Framework for Financial Statements

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Framework for Financial Statements Sets out concepts for preparation and presentation of general-purpose financial statements. Issued by the Accounting Standards Board (ASB) of ICAI in July 2000. Relevant for Companies (Accounting Standards) Rules, 2021. Provides basis for developing new standards and reviewing existing ones. Purpose of the Framework Assists: Enterprises in preparing financial statements compliant with Accounting Standards. ASB in developing and reviewing Accounting Standards. ASB in promoting harmonisation of accounting regulations. Auditors in forming opinions on financial statements' conformity to Accounting Standards. Users in interpreting financial statements. Those interested in ASB's work with information on its formulation approach. Status and Scope of the Framework Applies to general-purpose financial statements prepared annually for external users by commercial, industrial, and business enterprises (public or private). Special purpose financial reports (e.g., for tax) are outside the scope but may apply the framework if not inconsistent. Framework does not override specific Accounting Standards; in case of conflict, the Accounting Standard prevails. Components of Financial Statements A complete set normally consists of: Balance Sheet: Portrays value of economic resources controlled by an enterprise; provides liquidity and solvency information. Statement of Profit and Loss: Presents results of operations for an accounting period, depicting performance and profitability. Cash Flow Statement: Shows generation and use of cash, evaluating investing, financing, and operating activities. Notes and other statements: Present supplementary information (e.g., accounting policies, segment reporting, related party disclosures, EPS). Objectives and Users of Financial Statements Objective: To provide information about financial position, performance, and cash flows useful for economic decisions. Users: Investors: Concerned with risk and return; assess dividend payment ability. Employees: Interested in stability and profitability; assess ability to provide remuneration, benefits, and employment. Lenders: Determine if loans and interest will be paid. Suppliers & Trade Creditors: Determine if amounts owing will be paid. Customers: Interested in continuance, especially with long-term involvement. Governments & Agencies: Interested in resource allocation, regulation, taxation, and national statistics. Public: Assess enterprise's contribution to local economy, employment, and trends. Fundamental Accounting Assumptions Assumed to be followed unless specifically disclosed otherwise: Going Concern: Enterprise will continue in operation for the foreseeable future, with no intention or need to materially curtail operations. If not followed, the basis used (e.g., assets at net realisable values) must be disclosed. Accrual Basis: Revenues and costs are recognised as earned or incurred (not as money is received or paid) and recorded in related periods. Mandatory for companies per Companies Act, 2013 (Section 128(1)). If cash basis is used for any income/expense, it must be stated. Consistency: Accounting policies are consistent from period to period, improving comparability. Policy changes allowed if required by statute, Accounting Standard, or for more appropriate presentation. Qualitative Characteristics of Financial Statements Attributes that improve usefulness, maintained within reasonable cost/benefit limits: Understandability: Information should be readily understandable by users with reasonable knowledge of business, economic activities, and accounting. Relevance: Information influences economic decisions; helps evaluate past, present, or future events, or confirms/corrects past evaluations. Judged by materiality: misstatement (omission/error) can influence economic decisions. Constraint - Timeliness: Undue delay in reporting can reduce relevance. Balance timely reporting with reliable information. Constraint - Balance between Benefit and Cost: Benefits should exceed costs; a judgmental process. Reliability: Information is free from material error and bias. Faithfully represents transactions and events. Reports substance over form. Is neutral (free from bias). Prudence is exercised (uncertain outcomes). Information is complete. Comparability: Permits inter-firm and intra-firm comparison. Requires disclosure of financial effects of accounting policy changes. Not mere uniformity; allows for improved accounting standards. True and Fair View Financial statements must show a true and fair view of performance, financial position, and cash flows. Applying qualitative characteristics and appropriate accounting standards generally leads to a true and fair view. Elements of Financial Statements Classified into five broad groups: Asset: A resource controlled by the enterprise from past events, from which future economic benefits are expected. Need not have physical substance (e.g., patents, trade receivables). Control is key, not necessarily legal ownership (e.g., financial lease). Control must be sufficient (e.g., not employee talent). Must generate probable future economic benefits. Must have a reliably measurable cost or value. Liability: A present obligation of the enterprise arising from past events, settlement of which expects an outflow of resources embodying economic benefits. Must be a present obligation (probable existence based on evidence). Recognised when outflow of economic resources can be anticipated and reliably measured. Provisions for doubtful debts or depreciation are not liabilities but diminution in asset value. Equity: Residual interest in assets after deducting all liabilities (Owners' claim: capital and reserves). Changes due to contributions/distributions to participants, or income/expenses. Income: Increase in economic benefits during the period (inflows/enhancement of assets or decrease in liabilities) resulting in increased equity, excluding contributions from participants. Encompasses revenue (ordinary course of business) and gains (may or may not arise from ordinary activity). Shown separately in P&L for performance assessment. Always associated with asset increase or liability reduction. Expenses: Decrease in economic benefits during the period (outflows/depletions of assets or incurrence of liabilities) resulting in decreased equity, excluding distributions to participants. Encompasses ordinary expenses (e.g., wages) and losses (may or may not arise from ordinary activity). Shown separately in P&L for performance assessment. Always incurred with asset reduction or liability increase. Recognised by matching with revenue or when criteria for asset/liability decrease/increase are met. Recognised immediately if no future economic benefit is expected. Measurement of Elements in Financial Statements Four alternative measurement bases for valuing assets and liabilities: Historical Cost: Acquisition price. Assets: Amount of cash/cash equivalent paid or fair value at acquisition. Liabilities: Amount of proceeds received in exchange for obligation or cash/cash equivalent expected to be paid. Current Cost: Assets: Cash/cash equivalent that would be paid to acquire the same or equivalent asset currently. Liabilities: Undiscounted amount of cash/cash equivalents required to settle the obligation currently. Realisable (Settlement) Value: Assets: Amount of cash/cash equivalents currently realisable on orderly disposal. Liabilities: Undiscounted amount of cash/cash equivalents expected to be paid on settlement in normal course of business. Present Value: Assets: Present value of future net cash inflows expected to be generated. Liabilities: Present value of future net cash outflows expected to be required to settle liabilities. Formula: $P = A \times (1+R)^{-n}$ where $P$ is present value, $A$ is future amount, $R$ is interest rate, $n$ is years. Capital Maintenance Capital refers to net assets of a business. Maintaining net assets ensures continued operations at the same level. Dividends should not exceed profit after provisions for asset replacement. Retained profit (RP) must not be negative ($CE \ge OE + C$). Value of retained profit depends on asset/liability valuation. Financial Capital Maintenance at Historical Cost: Opening and closing assets at historical costs to ascertain equity. Capital maintained if retained profit $\ge 0$. Business has funds to replace assets at historical costs. Financial Capital Maintenance at Current Purchasing Power: Opening and closing equity at historical costs restated at closing prices using average price indices. Positive retained profit means funds are sufficient to replace assets at average closing price. Physical Capital Maintenance at Current Costs: Historical costs of opening and closing assets restated at closing prices using specific price indices for each asset. Liabilities restated to value of economic resources sacrificed at current date. Positive retained profit ensures funds for replacement of each asset at respective closing prices.