Prudence Preparation of financial statements requires the use of professional judgment in the adoption of accountancy policies and estimates.

Prudence requires that accountants should exercise a degree of caution in the adoption of policies and significant estimates such that the assets and income of the entity are not overstated whereas liability and expenses are not under stated. The rationale behind prudence is that a company should not recognize an asset at a value that is higher than the amount which is expected to be recovered from its sale or use. Conversely, liabilities of an entity should not be presented below the amount that is likely to be paid in its respect in the future. There is an inherent risk that assets and income of an entity are more likely to be overstated than understated by the management whereas liabilities and expenses are more likely to be understated. The risk arises from the fact that companies often benefit from better reported profitability and lower gearing in the form of cheaper source of finance and higher share price. There is a risk that leverage offered in the choice of accounting policies and estimates may result in bias in the preparation of the financial statements aimed at improving profitability and financial position through the use of creative accounting techniques. Prudence concept helps to ensure that such bias is countered by requiring the exercise of caution in arriving at estimates and the adoption of accounting policies. - See more at: http://accounting-simplified.com/financial-accounting/accounting-conceptsand-principles/prudence.html#sthash.JnyaRp8U.dpuf

To be reliable the information in the financial statements must be neutral, that is, free from bias. Prudence is the exercise of a degree of caution in the exercise of judgements under conditions of uncertainty. Prudence does not allow the deliberate overstatement of liabilities or expenses or the deliberate understatement of assets or income. A faithful representation should be neutral. A neutral depiction is without bias in the selection of financial information

Prudence is the inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. Neutrality is an important objective, as underlined in the ASB Statement of Principles as follows: "Financial information is not neutral if it has been selected or presented in such a way as to influence the making of a decision or judgement in order to achieve a predetermined result or outcome." "there can also be tension between two aspects of reliability - neutrality and prudence. Whilst neutrality involves freedom from deliberate or systematic bias, prudence is a potentially biased concept that seeks to ensure that, under conditions of uncertainty, gains and assets are not overstated, and losses and liabilities are not understated. This tension exists only where there is uncertainty, because it is only then that prudence needs to be exercised. In the selection of accounting policies, the competing demands of neutrality and

prudence are reconciled by finding a balance that ensures that the deliberate and systematic understatement of assets and gains and overstatement of liabilities and losses do not occur."

Neutrality Information contained in the financial statements must be free from bias. It should reflect a balanced view of the affairs of the company without attempting to present them in a favored light. Information may be deliberately biased or systematically biased. - See more at: http://accounting-simplified.com/financial-accounting/accounting-conceptsand-principles/neutrality.html#sthash.12P0hKwu.dpuf Prudence was rejected for IFRS because it was seen as introducing bias to accounts, which should be neutral

The concept of prudence is, on the surface, a simple one. Prudence is the inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. The problem with this is that prudence can lead accountants a bit of a dance. Historically prudence became the oldest trick in the book. You cite extra prudence one year and then, marvel upon marvel, discover that you can feed the fruits of that prudence into a bumper crop of profits the next year. This, as the IASB points out in the latest discussion paper on the conceptual framework, means that the financial statements concerned would not be neutral and therefore, not have the quality of reliability. Instead the IASB decided in 2008 that the problem of precisely defining the application of prudence meant prudence should be dropped and the idea of neutrality introduced instead. Neutrality would effectively cover the admirable aspects of prudence but not the more problematic and worrying downsides. The pursuit of neutrality, it was felt, would be more effective than prudence at ridding the process of bias.

