Framework for the Preparation and Presentation of Financial Statements

Institute of Chartered Accountants of India, which is the apex body of accountants in India has issued a framework on manner of presentation and preparation of Financial Statements in India and is called as Framework for the presentation and preparation of financial statements.. This framework sets out the concepts that underlie the preparation and presentation of financial statements for external users.

However, this Framework itself isn't an Accounting Standard and hence does not define standards for any particular measurement or disclosure issue. Hence, it also cannot override any specific Accounting Standard. Wherever, there is any conflict between the Accounting Standard and this Framework, Accounting Standard shall prevail. However, Accounting Standards Board shall consider such conflicts and be guided for its review of existing Standards and development of future Accounting Standards. This way the number of conflicts between this Framework and this Accounting Standard will diminish through time. Also this Framework will be revised from time to time on the basis of the experience of the Accounting Standards Board of working with it,

SCOPE – The framework deals with –

• The objective of financial statements;
• The qualitative characteristics that determine the usefulness of information provided in financial statements;
• Definition, recognition and measurement of the elements from which financial statements are constructed; and
• Concepts of capital and capital maintenance.

This Framework is concerned with general purpose financial statements which are prepared at least annually and are directed toward the common information needs of a wide range of users. Some of such users may require, and have power to obtain other information in addition to that contained in the financial statements. However, many users have to rely on the financial statements as their major source of financial information and such financial statements should, therefore, be prepared and presented with their needs in view. Special purpose financial reports, for example prospectuses and computations prepared for taxation purposes, are outside the scope of this Framework. However, this framework can be applied in preparation of such special purpose reports where their requirements permit.

Financial Statements form part of the process of Financial Reporting. A complete set of Financial Statements normally includes a Balance Sheet, a Statement of Profit and Loss (Also commonly referred as income statement), a Cash Flow statement and those notes and other statements as well as explanatory material that are an integral part of the Financial Statements. They may also include supplementary schedules and information based on or derived from, and expected to be read with, such statements. Such schedules and supplementary information may deal with, for example, with financial information about business and geographical segments, and disclosures about the effects of changing prices. However, such items as reports by directors, statements by the Chairman, discussion and analysis by management and similar items that may be included in a financial or annual report, are not included in meaning of financial statements.

This Framework applies to the Financial Statements of all reporting enterprises engaged in commercial, industrial and business activities, whether in the public or in the private sector. A reporting enterprise is an enterprise for which there are users who rely on the financial statements as their major source of financial information about the enterprise.

While all information needed by these users cannot be met by Financial Statements, there are needs which are common to all users. As providers of risk capital to the enterprise, investors need more comprehensive information that other users. The provision of financial statements that meet their needs will also meet most of the needs of other users that financial statements can satisfy.

The Management of an Enterprise has the responsibility for the preparation and presentation of the Financial Statements of the Enterprise. Management is also interested in the information contained in the Financial Statements even though it has access to additional management and financial information that helps it carry out its planning, decision-making and control responsibilities, Management has the ability to determine the forma and content of such additional information in order to meet its own needs. The reporting of such information, however, is beyond the scope of this Framework.

The Objective of Financial Statements

Constraints on Relevant and Reliable

1. Timeliness – Undue delay in reporting of information may make it lose its relevance. Hence, Management should ensure that information is provided on timely basis. However, some information may not be available at time to be completely reliable and Management will have to strike a balance between waiting for complete reliable information or present information on timely basis. It is to be noted that although reliability is an important characteristics of information, a complete reliable information if presented delayed can often be non-relevant.
2. Balance between Benefit and Cost
3. Balance between Qualitative Characteristics

True and Fair View

Financial Statements are often described as showing a true and fair view of the financial position, performance and cash flows of an enterprise. Although this Framework does not deal directly with such concepts, the application of the principal qualitative characteristics and of appropriate accounting standards normally results in financial statements that convey what is generally understood as a true and fair view of such information.

The Elements of Financial Statements

Financial statements portray the financial effects of transactions and other events by grouping them into broad classes according to their economic characteristics. These broad classes are termed the elements of financial statements. The elements directly related to the measurement of financial position in the balance sheet are assets, liabilities and equity. The elements directly related to the measurement of performance in the statement of profit and loss are income and expenses. The cash flow statement usually reflects elements of statement of profit and loss and changes in balance sheet elements; accordingly, this Framework identifies no elements that are unique to this statement. The presentation of these elements in the balance sheet and the statement of profit and loss involves a process of sub classification. For example, assets and liabilities may be classified by their nature or function in the business of the enterprise in order to display information in the manner most useful to users for purposes of making economic decisions.

