UNIT 1 : REGULATORY FRAMEWORK
Key unit competence: To be able to explain the Regulatory
Framework of Accounting
Introductory activity
Last time, the accounting was not well prepared; it was planned on each
personal understanding without respecting common rules and regulations
to conduct things in the same direction. As the time are replaced,
accounting preparation has been improved so that it was not prepared
based on a particular country’s rules and regulations but it was prepared
in the same manner through the world where the regulatory framework
exists on national and international levels.
Required: What accounting bodies should do in order to standardize
the different accounting policies and practices followed by
different business concerns?
1.1 Regulatory System
Learning Activity 1.1
Many figures in financial statements are derived from the application of
judgment in applying fundamental accounting assumptions and conventions.
This can lead to subjectivity.
Required: In attempt to deal with this subjectivity, and to achieve comparability
between different organizations, what can you develop?
In Accounting, the regulatory framework provides a set of rules and regulations
for accounting. Compliance and regulatory frameworks are sets of guidelines
and best practices. Organizations follow these guidelines to meet regulatory
requirements, improve processes, strengthen security, and achieve other
business objectives (such as becoming a public company, or selling cloud
solutions to government agencies).
Regulatory framework of accounting refers to the collection of accounting
standards, Laws, Codes, rules and regulations that are issued by
accounting bodies, government and regulatory units, which qualified accountant
must abide by. Remember, the IASB and FASB I mentioned earlier. They are
accounting standards setting bodies.
1.1.1 Introduction
Although new to the subject, you will be aware from your reading of the press
that there have been some considerable upheavals in financial reporting, mainly
in response to criticism. The details of the regulatory framework of accounting,
and the technical aspects of the changes made, will be covered later in this unit
and in your more advanced studies. The purpose of this unit is to give a general
picture of some of the factors which have shaped Financial Accounting. We
will concentrate on the accounts of limited liability companies, as these are the
accounts most closely regulated by statute or otherwise.
The following factors that have shaped Financial Accounting can be identified:
• National/local legislation
• Accounting concepts and individual judgment
• Accounting standards
• Other international influences
• Generally Accepted Accounting Principles (GAAP)
• Fair presentation
1.1.2 National/local legislation
In most countries, limited liability companies are required by law to prepare and
publish accounts annually. The form and content of the accounts is regulated
primarily by national legislation. In Rwanda, the main legislation is the Law
Governing Companies 17/2018
1.1.3 Accounting concepts and individual judgment
Many figures in financial statements are derived from the application of judgment
in applying fundamental accounting assumptions and conventions. This can
lead to subjectivity. Accounting standards were developed to try to address this
subjectivity.
Financial statements are prepared on the basis of a number of fundamental
accounting assumptions and conventions. Many figures in financial statements
are derived from the application of judgment in putting these assumptions into
practice.
It is clear that different people exercising their judgment on the same facts can
arrive at very different conclusions.
Case study
An accountancy training firm has an excellent reputation among students and
employers. How would you value this? The firm may have relatively little in the
form of assets that you can touch; perhaps a building, desks and chairs. If you
simply drew up a statement of financial position showing the cost of the assets
owned, then the business would not see to be worth much, yet its income
earning potential might be high. This is true of many service organizations where
the people are among the most valuable assets.
Other examples of areas where the judgment of different people may vary are
as follows.
• Valuation of buildings in times of rising property prices
• Research and development: is it right to treat his only as an expense?
In a sense it is an investment to generate future revenue
• Accounting for inflation
• Brands such as ‘Coca-Cola’ and ‘High Land Tea’. Are they assets in the
same way that a fork lift truck is an asset?
Working from the same data, different groups of people produce very different
financial statements. If the exercise of judgment is completely unfettered, there
will be no comparability between the accounts of different organizations. This
will be all the more significant in cases where deliberate manipulation occurs, in
order to present accounts in the most favorable light.
1.1.4 Accounting standards
In an attempt to deal with some of the subjectivity, and to achieve comparability
between different organizations, accounting standards were developed. These
are developed at both a national level (in most countries) and an international
level. The Financial Accounting syllabus is concerned with International
Financial Reporting Standards (IFRS Standards).