Conceptual Framework The Conceptual Framework sets out the concepts that underlie the preparation and presentation of financial statements. It is a practical tool that assists the IASB when developing and revising IFRSs. The objective of the Conceptual Framework project is to improve financial reporting by providing the IASB with a complete and updated set of concepts to use when it develops or revises standards. The existing Conceptual Framework has helped the IASB to improve financial reporting, but: some important areas are not covered by the existing Conceptual Framework (eg presentation including other comprehensive income (OCI), disclosure, measurement); and the guidance in some areas is unclear or out-of-date (eg some aspects of the asset and liability definitions). Consequently, restarting work on the Conceptual Framework received overwhelming support from the IASBs agenda consultation in 2011. The Discussion Paper

The IASB published a Discussion Paper addressing possible changes to the Conceptual Framework on 18 July 2013. The deadline for comments on this Discussion Paper is 14 January 2014. The Discussion Paper is the first step towards revising the Conceptual Framework. It is designed to obtain initial views and comments from parties with an interest in financial reporting. After the comment period, the IASB will consider their preliminary views in the light of comments received and develop an Exposure Draft a draft Conceptual Framework for comments to the public. How does this project link with standard-setting projects? In planning and conducting the work on the Conceptual Framework, the IASB will consider interactions with the IASBs existing standard-setting projects. Those projects are likely to provide input for the Conceptual Framework and to depend, at least to some extent, on developments in this project. Will this project lead to changes to existing Standards? A revised Conceptual Framework will not necessarily lead to changes to existing IFRSs. The Conceptual Framework is not an IFRS and does not override the requirements of any IFRSs. Any proposal to change an existing IFRS would need to go through the IASBs normal due process for adding a project to the agenda and conducting the project. Once finalised, the revised Conceptual Framework will be effective immediately and the IASB will use it when developing or revising IFRSs.

Prudence 9.15 Both paragraph QC12 of Chapter 3 and paragraph 36 of the pre-2010 Conceptual Framework state that financial statements should be neutral, that is, free from bias. However, the pre-2010 Conceptual Framework went on to describe the concept of prudence. Chapter 3 does not include any reference to prudence. 9.16 Paragraph 37 of the pre-2010 Conceptual Framework describes prudence as follows: Prudence is the inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. However, the exercise of prudence does not allow, for example, the creation of hidden reserves or excessive provisions, the deliberate understatement of assets or income, or the deliberate overstatement of liabilities or expenses, because the financial statements would not be neutral and therefore, not have the quality of reliability. 9.17 Hence, the pre-2010 Conceptual Framework expressed the view that the exercise of prudence need not be inconsistent with neutrality. 9.18 In developing Chapter 3 of the Conceptual Framework, the IASB removed reference to the concept of prudence. The Basis for Conclusions on Chapter 3 explains that prudence was not included as an aspect of faithful representation because: (a) including a reference to prudence would be inconsistent with neutrality. Even with the prohibitions against deliberate misstatement that appear in the pre-2010 Conceptual Framework, a requirement to be prudent would lead to bias in the preparation of financial statements. (b) deliberately understating assets or overstating liabilities in one period often leads to overstating financial performance in later periods.76 9.19 Many continue to object to the removal of the reference to prudence from the

Conceptual Framework, stating that: (a) deliberately reflecting conservative estimates in the financial statements may be desirable to counteract the effect of over-optimistic management estimates. (b) such a removal could result in the recognition of assets and gains whose existence is uncertain and the non-recognition of some possible liabilities and possible losses. The IASBs proposed approach to situations where the existence of an asset or a liability is uncertain is discussed in Section 2. (c) such a removal may increase the use of current value measurements (including fair value), which some view as inherently unverifiable and prone to error. 9.20 Few would disagree with the idea expressed in the pre-2010 Conceptual Framework that a preparer should exercise caution when making estimates and judgements under conditions of uncertainty. This idea is reflected in many of the decisions that the IASB makes when setting Standards. 9.21 However, it is unclear whether some who call for the reintroduction of references to prudence would agree with the description of prudence as the exercise of caution when making estimates and judgements under conditions of uncertainty. Some would prefer financial statements to show a bias towards conservatism and reject the notion of neutrality. 9.22 As noted in paragraph 9.19, some have expressed a fear that removing prudence will lead to a much more widespread use of current value measurements than at present. Section 6 on measurement indicates the factors that the IASB believes it will need to consider when determining which measurement to adopt when developing or revising particular Standards. It is not clear that including prudence as an additional factor to consider would result in a significantly different outcome.

prudence concept Definition Save to Favorites An accounting principle that requires recording expenses and liabilities as soon as possible, but the revenues only when they are realized or assured. Also called conservatism principle.

