Financial Accounting Study:

Topics:
1. Provisions and Contingent Liabilities
2. Accounting for Income Tax
3. Accounting for Financial Instruments
4. Equity
5. Accounting for Revenues, Construction Contracts
6. Accounting for Extractive Industries
7. Measurement of Profit and Reporting Comprehensive Income
Measurement of Profit and Reporting Comprehensive
Income:
Profit is the overriding goal of business entities and it is the reported
profit figure that generally attracts the most attention.
Traditionally, profit measurement has been a process of matching
the revenues for a period with the expenses incurred in earning
those revenues. Revenues for a period were identified, the expenses
incurred in generating those revenues were identified and the two
were matched to measure profit.
The Conceptual Framework for Financial Reporting 2010 identified
the two financial statement elements related to the measurement of
profit as income and expenses. Income is made up of revenue and
gains. Revenues arise in the course of the ordinary activities of the
entity, whereas gains may be within or outside the ordinary
activities of the entity and are often reported net of related
expenses. Likewise expenses consist of expenses and losses.
Expenses arise in the course of the ordinary activities of the entity,
whereas losses may be within or outside the ordinary activities of
the entity and are often reported net of related income.
With the development and adoption of Framework 2010, less
reliance is placed on matching as a basis for periodic profit
measurement. Instead, accounting problems relating to the
measurement of profit are resolved by reference to the definitions of
and recognition criteria for, income and expenses.
Under the operating-profit approach, profit is measured as
income from operations minus expenses from operations. Profit is
the result of ordinary operations for the reporting period. This
approach excludes income and expenses that relate to prior periods
and those resulting from events outside ordinary operations, such
as the effects of extraordinary transactions and events, and changes
in accounting policy.
Arguments For:

The operating-profit approach is supported by arguments that report

users require a profit figure that can be used as a basis for
predicting future profits that is, the most relevant measure of
profit focuses on income and expenses that are related to the
ordinary operations of the reporting period and are likely to recur.
The inclusions of these other items could materially affect the
results of some entities in some periods, making inter-period and
inter-firm comparisons difficult.
Arguments Against:
By allowing many items to bypass the statement of comprehensive
income may lead to profit manipulation and profit smoothing. If the
distinction between operating and non-operating is vague, then
reported operating profit could be manipulated in any year or
smoothed over time by the judicious classification of income and
expense items. It arguably results in information that is not a faithful
representation of the transaction.
Under the all-inclusive approach, profit for the period is measured
as the result of ordinary operations plus income and expenses
relating to prior periods, the effects of some accounting policy
changes and the result of extraordinary transactions and events.
Arguments For:
The all-inclusive approach restricts opportunities for profit
manipulation and/or profit smoothing because, compared to
operating-profit approach fewer items bypass the statement of
comprehensive income. Hence this approach arguably provides
more relevant information. It is also easier to prepare because it
removes the need for the accountant to exercise judgment in
deciding with an item is operating/non-operating.
Arguments Against:
It is argued that some items stull bypass the statement of
comprehensive income, indicating that the potential for profit
manipulation still exists. Further, in an effort to increase
comparability, the all-inclusive approach may result in the labeling
of certain included items as extraordinary or unusual. This process
may be open to manipulation.
Under the comprehensive income approach, profit for the period
includes all income and expenses as defined in Framework 2010. All
changes in net assets or equity, other than transactions with
owners, are included in the measurement of profit. The
comprehensive income approach requires that all recognized
changes in the carrying amount of assets and liabilities be included
in the measurement of profit.
Arguments For:

The contents of the statement of comprehensive income are

determined conceptually, not arbitrarily. No items that satisfy the
definition and recognition criteria for income or expenses bypass the
statement of comprehensive income. This reduces the potential for
manipulation and bias in reporting periodic profit, and thus may
result in a more faithful representation.
Arguments Against:
Many income and expense items included in the statement of
comprehensive income may arise from non-operating activities and
hence do not provide a good basis for predicting future profits.
Some items of income and expense included in comprehensive
income, such as non-current asset revaluation increments and
decrements, may not yet be confirmed by an arms-length
transaction between independent parties. This may result in a profit
figure of lower verifiability under the comprehensive income
approach.
AASB 101 adopts the title statement of profit or loss and other
comprehensive income, which seems to clearly indicate adoption of
the comprehensive income approach. AASB 101 also forbids use of
the term extraordinary describe items of income or expense that
arise outside of ordinary activities.
The retrospective treatment of the effects of errors and changes in
accounting policies in AASB 108, are to be included in the statement
of changes in equity. This seems inconsistent with the
comprehensive income approach in which the effects of all
recognized changes in net assets are to be included in the
statement of comprehensive income. This treatment is apparently
justified by the definition of total comprehensive income as the
changes in equity during a period resulting from transactions and
other events, other than those changes resulting from transactions
with owners in their capacity as owners..
Statement of Comprehensive Income
Income
Less: Expenses
= Profit or loss for the period
+/- Items of Other Comprehensive Income
= Total Comprehensive Income for the Period
According to AASB101, an entity can either:
1. Present a single statement of comprehensive income with
profit or loss and other comprehensive income presented in
two sections, where profit or loss is presented first followed by
components of other comprehensive income; or