IFRS Standards are produced by the International Accounting Standards
Board (IASB).
Accounting is a vital part of business operations that involves managing and
reporting the financial operations of companies.
Accounting standards allow
accounting departments nationally and internationally to use similar practices
and produce similar quality accounting. If you work or plan to work in the
accounting field, it may be helpful to learn about accounting standards and why
they matter. In this article, we explain what accounting standards are, discuss
why they are important and describe how organizations use them.
Definition
Accounting standards are a set of procedures and measures that inform how
businesses conduct their accounting activities. They contain best practices for
recording, measuring and disclosing financial transactions. They apply to all
parts of a company’s activities, including revenue, expenses, noncash expenses,
assets, liabilities, equity and reporting. The primary purpose of accounting
standards is to provide accurate financial information that banks, government
agencies and investors can use when interacting with private companies.
Objectives of accounting standards
Primary objectives of accounting standards are:
• To provide a standard for the diverse accounting policies and principles.
• To put an end to the non-comparability of financial statements.
• To increase the reliability of the financial statements.
• To provide standards which are transparent for users.
• To define the standards which are comparable over all periods
presented.
• To provide a suitable starting point for accounting.
• It contains high quality information to generate the financial reports.
This can be done at a cost that does not exceed the benefits.
• For the eradication the huge amount of variation in the treatment of
accounting standards.
• To facilitate ease of both inter-firm and intra-firm comparison.
Main objective of accounting standards is to standardize the different accounting
policies and practices followed by different business concerns.
Importance of Accounting Standards
Accounting standards play a very efficient role in the whole accounting system.
Some of its important roles are discussed below:
• Brings uniformity in accounting system
• Easy comparability of financial statements
• Assists auditors
• Makes accounting informative easy and simple
• Avoids frauds and manipulations
• Provides reliability to financial statements
• Measures management performance
Relevance of accounting standards
An accounting standard is a standardized guiding principle that determines
the policies and practices of financial accounting. Accounting standards not
only improve the transparency of financial reporting but also facilitates financial
accountability. An accounting standard is relevant to a company’s financial
reporting.
Accounting standards ensure the financial statements from multiple companies
are comparable. Because all entities follow the same rules, accounting standards
make the financial statements credible and allow for more economic decisions
based on accurate and consistent information.
Generally Accepted Accounting Principles (US GAAP or GAAP)
Generally Accepted Accounting Principles refers to the standards framework,
principles and procedures used by the companies for financial accounting. The
principles are issued by Financial Accounting Standard Board (FASB). It is a set
of accounting standards that consist of standard ways and rules for recording
and reporting of the financial data, that is, balance sheet, income statement, cash
flow statement, etc. The framework is adopted by publicly traded companies
and a maximum number of private companies in the United States.
GAAP principles are updated at periodical intervals to meet with current financial
requirements. It ensures the transparency and consistency of the financial
statement. The information provided as per GAAP by the financial statement
is helpful to the economic decision makers such as investors, creditors,
shareholders, etc.
Key differences between GAAP and IFRS
The important difference between GAAP and IFRS are explained as under:
• GAAP stands for Generally Accepted Accounting Principles. IFRS is
an abbreviation for International Financial Reporting Standards.
• GAPP is a set of accounting guidelines and procedures, used by the
companies to prepare their financial statements. IFRS is the universal
business language followed by the companies while reporting financial
statements.
• Financial Accounting Standard Board (FASB) issues GAAP whereas
International Accounting Standard Board (IASB) issued IFRS (i.e
GAAP is developed by FASB whereas IFRS is developed by IASB.
• Use of Last in First out (LIFO) in inventory valuation is not permissible
as per IFRS which is not in the case of GAAP, that is, GAAP uses
LIFO, FIFO and Weighted Average Method but IFRS uses FIFO and
Weighted Average Method only.
• Extraordinary items are shown below the statement of income in case
of GAAP. Conversely, in IFRS, such items are not segregated in the
statement of income.
• Development Cost is treated as an expense in GAAP, while in IFRS, the
cost is capitalized provided the specified conditions are met.