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accounting concepts Definition Save to FavoritesSee Examples Rules of accounting that should be followed in preparation of all accounts and financial statements. The four fundamental concepts are (1) Accruals concept: revenue and expenses are recorded when they occur and not when

the cash is received or paid out; (2) Consistency concept: once an accounting method has been chosen, that method should be used unless there is a sound reason to do otherwise; (3) Going concern: the business entity for which accounts are being prepared is in good condition and will continue to be in business in the foreseeable future; (4) Prudence concept (also conservation concept): revenue and profits are included in the balance sheet only when they are realized (or there is reasonable 'certainty' of realizing them) but liabilities are included when there is reasonable 'possibility' of incurring them. Other concepts include (5) Accounting equation: total assets equal total liabilities plus owners' equity; (6) Accounting period: financial records pertaining only to a specific period are to be considered in preparing accounts for that period; (7) Cost basis: asset value recorded in the account books should be the actual cost paid, and not the asset's current market value; (8) Entity: accounting records reflect the financial activities of a specific business or organization, not of its owners or employees; (9) Full disclosure: financial statements and their notes should contain all relevant data; (10) Lower of cost or market value: inventory is valued either at cost or the market value (whichever is lower); (11) Maintenance of capital: profit can be realized only after capital of the firm has been restored to its original level, or is maintained at a predetermined level; (12) Matching: transactions affecting both revenues and expenses should be recognized in the same accounting period; (13) Materiality: minor events may be ignored, but the major ones should be fully disclosed; (14) Money measurement: the accounting process records only activities that can be expressed in monetary terms (with some exceptions); (15) Objectivity: financial statements should be based only on verifiable evidence, including an audit trail; (16) Realization: any change in the market value of an asset or liability is not recognized as a profit or loss until the asset is sold or the liability is paid off; (17) Unit of measurement: financial data should be recorded with a common unit of measure (dollar, pound sterling, yen, etc.). Also called accounting conventions, accounting postulates, or accounting principles.

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Many believe that prudence contributes to the credibility of _ nancial statements, especially as it provides a high degree of con_ dence that the net assets represented in the balance sheet are at least as great as their reported amount, and that all reported pro_ ts are certain. 6 However, just as prudence has a long history, so does the debate about it. The main objection some raise is that prudence introduces bias into reporting, which con_ icts with the neutral (or unbiased) view that _ nancial statements should provide. In particular, they argue that

prudence may be used to arti_ cially smooth income, reducing pro_ ts in good years to provide a cushion that may camou_ age the results of poor years, making it dif_ cult to understand the entitys performance. Because it is often dif_ cult for users to detect the exercise of prudence, and to quantify its effect, prudence may impair, in their view, the transparency of _ nancial information. 7 In contrast, others believe that the application of prudence results in an earlier re_ ection of existing risks in the _ nancial statements, preventing the recognition of pro_ ts which are not yet realised. They see prudence as the opposite of imprudence, which concept may result in recognising illusory pro_ ts and an overstatement of income, and can lead to ill-based economic decisions. In their view, prudence is clearly linked to pro_ t distribution, as noted in paragraph 1, in particular in jurisdictions where legislation has established a direct link between net income and dividend distributions.