2. Present the profit or loss section in a separate statement of

profit or loss to be followed by a statement of comprehensive
income, which shall begin with profit or loss.
AASB 101 states that an entity shall present the following items, in
addition to the profit or loss and other comprehensive income
sections, as allocation of profit or loss and other comprehensive
income for the period:
a) profit or loss for the period attributable to:
a. non-controlling interest, and
b. owners of the parent.
b) Comprehensive income for the period attributable to:
a. Non-controlling interest, and
b. Owners of the parent.
c) If an entity presents profit or loss in a separate statement it
shall present (a) in that statement.
The profit or loss section shall include line items that present the
following amounts for the period:
a) Revenue
b) Gains and losses arising from the recognition of financial
assets measured at amortized cost;
c) Share of the profit or loss of associates and joint ventures
accounted for using the equity method
d) If a financial assets is reclassified so that it is measured at fair
value, any gain or loss arising from a difference between the
previous carrying amount and its fair value at the
reclassification date
e) Tax expense
f) A single amount for the total discontinued operations.
The information to be presented in the other comprehensive income
section shall present line items for amounts of other comprehensive
income in the period, classified by nature and grouped into those
that:
1. will not be reclassified subsequently to profit or loss; and
2. will be reclassified subsequently to profit or loss when specific
conditions are met.
The components of other comprehensive income include:
1. Changes in revaluation surplus
2. Remeasurement of defined benefit plans
3. Gains and losses arising from translating the financial
statements of a foreign operation
4. Gains and losses from investments in equity instruments
measured at fair value through other comprehensive income
5. The effective portion of gains and losses on hedging
instruments in a cash flow hedge

6. For particular liabilities designated at fair value through profit

or loss, the amount of the change in fair value that is
attributable to changes in the liabilitys credit risk.
The statement requires the entity to disclose the amount of tax
relating to each item of other comprehensive income either in the
statement of comprehensive income or in the notes.
The statement requires entities to present additional line-items,
headings and subtotals when such presentation is relevant to an
understanding of the entitys financial performance. The user has
a need for information to assist in understanding the entitys current
financial performance and in in making projections of its future
performance.
When items of income or expense are material, an entity shall
disclose their nature and amount separately.
Material is defined as:
Omissions or misstatements of items are material if they
could, individually or collectively, influence the economic decisions
that users make on the basis of financial statements. Materiality
depends on the size and nature of the omission or misstatement
judged in the surrounding circumstances.
Circumstances that are considered to result in items requiring
separate disclosure:
1. write-downs of inventories to net realizable value or of
property, plant and equipment to recoverable amount, as well
as reversals of such write-downs;
2. restructurings of the activities of an entity and reversals of
any provisions for the cost of restructuring;
3. disposals of items of property, plant and equipment;
4. disposals of investments;
5. discontinued operations;
6. litigation settlements; and
7. other reversals of provisions.
An entity shall present an analysis of expenses recognizes in profit
or loss using a classification based on either their nature or their
function within the entity, whichever provides information that is
more reliable and more relevant.
AASB 101 defines a reclassification adjustment as amounts
reclassified to profit or loss in the current period that were
recognised in other comprehensive income in the current or
previous periods
Individual accounting standards specify whether and when amounts
previously recognised in other comprehensive income are

reclassified to profit or loss (e.g. the disposal of available-for-sale

financial instruments)
A reclassification adjustment is included with the related component
of other comprehensive income in the period that the adjustment is
reclassified to profit or loss.
Why disclose reclassification adjustments?
The purpose is to provide users with information to assess the effect
of such reclassifications on profit or loss.
For example, gains realised on the disposal of available-for-sale
financial assets are included in profit or loss of the current period.
These amounts may have been recognised in other comprehensive
income as unrealised gains in the current or previous periods. Those
unrealised gains must be deducted from other comprehensive
income in the period in which the realised gains are reclassified to
profit or loss to avoid including them in total comprehensive income
twice.
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A major purpose of accounting standards is to reduce the choice of
accounting policies available to those preparing financial
statements. A reduction in choice is seen as desirable because it
limits the opportunity for management to use accounting policies to
manage accounting earnings or for other creative purposes.
AASB 108 Accounting Policies, Changes in Accounting Estimates
and Errors.
Accounting Policies are defined as the specific principles, bases,
conventions, rules and practices applied by an entity in preparing
and presenting financial statements.
The selection and application of accounting policies is to be guided
by the relevant Australian Accounting Standards applicable to the
issue under consideration. If there is no applicable Standard, the
statement preparers must draw from Framework 2010s qualitative
characteristics of financial information. Preparers are to use
judgment in developing and applying an accounting policy to ensure
it results in formation that is reliable and relevant to the economic
decision-making needs of the users.
A change in accounting policy is permitted by AASB 108 only if the
change:
a) is required by an Australian Accounting Standard; or

