CPA Financial Reporting (FR) Study Notes
Subject: Financial Reporting (FR)
Period: Semester 2, 2024
Details: Detailed Study notes with page references and worked examples for the official CPA Australia Study Guide.
Study Guide Edition: CPA Financial Reporting 5th Edition notes (publishe...
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CPA Financial Reporting Notes
Module 1: The Role and Importance of Financial Reporting
1.1: The Role and Importance of Financial Reporting (p.2)
The Role of Financial Reporting:
• The role of financial reporting is to provide users with information to enable them to achieve
effective decision making.
• It also provides a stewardship or accountability role by requiring managers to give an
account of how they have used the resources provided by those users, which is particularly
important when there is a separation between ownership and management in an entity.
• Effective financial reporting communicates the ‘story’ of the entity during the period so that
the users can understand what the entity has achieved and how it has achieved it.
• The objective of general-purpose financial reporting is to provide financial information about
the reporting entity that is useful to its primary users for making decisions about providing
resources to the entity such as:
➢ Buying, selling or holding equity and debt instruments;
➢ Providing or settling loans and other forms of credit; or
➢ Exercising rights to vote on, or otherwise influence, management’s actions that
affect the use of the entity’s resources
• Identification of the primary users of financial reports is crucial in determining the
information that should be disseminated through the financial reports to effectively satisfy
their decision-making needs.
• The IASB identifies primary users as those that provide equity or debt finance to the entity,
such as existing and potential investors, lenders and other creditors that must rely on
general purpose financial reports for much of the information they need as they may be
unable to command information from an entity directly
• General purpose financial reports are directed to those primary users to provide information
about the economic resources of the entity, claims against the entity, and changes in those
resources and claims, which is necessary for these users to assess the entity for their
decision making
• Financial reports provide information about an entity’s financial position at a point in time
and provide information about an entity’s financial performance as a result of transactions
and other events that change the financial position during a reporting period
• Specifically, the balance sheet provides information about the financial position (i.e. the
assets, liabilities and equity) of the entity at a point in time
• The P/L reports on the financial performance (i.e. the income, expenses and profitability) for
a reporting period on an accrual basis.
• The statement of cash flows reports on the cash inflows and outflows of the entity for a
reporting period on a cash basis.
• Changes in the net assets, or equity, are reported in the statement of changes in equity.
• All individual financial reports are prepared by an entity as at a particular point in time or for
a particular reporting period, but the presentation of financial reports is prescribed to
ensure that they are comparable with the entity’s previous financial statements and with the
financial statements of other entities (IAS 1, para. 1).
• Technology advancements provide opportunities for various other methods of information
dissemination that, together with financial reporting via GPFSs, can be incorporated into a
, whole suite of reporting tools to properly and efficiently address the information needs of
users.
The Importance of Financial Reporting:
• Financial reporting is important because of the significant level of resources under the
responsibility of managers and the financial impact of the decisions that users make from
relying on the information provided in financial reports.
Information Needs of the User:
• Management of an entity also require financial information for decision making, but they
can obtain whatever information they need internally and do not need to rely on general
purpose financial reports
• Other users of financial information include regulators and members of the public, such as
community groups and potential employees; however, general purpose financial reports are
not primarily directed to these users
• In the Conceptual Framework, entities are required to prepare general purpose financial
reports specifically to assist their primary users in their decision making however, these
decisions may give rise to varying or even conflicting information needs.
• E.g. Lenders are interested in assessing an entity’s capacity to meet its interest and principal
repayment obligations and the level of risk associated with a loan whilst investors are
interested in the assessment of risk and the ability of the entity to service its debt, so that
the entity can continue its operations and provide a return
• These varying information needs and the resulting information demands may give rise to
different preferences for the measurement of assets or the timing of the recognition of
revenue.
• E.g. Lenders may prefer a measure of the net realisable value of certain assets provided as
security whereas investors may prefer a measurement of those assets based on their value
in use, which provides a better indication of the expected benefits to be derived from the
continued use of the assets.