Neutrality Neutrality is the ability to achieve a depiction without bias in the selection or presentation of financial information. The conceptual approach under IFRS is similar to the approach to neutrality and prudence taken by UK GAAP that requires the exercise of prudence in conditions of uncertainty about the existence and measurement of items in the financial statements. On the other hand UK GAAP prescribe that it is not necessary to exercise prudence where there is no uncertainty and that doing so in such circumstances, for example by deliberately understating assets and gains or overstating liabilities and losses, would result in accounts that are not neutral and therefore not reliable. For Mr Moore the concept of neutrality has been given more relevance than prudence in IFRS for the purpose of preventing manipulation, or smoothing of financial statements, by the use of caution as its pretext. However, the use of prudence and common sense is still very much engrained in IFRS in the definition of items subject to uncertainty, mostly in the letter of the standards, and as such it cannot be used as a reason for arguing that IFRS are not able to result in a true and fair representation. Mark to market or mark to model profits under IAS 39 In respect of the inclusion of unrealised mark to market or mark to model profits under IAS 39, which were alleged to be inconsistent with the European Directive and therefore unable to show a true and fair view by Mr Bompas, Mr Moore points out that the new European Accounting Directive (2013/34/EU) expressly permits a deviation in the recognition of profits when fair value accounting is used. Furthermore such deviation has also made its way in UK legislation under the Accounts Regulations (paragraph 40 of S.I. 2008/410). The criticism of the approach to provisions under IAS 39 and other international standards which were alleged not to account for all foreseeable liabilities and likely losses irrespective of the time in which they arise, as required by the Fourth Directive then incorporated in UK GAAP, is also refuted by Mr Moore, whose conclusions point out that the Directive only

refers to all liabilities arising in the course of the financial year concerned or of a previous one. The effect is that only liabilities that have arisen at the balance sheet date should be recognised while the consequences of future events that are speculative or hypothetical are not required to be recognised. Finally the suggestion by Mr Bompas that IFRS may not allow a true and fair override facility is rejected by Mr Moore, who argues that IFRS allow departure from compliance, specifically in IAS 1 paragraph 19, where such compliance would be so misleading as to conflict with the objective set out in the Conceptual Framework, ie that accounts should be useful by being relevant, reliable, comparable and understandable. Mr Moore argues that, although the override contemplated by IAS 1 does not directly mention true and fair, or fair presentation, the intertwining of the concepts of usefulness and true and fair in IFRS effectively makes the option under paragraph 19 of IAS 1 a true and fair override. On the basis of the legal advice received from Mr Moore the FRC has confirmed the legality of IFRS as a financial reporting framework adopted by UK entities and it has also confirmed that the concerns expressed by some investors in such respect are misconceived. The Department for Business has in the meantime expressed a similar view to dispel the doubts raised.

RS 102: WHAT ARE THE CHANGES TO CURRENT UK GAAP? Many thousands of words have already been written about FRS 102, and no doubt many more will materialise before the implementation date of 1 January 2015. This standard, based on the IFRS for SMEs, will replace the existing FRSs, UITF abstracts and SSAPs (apart from the FRSSE and FRS 27). This is a big change to the structure of UK GAAP, but how much will disclosure in and presentation of accounts differ under the new regime? In this article (factsheet?) we summarise the main differences between current UK GAAP and the new FRS 102. A more detailed comparison of topical areas between the current and the new UK GAAP framework, including analysis of the potential tax impact of the new accounting requirements, the adoption timeframe and first-time adjustments and options available to different entities will be delivered via Technical Factsheets, which are aimed at members, and ACCA UK Guides To, which are designed to be passed to clients to inform them about key issues and can be personalised by adding your firms logo and details. These are expected to be ready by the end of August 2013 and we will announce these as and when they are produced. Terminology One of the first things that is obvious about FRS 102 when compared to current UK GAAP is that the terminology is quite different. The terms relating to financial statements that are familiar to UK accountants and have been used for many years are mostly lacking in FRS 102 and are replaced by the terminology of the international standards. The balance sheet is referred to as the statement of financial position, and the profit and loss account as a statement of comprehensive income. The format of the accounts will remain largely similar. Section four of FRS 102, which deals with the statement of financial position, states: The statement of financial position (which is referred to as the balance sheet in the Act) presents an entitys assets, liabilities and equity as of a specific datethe end of the reporting period. This section applies to all entities, whether or not they report under the Act. Entities that do not report under the Act should comply with the requirements of this