b) results in the financial statements providing reliable and more

relevant information about the effects of transactions, other
events or conditions on the entitys financial position, financial
performance or cash flows.
In the first circumstance, the change should be accounted for in
accordance with any transitional provisions contained in the
relevant standard. Where there are no such provisions, the change
is to be retrospectively applied unless it is impracticable to do so. In
the second circumstance, retrospective application of the new
accounting policy is required.
Retrospective application means applying the new accounting policy
as if that policy had always been applied. This involves making
adjustments to the opening balance of each affected component of
equity. Also adjustments are to be made to other comparative
amounts disclosed.
An entity must make every reasonable effort to apply a change in
accounting policy retrospectively before the situation is assessed as
impracticable. In this case the earliest period and earliest date
practicable are to be used to calculate the period-specific effects
and the cumulative effect.
Disclosures: For mandatory changes, AASB 108 requires disclosure
of the title of the Australian Accounting Standard, the nature of the
change in accounting policy, whether the change is made in
accordance with transitional provisions and any likely future impacts
of such provisions, expect where it is impracticable to determine the
amounts.
In addition, disclosures are required of the amount of the
adjustment for each financial statement line item affects in the
current period and each prior period presented, and any
adjustments for basic and diluted earnings per share except where it
is impracticable to do so. Further, if retrospective application of the
new policy is impracticable, disclosure is required of the
circumstances and a description of how and from when the change
in policy has been applied.
Similar disclosures are required for voluntary changes in accounting
policies that have an effect on the current period or any prior period,
except where it is impracticable to determine the amount of the
adjustment. Disclosures are required of the nature of the change in
accounting policy, the reasons why the change was implemented,
the amount of the adjustment for each financial statement line item
affects in the current period and each prior period presented, and
any adjustments for basic and diluted earnings per share except
where it is impracticable to do so. If retrospective application of the
new policy is impracticable, disclosure is required of the

circumstances and a description of how and from when the change

in policy has been applied.
AASB 101 required that information on accounting policies is to be
presented in a manner that provides relevant, reliable, comparable,
and understandable information. Financial statements must be
prepared on a going concern basis unless management intends to
liquidate or has no choice but to do so. If the going concern basis is
not used, this must be disclosed with supporting reasons and details
of the alternative basis used. Entities are required to present
information, except for cash flow, using the accrual basis of
accounting.
Revisions to prior-period estimates are a normal part of the
estimation process and should be viewed as the correction of errors.
Errors can be made in relation to the recognition, measurement,
presentation or disclosure of the elements of financial statements.
There are two methods in which prior-period items can be treated. If
a prior-period adjustment is passed through the current periods
statement of comprehensive income, there is an inappropriate
matching of revenues and expenses, both in the period when the
item should have been recognized and in the current period when it
is recognized. The inclusion of prior-period adjustments in the
current periods statement of comprehensive income is, therefore,
misleading.
An alternative is making an adjustment to retained earnings.
However this leaves the door open for the manipulation of reported
profit. In addition, where errors in one period can be corrected by
adjustments to retained earnings in a subsequent period, the
incentive to avoid errors may be reduced.
AASB108 defined a change in accounting estimate as:
An adjustment of the carrying amount of an asset or liability,
or the amount of the periodic consumption of an asset, that results
from the assessment of the present status of, and expected future
benefits and obligations associated with, assets and liabilities.
Changes in accounting estimates result from new information or
new developments, and accordingly, are not corrections of errors.
The required treatment of revisions in accounting estimates is to be
recognized in the statement of comprehensive income in:
a) the period of the change, if the change affects that period
only; or
b) the period of the change and future periods, if the change
affects both.

Also if the change estimate results in changes in assets, liabilities or

an item of equity, an adjustment is required to the carrying amount
of the affected asset, liability or equity item. The recognition of
changes in accounting estimates is prospective that is, the change
in estimate is only applied from the date of the change in estimate.
AASB108 required entities to disclose the nature and amount of a
change in an accounting estimate that has an effect in the current
period or is expected to have an effect in future periods.
Alternatively, if it is impracticable to estimate the effects in future
periods, an entity must disclose this fact.
AASB108 defined prior period errors as follows:
Omissions from, and misstatements in, the entitys financial
statements for one or more prior periods arising from failure to use,
or misuse of, relatable information that:
a) was available when the financial statements for those periods
were authorized for issue; and
b) could reasonably be expected to have been obtained and
taken into account in the preparation and presentation of
those financial statements.
Material prior-period errors must be corrects in the first set of
financial statements authorized for issue after their discovery. The
correction is to be retrospective, with restatement of the
comparative amounts for the prior periods in which the errors
occurred. If the error occurred before the earliest period presented
in the financials statements, the opening balances of affected
assets, liabilities and equity are to be restated for the earliest period
presented.
AASB108 required entities to disclose the nature of the prior-period
error, the amount of the correction for each financial statement line
item and the amount of the correction at the beginning of the
earliest prior period presented. If it is not possible to undertake
retrospective restatement, disclosure is required of the
circumstances that contributed to the error, as well as a description
of how and from when the error has been corrected.
APPARENTLY GROSS/NET METHOD QUESTION WHERE IS
THIS??