration test would help in providing a useful simplification that would enable a sizeable population of transactions motivated though the acquisition of an asset for instance in the real estate sector or the pharmaceuticals which would have to be excluded from the business combinations scope in accounting. The amendments proposed would also lead to a clear definition of identifiable assets. The amendments would also serve to clarify the fact that two assets in different classes are not considered similar since this would exclude asset groups which though having different form, they share risk characteristics and are also inextricably linked in terms of their value and utilization. For instance, a physical asset and its taxation attributes, land as well as associated planning permission and an oil pipeline or a mine as a customer contract for taking output only from the asset. Purchasing any of the above assets alone will likely be a transaction that is excluded from the concentration test. The exposure draft also aims at evaluating whether an acquired process is substantive. The draft proposes to narrow the definition of output and concentrate on revenue as opposed to cost reduction and also with the differentiation between acquires with or without an organized workforce as well as with or without outputs in a bid to provide simplification and consistency with the commonly understood view of a business as an entity involving people conducting sales. The amendment would also eliminate the requirement that there be the presence of goodwill as an indicator that the acquire constituted a business owing to its inconsistence with the IFRS 3 and IFRS 11. This is because determination of whether goodwill is present happens after determining whether the transaction is a business combination and as such its being used as an indicator that an acquire is business is not merited. This is especially so with acquisitions of a single asset entity since determination of whether the acquisition is a business combination will in turn determine whether a deferred tax asset or liability is to be recognized. The amendment also does provide illustrative examples distinguishing between single asset acquisitions and business combinations. This is important as it sheds light as to how to account for each type of acquisitions and hence properly accounting for their taxation. The amendments also are aimed at eliminating any differences whether intentional or not of business to provide consistency between IASB and FASB hence providing consistency in accounting for either single assets business combination acquisitions. The amendment would also serve to expand IFRS 3 in a bid to address diversity of practice that regard acquisition of business interests which are joint operations. This would serve to clarify two issues including whether on obtaining control, the entity ought to remeasure previously held interests in the assets and liabilities of the joint operation in accordance to paragraph 42 of IFRS 3 and whether on obtaining joint control, an entity ought not to measure previously held interests in the assets and liabilities of the joint operation (iasplus.com, 2013). The amendment would also provide examples of how the requirement of measuring previously held interests in the joint operations applies to a previously held interest accounted for by recognizing shares of individual assets and liabilities as opposed to a single asset. Finally, the amendments serves the purpose of clarifying whether the guidance on the definition of a business and accounting for previously held interests be retrospectively applies with early application permitted. Based on the above critical discussion of the issues raised in the exposure draft, it is important to resolve the issues from a standard setting perspective for a number of reasons including; i) The amendments would give guidance on how to account for previously held interests in a joint operation, ii) The amendments would help in determining whether the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets iii) It would assist in determining whether acquired set of activities and assets include an input and a substantive process which together contribute to the ability for creating output. iv) The amendments would give guidance on how to account for previously held interests in a joint operations v) Overall, the amendments would help in clarifying on how to account for deferred tax assets or liabilities arising from acquisitions whether they are single asset entities or business combinations. References Aasb.gov.au, 2017, Statement of accounting concepts: Definition and recognition of the elements of the financial statements, Retrieved on 7th April 2017, from; http://www.aasb.gov.au/admin/file/content102/c3/SAC4_3-95.pdf ifrs.org, 2015, Conceptual framework for financial reporting, Retrieved on 7th April 2017, from; http://www.ifrs.org/Current-Projects/IASB-Projects/Conceptual- Framework/Documents/May%202015/ED_CF_MAY%202015.pdf Masb.org.my, 2015, Conceptual framework for financial reporting, Retrieved on 7th April 2017, from; http://www.masb.org.my/pdf.php?pdf=BC_ED2015_3_Conceptual- Framework.pdf&file_path=pdf efrag.org, 2017, Distinguishing between liabilities and equity, : Discussion of the classification of liabilities and equity and under international financial reporting standards, Retrieved on 7th April 2016, from; https://www.efrag.org/Assets/Download?assetUrl=%2Fsites%2Fwebpublishing%2FSite Assets%2FEuropean%2520Discussion%2520Paper%2520on%2520Equity%2520and%2 520Liabilities.pdf&AspxAutoDetectCookieSupport=1 iasplus.com, 2013, Conceptual framework- Definition of equity and distinction between liabilities and equity instruments, Retrieved on 7th April 2017, from; https://www.iasplus.com/en/meeting-notes/iasb/2013/april/cf-definition iasplus.com, 2010, Conceptual framework for financial reporting 2010, Retrieved on 7th April 2017, from; https://www.iasplus.com/en-gb/standards/other/framework Read More
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