section, and with the Regulations (or, where applicable, the LLP Regulations) where referred to in this section, except to the extent that these requirements are not permitted by any statutory framework under which such entities report. The regulations referred to are those in Statutory Instrument 2008/410, which set out the acceptable formats that financial statements may take under UK law. FRS 102 allows accounts to continue to be prepared using the Companies Act formats. It is a little more complex when looking at the statement of comprehensive income, as FRS 102 allows the entity to present its income in one OR two statements; either in a single statement of comprehensive income, or in two statements an income statement (which is referred to as the profit and loss account in the Act) and a statement of comprehensive income. The standard uses other terms that are different to what we are used to in UK GAAP, such as calling stock inventories, tangible fixed assets property plant and equipment and a cash flow statement is a statement of cash flows, but there is nothing there that cannot easily be understood by someone with accounting knowledge. Transition to FRS 102 On first-time adoption of FRS 102 an entity shall restate its comparatives to recognise, reclassify and measure items in accordance with the requirements of FRS 102. In particular the comparatives that have to be restated are those at the date of transition to FRS 102. This date is the beginning of the earliest period for which the entity presents full comparative information; that means that for an entity applying FRS 102 for the first time for the year ended 31 December 2015, the date of transition will be the first day of the comparative year to 31 December 2014, i.e. 1 January 2014. The adjustments resulting from the restatement of comparatives in accordance with the requirements of FRS 102 are recognized directly in retained earnings, or another category of equity if appropriate, at the date of transition. An entity needs to produce disclosures about how the transition to FRS 102 affected its reported financial position and financial performance. In order to do so the first financial statements prepared under FRS 102 need to include: a) A description of the nature of each change in accounting policy. b) Reconciliations of equity determined in accordance with the previous financial reporting framework to equity determined in accordance with FRS 102 for both of the following dates: (i) the date of transition to FRS 102; and (ii) the end of the period covered by the previous financial statements prepared. c) A reconciliation of the profit or loss determined in accordance with its previous financial reporting framework, for the last period covered by the previous financial statements, to its profit or loss determined in accordance with FRS 102 for the same period. Investment property Possibly one of the biggest differences between FRS 102 and the current standards is the treatment of investment properties. SSAP 19 defines investment properties as held not for consumption in the business operations but as investments, and excludes a property let to and occupied by another group company. FRS 102 defines an investment property with different words, but has largely the same meaning: Investment property is property (land or a building, or part of a building, or both) held by the owner or by the lessee under a finance lease to earn rentals or for capitalappreciation or both, rather than for:

(a) use in the production or supply of goods or services or for administrative purposes; or (b) sale in the ordinary course of business. However, SSAP 19 requires investment properties to be held on the balance sheet at open market value, though it does not require the valuation to be made by qualified or independent valuers. FRS 102, on the other hand, requires valuation at fair value, only if the property can be measured reliably without undue cost or effort. If that is not possible, the property should be accounted for as property, plant and equipment, and not as investment property. If the investment property fair value can be measured reliably, it shall be measured at fair value at each reporting date with changes in fair value recognised in profit or loss. This is clearly quite a departure from SSAP 19 and the use of a revaluation reserve. Subsequent expenditure Another difference between the current standards and FRS 102 is the treatment of subsequent expenditure on fixed assets. FRS 15 Tangible Fixed Assets deals at some length with accounting for subsequent expenditure. Paragraphs 34 to 41 set out how repairs and maintenance type expenditure should be recognised in the profit and loss account as incurred, while recognising the fact that this type of expenditure prevents an increase in depreciation which would ensue, should the asset not be properly maintained. It sets out the three circumstances when subsequent expenditure should be capitalised, and these are: (a) Where the subsequent expenditure provides an enhancement of the economic benefits of the tangible fixed asset in excess of the previously assessed standard of performance. (b) Where a component of the tangible fixed asset that has been treated separately for depreciation purposes and depreciated over its individual useful economic life, is replaced or restored. (c) Where the subsequent expenditure relates to a major inspection or overhaul of a tangible fixed asset that restores the economic benefits of the asset that have been consumed by the entity and have already been reflected in depreciation. FRS 102 does not explicitly set out circumstances when subsequent expenditure should be capitalised, though some of the wording does mirror what is in FRS 15. In paragraph 17.15 it states: An entity shall recognise the costs of day-to-day servicing of an item of property, plant and equipment in profit or loss in the period in which the costs are incurred. Paragraph 17.6 says: Parts of some items of property, plant and equipment may require replacement at regular intervals (eg the roof of a building). An entity shall add to the carrying amount of an item of property, plant and equipment the cost of replacing part of such an item when that cost is incurred if the replacement part is expected to provide incremental future benefits to the entity. Additionally, paragraph 17.7 says: A condition of continuing to operate an item of property, plant and equipment (eg a bus) may be performing regular major inspections for faults regardless of whether parts of the item are replaced. When each major inspection is performed, its cost is recognised in the carrying amount of the item of property, plant and equipment as a replacement if the recognition criteria are satisfied. Any remaining carrying amount of the cost of the previous major inspection (as distinct from physical parts) is derecognised. Other than these few paragraphs, FRS 102 does not refer to subsequent expenditure, so the correct accounting treatment is far more subjective than under FRS 15. Employee benefits The accounting treatment of certain employee benefits varies considerably as there is no explicit guidance in current UK GAAP. FRS 102 defines them as all forms of consideration

given by an entity in exchange for service rendered by employees, including directors and management. This section will apply to such things as wages, bonuses, termination payments and pension contributions. These will be accounted for largely as they are under current UK GAAP. However, the standard specifically refers to paid annual leave and paid sick leave. FRS 102 requires that an entity shall recognise the cost of all employee benefits to which its employees have become entitled as a result of service rendered to the entity during the reporting period. The detail of how an entity should recognise paid annual leave is set out in paragraphs 28.6 and 28.7 of FRS 102: An entity may compensate employees for absence for various reasons including annual leave and sick leave. Some short-term compensated absences accumulate they can be carried forward and used in future periods if the employee does not use the current periods entitlement in full. Examples include annual leave and sick leave. An entity shall recognise the expected cost of accumulating compensated absences when the employees render service that increases their entitlement to future compensated absences. The entity shall measure the expected cost of accumulating compensated absences at the undiscounted additional amount that the entity expects to pay as a result of the unused entitlement that has accumulated at the end of the reporting period. The entity shall present this amount as falling due within one year at the reporting date. An entity shall recognise the cost of other (non-accumulating) compensated absences when the absences occur. The entity shall measure the cost of non-accumulating compensated absences at the undiscounted amount of salaries and wages paid or payable for the period of absence. Leases FRS 102 classifies leases into finance and operating leases, respectively, depending on whether or not a lease transfers substantially all the risks and rewards incidental to ownership from the lessor to the lessee. Such approach and classification is consistent with current UK GAAP (SSAP 21), however FRS 102 removes the presumption that a lease would be a finance lease if the present value of the minimum lease payments amounts to 90 per cent or more of the leased asset. This change may result in a different classification of some leases. FRS 102 also confirms that the classification of a lease depends on the substance of the transaction rather than the form of the contract and includes examples of situations in which a lease would be normally classified as a finance lease, which are: a) The lease transfers ownership of the asset to the lessee by the end of the lease term; b) The lessee has an option to purchase the asset at a price sufficiently lower than fair value at the date the option becomes exercisable that it will be reasonably certain at the inception of the lease that the option will be exercised; c) The lease is for the major part of the assets economic life even if the title is not transferred; d) At the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset. In this example there is no mention of the 90 per cent test; and e) The leased assets are of such specialised nature that only the lessee can use them without major modifications. FRS 102 also includes indicators of situations that could result in a lease being classified as a finance lease: a) Lessors losses associated with the cancellation of the lease are borne by the lessee;