• The IASB’s approach to resolving conflicting user information needs is to provide the
information that will meet ‘the needs of the maximum number of primary users’
• However, according to the IASB, focusing on common information needs does not prevent
an entity from providing additional information that may be useful to another sub-group of
primary users
, • It should also be noted that trying to meet the needs of the maximum number of primary
users may have different implications depending on the context
• E.g. In some entities, the largest group of primary users may be investors but in others it
may be lenders
Understanding the International Financial Reporting Standards:
• The information included in GPFSs prepared for external users (E.g. P&L, B/S, statement of
changes in equity and cash flow statements) must comply with the International Financial
Reporting Standards (IFRSs) and achieve fair presentation in accordance with the definition
and recognition criteria in the Conceptual Framework.
• If a conflict is identified between provisions of an IFRS and the Conceptual Framework, the
IFRS will take precedence.
• If any new provisions in the IFRSs depart from the Conceptual Framework, the IASB will
explain the departure in the Basis for Conclusions of the relevant standard.
• The IFRSs are ‘an internationally recognised set of accounting standards that bring
transparency, accountability and efficiency to financial markets around the world’
• The Australian Accounting Standards Board adopted the IFRSs for Australian entities
required to report under the Corporations Act 2001 (Cwlth) (Corporations Act) for annual
reporting periods beginning on or after 1 January 2005.
• There are 2 series of international accounting standards:
1. The International Accounting Standards (IASs), are those standards issued from 1973 to
2001, before the new International Accounting Standards Board (IASB) was formed.
2. The International Financial Reporting Standards (IFRSs), are those standards issued
under the IASB since 2001 and reflect the changes in accounting and business practices
since that date
• AASB standards (AASBs) are the accounting standards developed by the Australian
Accounting Standards Board for all economic sectors in Australia.
• AASB standards numbered by using:
➢ 1 or 2 digits (from 1 to 99) are the equivalent of IFRSs.
➢ 3 digits (from 101 to 999) are the equivalent of IASs;
➢ 4 digits (from 1001 onwards) have no international equivalent (AASB 2019a).
• The AASBs, whilst complying with the IFRSs, include additional paragraphs where reporting
requirements differ for specific economic entities such as Australian not-for-profit entities.
• These paragraphs have the prefix ‘AUS’ or ‘RDR’ (Reduced Disclosure Requirements) and
generally begin with words that highlight their limited applicability (E.g. ‘Notwithstanding
paragraphs xx, in respect of not-for-profit entities . . . ’)
, • Each standard begins with statements on its Objective and Scope and includes a section for
its Effective Date (ED) and whether earlier adoption is permitted.
• Additional sections such as the Basis for Conclusions (BC) and the Illustrative Examples (IE)
accompany the standard but are not considered to be a part of the standard.
• The BC section provides detailed explanations of the IASB’s considerations when developing
and/or updating the standard.
• The IE section is included for those standards requiring practical explanations and may
provide general examples to demonstrate the application of the main principles of the
standard.
Interaction Between Financial Reporting and the Regulatory Environment – Who Must Prepare
General Purpose Financial Reports?
International Accounting Standards Board (IASB):
• General purpose financial reporting applies to reporting entities. The question of who must
prepare general purpose financial reports is a matter for governments and regulatory
agencies of each jurisdiction that adopts IFRS to decide.
• A reporting entity is an entity that is required, or chooses, to prepare financial statements
and can be in the non-profit, for profit, private and/or public sector
• A reporting entity can be a single entity or a portion of an entity or can comprise more than
one entity but is not necessarily a legal entity.
• In jurisdictions adopting IFRSs, legislation and other regulatory requirements usually require
general purpose financial reports from entities that have issued debt or equity securities
traded in a public market.