• Inventory reversal is strictly prohibited under GAAP, but IFRS allows
inventory reversal subject to specific conditions.
• IFRS is based on principles, whereas GAAP is based on rules.
Note that as efforts are continuously made to converge these two standards, so
it can be said that there is no comparison between GAAP and IFRS. Moreover,
the differences between the two are as per a particular point of time that may
get a change in the future.
www.accounting.com/resources/gaap/
Similarities
Both are guiding principles that help in the preparation and presentation of
a statement of accounts. A professional accounting body issues them, and
that is why they are adopted in many countries of the world. Both of the two
provides relevance, reliability, transparency, comparability, understandability of
the financial statement.
Application activity 1.1
1. Mention the main objectives of the IASB when it develops IFRS
Standards.
2. Which of the following is not an objective of the accounting
standards?
a) Standardize the different accounting policies and practices
followed by different business concerns.
c) Increase the reliability of the financial statements.
b) Provide a standard for the diverse accounting policies and
principles.
d) Put an end to the non-comparability of financial statements.
e) Increase the huge amount of variation in the treatment of
accounting standards.
3. Explain the important difference between GAAP and IFRS.
4. Explain how there is subjectivity in financial statements.
5. Discuss the important roles of accounting standards in the whole
accounting system.
1.2 Structure of International Accounting Standards
Committee (IASC) Foundation
Learning Activity 1.2
Accounting standards are developed at both national and international
levels in order to raise the standard of financial reporting and eventually
bring about global harmonization of accounting standards.
Required: Mention at least two international bodies in charge of developing
these accounting standards.
1.2.1 History and structure of IASC Foundation
History of IASC Foundation
The IASC Foundation is an independent body, not controlled by any particular
Government or professional organization. Its main purpose is to oversee the
IASB in setting the accounting principles which are used by business and other
organizations around the world concerned with financial reporting.
The IASC was formed in June 1973 in London through an agreement made
by professional accountancy bodies from Australia, Canada, France, Germany,
Ireland, Japan, Mexico, the Netherlands, the UK and the USA with a view
to harmonizing the international diversity of company reporting practices.
Between its founding in 1973 and its dissolution in 2001, it developed a set of
International Accounting Standards (IAS) that gradually acquired a degree of
acceptance in countries around the world. Although the IASC came to include
some organizations representing preparers and users of financial statements, it
largely remained an initiative of the accountancy profession. On 1 April 2001,
it was replaced by the International Accounting Standards Board (IASB), an
independent standard-setting body. The IASC Foundation is the parent entity
of the International Accounting Standards Board, an independent accounting
standard-setter based in London, UK. The IASB adopted the extant corpus of
IAS which it continued to develop as International Financial Reporting Standards.
The structure of IASC Foundation
• The IASC Foundation is an independent organization having two main
bodies, the Trustees and the IASB, as well as a Standards Advisory
Council and the International Financial Reporting Interpretations
Committee.
• The IASC Foundation Trustees appoint the IASB members, exercise
oversight and raise the funds needed, but the IASB has sole responsibility
for setting accounting standards.
1.2.2 International Accounting Standards Board (IASB)
The IASB develops International Financial Reporting Standards (IFRS
Standards). The main objectives of the IFRS Foundation are to raise the
standard of financial reporting and eventually bring about global harmonization
of accounting standards. The IASB is an independent, privately funded body
that develops and approves IFRS Standards.
Prior to 2003, standards were issued as International Accounting Standards
(IAS Standards). In 2003 IFRS 1 was issued and all new standards are now
designated as IFRS Standards. Therefore, IFRS Standards encompass both
IFRS Standards, and IAS Standards still in force (eg: IAS 7).
Note: Throughout this text, we will use the abbreviation IFRS Standards to
include both IFRSs and IAS Standards.
The members of the IASB come from several countries and have a variety of
backgrounds, with a mix of auditors, preparers of financial statements, users of
financial statements and academics. The IASB operates under the oversight of
the IFRS Foundation.
The IFRS Foundation
IFRS standards are International Financial Reporting Standards (IFRS) that
consist of a set of accounting rules that determine how transactions and other
accounting events are required to be reported in financial statements. They are
designed to maintain credibility and transparency in the financial world, which
enables users, such as, investors and business operators to make informed
financial decisions or rational economic decisions with information about the
financial position, performance, profitability and liquidity of the company.