b) Gains or losses from the fluctuation of the residual value of the leased asset accrue to the lessee; and c) The lessee has the ability to continue to lease the asset for a secondary period for a rent substantially lower than market rent. Another difference between FRS 102 and the current UK GAAP is in respect of the recognition of lease incentives for operating leases, for example rent free periods. FRS 102 requires recognition of the incentive over the lease term while under current UK GAAP the benefit is allocated over the shorter of the lease term and the period ending when market rent will be payable, i.e. the period up to the first rent review. Thus under FRS 102 lease incentives may be spread over a longer period of time. Financial Instruments FRS 102 includes separate accounting requirements, outlined in two different sections of the standard, for basic and other, more complex, financial instruments and transactions. The requirements that apply to basic financial assets and liabilities are relevant to all entities, whilst if an entity only enters into basic financial instrument transactions it will not need to apply the section of the standard that deals with more complex financial instruments. However FRS 102 clarifies that entities deemed to have only basic financial instruments should ensure that they are exempt by considering whether any of their financial assets or liabilities falls within the scope of complex instruments. FRS 102 also allows an entity to apply the recognition and measurement provisions of IAS 39 or IFRS 9 as an alternative to its own requirements for basic and complex financial instruments. Basic financial instruments will normally include: a) Trade accounts receivables and payables b) Loans from banks or other third parties c) Loans to and from subsidiaries and associates or to other third parties d) Bonds and similar debt instruments e) Investments in non-convertible preference shares and in non-puttable ordinary and preference shares. Examples of more complex financial instruments include: a) Options and forward contracts b) Interest rate swaps c) Investments in convertible debt and convertible preference shares d) Investments in anothers entity equity instruments other than non -puttable ordinary and preference share e) Rights, warrants and futures contracts. For a debt instrument (like a bond, loan or trade receivable or payable) to be classified as a basic financial instrument a number of conditions need to be satisfied. For instance the return to the holder should be either a fixed amount, or at a fixed rate over the life of the instrument, or at a variable rate linked to a quoted or observable interest rate (e.g. LIBOR), or even a combination of fixed and variable rates (e.g. LIBOR plus x basis points) provided that both components are positive (i.e. not a positive rate offsetting a negative rate as in an interest rate swap). Another important condition is that the holder of the instrument should not be able to put it back to the issuer before maturity, i.e. to obtain immediate repayment, unless that is permitted to protect him from the credit deterioration of the issuer, for instance in case of defaults, breaches of loan covenants or credit downgrades of the borrower. Basic financial instruments are required to be measured in different ways depending on the type and characteristics of the instruments:

a) Debt instruments like bonds, loans etc. will be measured at amortised cost using the effective interest method; b) Debt instruments that are payable or receivable within one year, typically trade payables or receivables, will be measured at the undiscounted amount of the cash or other consideration expected to be paid or received, net of impairment. However if the arrangement constitutes a financing transaction, for instance if the payment of a trade debt is deferred beyond normal business terms or is financed at a rate of interest that is not a market rate or in case of an outright short-term loan, the financial asset or liability will be measured at the present value of the future payments discounted at a market rate of interest for a similar debt instrument. In practice for goods or services sold to a customer on short-term credit a receivable is recognised at the undiscounted amount of cash receivable, normally the invoice price. The same applies for a purchase on short-term credit where a payable is recognised at its undiscounted invoice amount. If instead an item is sold to a customer on two-year interest-free credit, a receivable should be recognised at the present value of the cash receivable, for which the cash sale price of the item may be used as a close approximation. If however the cash sale price is not known, the cash receivable should be discounted using the prevailing market rate of interest for a similar receivable; c) Debt instruments may also be designated by entity to be measured at fair value through profit or loss in certain specific circumstances; d) Investments in non-convertible preference shares and in non-puttable ordinary and preference shares should be measured: i. At fair value with changes recognised in profit or loss if the shares are publicly traded or their fair value can otherwise be measured reliably; ii. At cost less impairment for all other investments. Other complex financial instruments are required to measured at fair value with changes in fair value recognised in profit or loss except for: a) Investments in equity instruments that are not publicly traded and whose fair value may not be reliably estimated which shall be measured at cost less impairment and b) Hedging instruments for which the entity is applying the hedge accounting provisions in FRS 102. Some of the complex financial instruments would not be recognised under current UK GAAP but would only require disclosures. Statement of Cash Flows FRS 102 requires an entity to present a statement of cash flows providing information about the changes in cash and cash equivalents for a reporting period that should be classified under three headings: Operating activities Investing activities Financing activities. Compared to current UK GAAP (FRS 1), FRS 102 extends the scope of the statement of cash flows by requiring the inclusion not only of inflows and outflows of cash, defined as cash in hand and demand deposits, but also of cash equivalents, which are short-term, highly liquid investments that are readily convertible to known amounts of cash and that are subject to an insignificant risk of changes in value. Cash equivalents include investments with a maturity of three months or less that under FRS 1 are normally classified as short term investments. Bank overdrafts repayable on demand and integral to the entitys cash management are also a component of cash and cash equivalents.

The three headings for classification of cash flows are also a significant reduction on the nine required by FRS 1 and will require careful re-thinking for the reclassification of items on first adoption of FRS 102. Operating activities are the main revenue-producing activities of the entity and therefore cash flows from such activities normally result from transactions that generate a profit or a loss. Examples are: a) Cash receipts and payments for sale or purchase of goods and services; b) Cash payments and refunds of tax, unless they relate specifically to investment of financing activities; c) Cash receipts and payments from investments, loans and other contracts held for dealing or trading purposes, i.e. those similar to inventory acquired specifically for resale. However the cash flows for some transactions that result in a gain or loss, like the sale of plant by a manufacturing entity, are classified as from investing activities. Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Examples of investing activities cash flows are: a) Cash payments and receipts to acquire or to sell property, plant and equipment, intangible assets and other long-term assets b) Cash payments and receipts to acquire or sell equity or debt instruments of other entities and interests in joint ventures c) Cash advances and loans made to other parties and connected repayments. Financing activities are activities resulting in changes in the size and composition of contributed equity and borrowings of an entity. Examples of cash flows from such activities are: a) Cash proceeds from issuing shares and other equity instruments b) Cash payments to owners to acquire or redeem the entitys shares c) Cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other longterm or short-term borrowings d) Repayments of amounts borrowed e) Lessees payments to reduce a liability on a finance lease. In respect of interest and dividends, FRS 102 requires that cash flows from interest and dividends paid and received should be presented separately. An entity may classify interest paid and interest and dividends received as operating cash flows. Alternatively interest paid may be classified as financing cash flows and interest and dividends received as investing cash flows. Dividends paid may be classified as financing cash flows because they are a cost of obtaining financial resources. Alternatively they may be classified as a component of cash flows from operating activities because they are paid out of operating cash flows. Goodwill Under FRS 102, goodwill acquired in a business combination, i.e. the combination of separate entities or businesses into one reporting entity, is considered to have a finite useful life and should be amortised systematically over its life. If it is not possible to make a reliable estimate of the useful life, it should be deemed not to exceed five years. Current UK GAAP (FRS 10) presumes that the useful economic life of goodwill would not exceed 20 years but the presumption may be rebutted if it possible to justify a longer or indefinite useful economic life.