• In this regard, the Conceptual Framework indicates that a reporting entity can be any entity
that has existing and potential investors, lenders and other creditors who must rely on
general purpose financial reports for much of the information they need to make decisions
about providing resources to the entity.
Australian Accounting Standards Board (AASB):
• In Australia, for-profit private sector entities are subject to the Conceptual Framework and
must prepare general purpose financial reports when they satisfy both of the following
conditions:
1. They have public accountability
2. They are required by legislation to comply with Australian Accounting Standards
• Other for-profit private sector entities may nonetheless elect to apply the Conceptual
Framework and prepare general purpose financial reports
Public Accountability
• A for-profit private sector entity has public accountability if:
➢ It has debt or equity instruments (i.e. securities) that are traded in a public market
or it in the process of issuing securities for such trading; or
• ‘it holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary
businesses’ (E.g. Banks, brokers, insurance firms etc.) for example, banks, insurance
companies, securities brokers/dealers and mutual funds Appendix A).
Legislation
, • The Corporations Act requires an entity that is a disclosing entity, public company, large
proprietary company or registered scheme to prepare an annual financial report that
complies with the AASB rules (s. 292).
• A disclosing entity is an entity with enhanced disclosure securities on issue, which is like the
notion of public accountability (s. 111AC).
• A proprietary company is usually limited by shares and can have no more than 50
shareholders.
• A large proprietary company is based on qualifying for 2 of the 3 size thresholds for revenue,
gross assets and number of employees
• For financial years beginning from 1 July 2019, the thresholds are revenue of $50 million or
more, gross assets of $25 million or more, and employees of 100 or more.
• A public company is a company other than a proprietary company
• The financial reporting obligations of other types of entities are included in other federal or
state-based legislation.
• E.g. For associations, the appropriate legislation is the relevant state-based Incorporated
Associations Act
The 2 Tiers of General-Purpose Financial Reporting
• The Australian Accounting Standards Board has a 2-tier model of general purpose financial
reporting:
1. Australian Accounting Standards
➢ Tier 1 general purpose financial reporting means an entity must satisfy all the
recognition, measurement and disclosure requirements in Australian Accounting
Standards, which incorporates IFRSs
➢ Tier 1 applies to for-profit private sector entities with public accountability and
Australian Governments either at the federal, state, territory or local level
2. Australian Accounting Standards — Reduced Disclosure Requirements.
➢ Tier 2 general purpose financial reporting means an entity must satisfy all the
recognition and measurement requirements in Australian Accounting Standards but
has substantially reduced disclosure requirements (RDR) relative to Tier 1
➢ An example of RDR is the omission of the requirement for disclosure of audit fees,
financial instruments, income tax, and related parties
➢ Tier 2 applies to entities in respect of which it is reasonable to expect the existence
of users dependent on general purpose financial reports for information which will
be useful to them for making and evaluating decisions about the allocation of scarce
resources
External Reporting Board of New Zealand (XRBNZ):
,International Initiatives to Decrease Financial Reporting Complexity:
• An ongoing criticism of financial reporting is the complexity of financial reports and as such
improving the communication effectiveness of disclosures in financial statements is a
current focus of many accounting setters
• There are a growing number of initiatives to help combat the issue, including:
1. Reducing differences in reporting standards among countries
2. Reducing reporting requirements of small and medium-sized entities
3. Catering to the information needs of multiple stakeholder
4. Improving the content and structure of the primary financial statements
5. Clarifying disclosure requirements and improving the usefulness of disclosures
6. Improving understanding of the existing requirements and helping entities make
better materiality judgments
7. Considering how management commentary outside the financial statements could
better complement and support the financial statements
8. Improving communication between preparers and users by enabling information to
be delivered in an electronic format
1. Reducing Differences in Reporting Standards among Countries:
• More than 140 jurisdictions worldwide require the use of the IFRSs for their publicly listed
companies
• The global acceptance of the IFRSs led to the commitment of the US Financial Accounting
Standards Board (FASB) to work with the IASB to explore the possibilities of the convergence
of US Generally Accepted Accounting Principles (GAAP) with the IFRSs.