IFRS standards are issued and maintained by the International Accounting
Standards Board. Formerly, they are known as International Accounting
Standards (IAS). The standards are used for the preparation and presentation
of the financial statement that is, balance sheet, income statement, cash flow
statement, changes in equity and footnotes, etc. I FRS were created to establish
a common language so that financial statements can easily be interpreted
from company to company and country to country.
The IFRS Foundation (formally called the International Accounting Standards
Committee Foundation or IASCF) is a not for profit, private sector body that
oversees the IASB.
The objectives of the IFRS Foundation, summarized from its document IFRS
Foundation Constitution, are to:
• Develop a single set of high quality, understandable, enforceable and
globally accepted IFRS Standards through its standard-setting body,
the IASB;
• Promote the use and rigorous application of those standards;
• Take account of the financial reporting needs of emerging economies
and small-and medium-sized entities (SMEs); and
• Bring about convergence of national accounting standards and IFRS
Standards to high quality solutions.
In late 2018, the IFRS Foundation Constitution had been amended mainly
regarding the tenure terms which the Trustee Chair and Vice-Chairs may hold
their positions for, and how they can be appointed. The main four objectives
have not changed.
As at January 2019, the IFRS Foundation is made up of 22 named trustees,
who essentially monitor and fund the IASB, the IFRS Advisory Council and the
IFRS Interpretations Committee. The Trustees are appointed from a variety of
geographical and functional backgrounds.The structure of the IFRS Foundation and related bodies is shown below.
• IFRS Advisory Council
The IFRS Advisory Council (formally called the Standards Advisory Council or
SAC) is essentially a forum used by the IASB to consult with the outside world.
It consults with national standard setters, academics, user groups and a host
of other interested parties to advise the IASB on a range of issues, from the
IASB’s work program for developing new IFRS Standards to giving practical
advice on the implementation of particular standards.
The IFRS Advisory Council meets the IASB at least three times a year and putsforward the views of its members on current standard-setting projects.
• IFRS Interpretations Committee
The IFRS Interpretations Committee (formally called the International Financial
Reporting Interpretations Committee or IFRIC) was set up in March 2002 and
provides guidance on specific practical issues in the interpretation of IFRS
Standards. Note that despite the name change, interpretations issued by the
IFRS Interpretations Committee are still known as IFRIC Interpretations. In
your exam, you may see the IFRS Interpretations Committee referred to as the
IFRSIC.
The IFRS Interpretations Committee has two main responsibilities:
i. To review, on a timely basis, newly identified financial reporting issues not
specifically addressed in IFRS Standards.
ii. To clarify issues where unsatisfactory or conflicting interpretations have
developed, or seem likely to develop in the absence of authoritative
guidance, with a view to reaching a consensus on the appropriatetreatment.
Application activity 1.2
1. What is the purpose of IAS 37?
2. What is IFRS?
3. Discuss the main objectives of IFRS Foundation.
4. What are the objectives of the IFRS Foundation as they are included
in the document of the IFRS Foundation Constitution?
5. Explain the two main responsibilities of the IFRS Interpretations Committee.
1.3 International Financial Reporting Standards (IFRS
Standards)
Learning Activity 1.3
International Financial Reporting Standards (IFRS) that consist of a set
of accounting rules that determine how transactions and other accounting
events are required to be reported in financial statements.
Required: Mention any two IFRS Standards or IAS that you know.
IFRS Standards are created in accordance with due process. There are currently25 IAS Standards and 16 IFRS Standards in issue.
1.3.1 The use and application of IFRS Standards
The IFRS Standards have helped to both improve and harmonize financial
reporting around the world. The standards are used in the following ways:
• As national requirements
• As the basis for all or some national requirements
• As an international benchmark for those countries which develop
their own requirements
• By regulatory authorities for domestic and foreign companies• By companies themselves
1.3.2 Standards-setting process
The IASB prepares IFRS Standards in accordance with due process. You do
not need this for your exam, but the following diagram may be of interest.The procedure can be summarized as follows.