Financial Position

The elements directly related to the measurement of financial position are assets, liabilities and equity. These are defined as follows –

• An Assets is a resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise.
• A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.
• Equity is the residual interest in the assets of the enterprise after deducting all its liabilities.

Assets

The future economic benefit embodied in an asset is the potential to contribute, directly or indirectly, to the flow of cash and cash equivalents to the enterprise. There must be such future benefits to let any resource be classified as asset and be recognised. This future economic benefits embodied in an asset may flow to the enterprise in a number of ways. For example, an asset may be –

• Used singly or in combination with other assets in the production of goods or services to be sold by the enterprise;
• Exchanged for other assets;
• Used to settle a liability; or
• Distributed to the owners of the enterprise.

Although most of the assets have physical presence such as Plants and Machinery, Physical form is not essential to the existence of an asset. Hence, patents and copyrights or other intangible assets are also assets provided they are controlled by the enterprise and there is expected flow of benefits in future.

Also mere legal form such as legal deeds, registration, etc. do not meet essential criteria for recognition. What is more important is not the ownership tittle, but the control exercised by the enterprise. This is why even though items purchased under hire purchase may not be under enterprise's legal title, still they are assets of the enterprise because it exercised complete control over it. One of the most important characteristics of an asset is that it results from past expenditure incurred by the enterprise. For example, although Land is not transferred under legal title of the enterprise, when payment is made and it is almost sure there doesn't lies any contingencies, enterprise is capable of recognising it as its asset. However, where no expenditure is made and mere intention is there to buy an inventory, it cannot recognise such inventory as its assets. It is therefore that there lies essential relationship between expenditure and the assets. In fact, it acts as a proof of existence of asset.

Liabilities

An important characteristic of a liability is that the enterprise has a present obligation. An obligation is a duty or responsibility to act or perform in a certain way. Obligations may be legally enforceable as a consequence of a binding contract or statutory requirement. Although liabilities arise in normally from contracts or statutory requirement, it may also arise from normal business practice, custom and desire to maintain good business relations or act in an equitable manner. If, for example, an enterprise decides as a matter of policy to rectify faults in its products even when these become apparent after the warranty period has expired, the amounts that are expected to be expended in respect of goods already sold are liabilities.

A distinction needs to be drawn between a present obligation and a future commitment. A decision by the management of an enterprise to acquire assets in the future does not, of itself, give rise to a present obligation. An obligation normally arises only when the asset is delivered or the enterprise enters into an irrevocable agreement to acquire the asset. In the latter case, the irrevocable nature of the agreement means that the economic consequences of failing to honour the obligation, for example because of the existence of a substantial penalty, leave the enterprise with little, if any, discretion to avoid the outflow of resources to another party.

The settlement of a present obligation usually involves the enterprise giving up resources embodying economic benefits in order to satisfy the claim of the other party. Settlement of a present obligation may occur in a number of ways, for example, by-

• Payment of cash;
• Transfer of other assets;
• Provision of services;
• Replacement of that obligation with another obligation; or
• Conversion of the obligation to equity.

An obligation may also be extinguished by other means, such as a creditor waiving or forfeiting its rights.

Liabilities result from past transactions or other past events. Thus, for example, the acquisition of goods and the use of services give rise to trade creditors (unless paid for in advance or on delivery) and the receipt of a bank load results in an obligation to repay the loan. An enterprise may also recognise future rebates based on annual purchases by customers as liabilities; in this case, the sale of the goods in the past is the transaction that give rise to the liability. Some liabilities can be measured only by using a substantial degree of estimation. Such liabilities are commonly described as 'provisions'. Examples include provisions for payments to be made under existing warranties and provisions to cover pension obligations.

Performance

Profit is frequently used as a measure of performance or as the basis for other measures, such as return on investment or earnings per share. The elements directly related to the measurement of profit are income and expenses. The recognition and measurement of income and expenses, and hence profit, depends in part on the concepts of capital and capital maintenance used by the enterprise in preparing its financial statements. These concepts are discussed in paragraphs 101 to 109.

Income is increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.

Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

The definitions of income and expenses identify their essential features but do not attempt to specify the criteria that need to be met before they are recognised in the statement of profit and loss. Criteria for recognition of income and expenses are discussed in paragraphs 81 to 97. Items of income and expenditure can be presented in the statement of profit and loss in different ways so as to provide relevant information for decision making. However, it is generally accepted practice to disclose incomes and expenditure from ordinary activities separate from those from other activities.

Beside, these this Framework also lists, criteria to recognise any items in financial statements in general and other relevant characteristics needed in preparation and presentation of financial statements. There are also definitions of cost methods used in recognising the items such as historical cost, market cost, etc. as well definitions of capital maintenance concept dealing with proper recognition of income and expenditure, and equity elements.