• In 2007, the US Securities and Exchange Commission (SEC) eliminated the requirement for
foreign companies registered with the US SEC to reconcile their IFRS-based financial
statements to US GAAP but the US SEC does not permit domestic issuers to adopt the IFRSs
2. Reducing Reporting Requirements of Small and Medium-Sized Entities:
, • The IASB has introduced IFRS for SMEs which are simpler because:
➢ Topics not relevant to SMEs, such as earnings per share, interim financial reporting
and segment reporting, are omitted
➢ Many principles for recognising and measuring assets, liabilities, income and
expenses in the full IFRSs are simplified (E.g. Amortising goodwill)
➢ Significantly fewer disclosures are required (about a 90% reduction)
➢ The standards are written in clear, easily understandable language.
➢ Revisions to these standards are expected to be limited to once every 3 years
• The AASB has not adopted IFRS for SME’s but they must comply with:
➢ Providing Special Purpose Financial Statements (SPFS) in accordance with the
specific information needs of the entity’s financial statement userss
➢ The standards to follow include:
❖ AASB 101: Presentation of Financial Statements
❖ AASB 107: Statement of Cash Flows
❖ AASB 108: Accounting Policies, Changes in Accounting Estimates and Errors
❖ AASB 1048: Interpretation on and Application of Standards
❖ AASB 1053: Application of Tiers of Australian Accounting Standards
❖ AASB 1054: Australian Additional Disclosures
❖ AASB 1057: Application of Australian Accounting Standards
Catering to the Information Needs of Multiple Stakeholders:
• One aspect of the current complexity in financial reporting has resulted from the need to
measure ‘performance’ from multiple perspectives which can’t be met simply by the
reporting of financial statements.
• Therefore, there is a need for information such as the progress of the company — in terms
of strategy and plan — rather than financial measures such as profit, assets and liabilities.
• The increase in the reporting of non-mandatory information in annual reports (relative to
the mandated financial information) makes financial reporting seem like a mere compliance
exercise rather than an exercise that communicates the information needs of multiple
stakeholders
• To address this concern, some of the present research projects in progress include:
➢ IASB: Engaged in the “Disclosure Initiative” to help develop better disclosure
requirements in accounting standards and accounting policies.
➢ FRC: Introduced the Financial Reporting Lab in 2011 as a forum for companies and
investors to solve contemporary reporting needs with the aim of improving
disclosures
➢ Technology Advancements: New items need to be recognised (E.g. Crypto-assets),
new avenues to disseminate and consume information (E.g. Electronically) and new
techniques used to analyse information (E.g. Big data and AI)
1. 2: The Conceptual Framework for Financial Reporting (p.12)
,The Purpose and Application of the Conceptual Framework:
• When the accounting standards don’t provide guidance, it is the role of the Conceptual
Framework to provide guidance to facilitate consistency in the reporting of transactions and
events.
• The Conceptual Framework provides a formal frame of reference for:
➢ What types of transactions and events should be accounted for
➢ When the effects of transactions and events should be recognised
➢ How the effects of transactions and events should be measured
➢ How the effects of transactions and events should be summarised and presented in
financial statements
• E.g. As an asset represents a resource that has the potential to produce future benefits, the
amount at which it is reported in the statement of financial position (i.e. its carrying amount)
should not exceed the expected benefits to be derived from the asset (i.e. the recoverable
amount).
Objectives and Limitations of General-Purpose Financial Reporting:
Objectives:
• The objective of general-purpose financial reporting is to provide financial information to
the primary users to support their decision-making needs.
, • General-purpose financial reporting performs a stewardship function, which involves
reporting on how efficiently and effectively management has used its resources
• This emphasis on user decision making, in order to ascertain the information, the entity
should provide, follows a decision-usefulness approach which is the most important
objective.