Current IFRS Standards
The current list is as follows. Those examinable in Financial Accounting are
marked with a *.
Conceptual Framework for Financial Reporting 2018 *
IFRS 1 First-time adoption of International Financial Reporting Standards
IFRS 2 Share-based payment
IFRS 3 * Business combinations
IFRS 4 Insurance contracts
IFRS 5 Non-current assets held for sale and discontinued operations
IFRS 6 Exploration for the evaluation of mineral resources
IFRS 7 Financial instruments: disclosures
IFRS 8 Operating segments
IFRS 9 Financial instruments
IFRS 10 * Consolidated financial statements
IFRS 11 Joint arrangements
IFRS 12 Disclosure of interests in other entities
IFRS 13 Fair value measurement
IFRS 14 Regulatory deferral accounts
IFRS 15 Revenue from contracts with customers
IFRS 16 * Leases
IAS 1 * Presentation of financial statements
IAS 2 * Inventories
IAS 7 * Statement of cash flows
IAS 8 Accounting policies, changes in accounting estimates and errors
IAS 10 * Events after the reporting period
IAS 12 Income taxes
IAS 16 * Property, plant and equipment
IAS 19 Employee benefits (2011)
IAS 20 Accounting for government grants and disclosure of government
assistance
IAS 21 The effects of changes in foreign exchange rates
IAS 23 Borrowing costs
IAS 24 Related party disclosure
IAS 26 Accounting and reporting by retirement benefit plans
IAS 27 * Separate financial statements (2011)
IAS 28 * Investments in associates and joint ventures (2011)
IAS 29 Financial reporting in hyperinflationary economies
IAS 32 Financial instruments: presentation
IAS 33 Earnings per share
IAS 34 Interim financial reporting
IAS 36 Impairment of assets
IAS 37 * Provisions, contingent liabilities and contingent assets
IAS 38 * Intangible assets
IAS 39 Financial instruments: recognition and measurement
IAS 40 Investment property
IAS 41 Agriculture
Various exposure drafts and discussion papers are currently at different stages
within the IFRS process, but these are not concern to you at this stage.
1.3.3 Scope and application of IFRS Standards
Scope
Any limitation of the applicability of a specific IFRS is made clear within that
standard. IFRS Standards are not intended to be applied to immaterial items,
nor are they retrospective. Each individual standard lays out its scope at the
beginning of the standard.
Application
Within each individual country, local regulations govern to a greater or lesser
degree, the issue of financial statements. These local regulations include
accounting standards issued by the national regulatory bodies and/or
professional accountancy bodies in the country concerned.
Application activity 1.3
1. How many IAS Standards and IFRS Standards are currently in
issue?
2. In which ways the IFRS Standards are used?
Skills Lab
Students must visit any company and analyze operating environment, they
will then discuss if the company applies any regulatory system, accounting
standards developed by International Accounting Standards Committee
(IASC) Foundation and International Financial Reporting Standards (IFRS
Standards) arising from their operations.
End unit assessment
1. Which of the following is not an objective of the IFRS Foundation?
a) To enforce IFRS Standards in most countries
b) To develop IFRS Standards through the IASB
c) To bring about convergence of accounting standards and IFRS
Standards
d) To take account of the financial reporting needs of SMEs
2. Fill in the blanks.
The IFRS…………………………………issues…………………….
……………. which aid users’ interpretation of IFRS Standards.
3. How many IAS Standards and IFRS Standards are currently in
issue?
4. The IFRS Foundation is a government-controlled body, based in the
EU. True or False?
5. The IASB is responsible for the standard-setting process. True or
False?
6. Olivier is a trainee accountant with ICPAR. One of his friends, who
works in a local supermarket, said the following: “I don’t know why
you waste your time getting qualified-everyone does whatever they
like when it comes to accounting.
Required:
List and describe the various regulations that need to be considered
when performing the financial accounting function within a business.
7. There are those who suggest that any standard-setting body is
redundant because accounting standards are unnecessary.
Required:
Discuss the statement that accounting standards are unnecessaryfor the purpose of regulating financial statements.