• Preparers of the general-purpose financial statements are required to exercise some
judgment in deciding which information is required for the decision-usefulness objective to
be met.
Limitations
• Lack of familiarity with new types of information.
➢ If users of financial statements are not familiar with an item of information, it is
difficult to assess its usefulness to their decision-making processes.
➢ Preparers will then be faced with difficulties in trying to assess if the new item of
information should be recognised under an existing category in the financial reports
or disclosed separately.
➢ Some users may not have the technical expertise to understand complex
information (E.g. PV calculations) or the technological awareness (E.g. Crypto assets)
• Decision-usefulness may vary among users.
➢ The personal beliefs and values of users may determine the information that they
tend to use in their decision making (E.g. Environmental concerns)
➢ The differences in what users find relevant are also likely to depend on the decision
being made. (E.g. Information required for a long-term contract differs from a union
negotiating higher wages for its members)
• Capable of multiple interpretations.
➢ Preparers may have a different perception of what is useful information to users
than the users themselves.
➢ E.g. Using fair value for assets may be to assess the entity’s future economic benefits
vs other entities; however, value in use may be better at capturing the
management’s plans and expectations regarding assets.
➢ These competing views are difficult to reconcile under the currently specified
decision-usefulness objective of general purpose financial reporting.
• Time and cost constraints in preparing GPFSs.
➢ Due to time and cost constraints in preparing general-purpose financial reports, it is
not possible for entities to provide all the useful information that will meet all the
varying needs of users.
➢ When a user requires specific information that has not been disclosed in an entity’s
financial reports, the IASB recommends the use of other sources such as ‘general
economic conditions and expectations, political events and political climate, and
industry and company outlooks’
➢ The IASB also explains that the financial reports are ‘not designed to show the value’
of the organisation but to help decision makers make their own estimates as to its
value
➢ Nevertheless, the time and cost constraints in preparing GPFSs can be reduced with
the help of new technologies that are capable of capturing, managing, processing
and reporting on vast amounts of data
Principles Established in the Conceptual Framework:
, Accrual Basis:
• The accrual basis of accounting requires an entity to recognise revenues when they are
earned rather than when cash is received.
• Expenses are recognised when they are incurred rather than when cash is paid. (E.g. An
entity selling goods or services on credit recognises the revenue and related expenses
(COGS) incurred in earning that revenue when the sale takes place, regardless of the timing
of the cash inflow and cash outflow relating to that revenue and those expenses.
• The accrual basis requires an entity to recognise the depreciation of a non-current asset
(with a limited useful life) as the economic benefits of that asset are consumed or expire; an
entity does not account for the asset as an expense in the period in which it is acquired.
• The Conceptual Framework advocates for accrual basis of accounting as it considers that it
provides a better basis for assessing the entity’s past performance and predicting future
performance than relying only on financial statements prepared on a cash basis
Going Concern:
• Financial statements prepared in accordance with the going concern assumption presume
that the entity will continue to operate for the foreseeable future.
• The carrying amounts of assets and liabilities in the statement of financial position are
normally based on the going concern assumption
• E.g. The carrying amount of property, plant and equipment — whether measured on a cost
or fair value basis —assumes that the carrying amount will be recoverable through the
entity’s continuing operations.
• Some assets, such as property and plant, may be stated at amounts that exceed their
disposal value because the entity expects to obtain greater economic benefits through the
continued use of such an asset.
• Where the going concern, assumption is not appropriate (e.g. because of the entity’s
intention or need to wind up operations), the financial statements should be prepared on
some other basis.
• One approach may be to state assets at their net realisable value and liabilities at the
amount required for their immediate settlement
1.3: Qualitative Characteristics of Useful Financial information (p.15):
Fundamental Qualitative Characteristics:
Relevance:
• Information is relevant when can influence the decisions of users which can occur through
the predictive/confirmatory value it of financial information
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