Going concern

When preparing financial statements, management makes an assessment regarding the entity's ability to continue in operation for the foreseeable future, i.e., as a going concern. Financial statements should be prepared on a going concern basis unless management either intends to liquidate the entity or to cease trading or has no realistic alternative but to do so. If the result of the assessment casts significant doubt upon the entity's ability to continue as a going concern, management is required to disclose that fact, together with the basis on which it prepared the financial statements and the reason why the entity is not regarded as a going concern. When the financial statements are prepared on the going concern basis it is not necessary to disclose this basis.

Most accounting methods are based on this going concern assumption. For example, the cost principle would be of limited usefulness if we assume potential liquidation of the entity. Using a liquidation approach, fixed assets would be valued at net realisable value (sale price less cost to sell) rather than at amortised cost. The concept of depreciation, amortisation and depletion is justifiable and appropriate only if it is reasonable to assume that the entity will continue to operate for the foreseeable future.

Accrual basis of accounting

Financial statements, except for the statement of cash flows, are to be prepared using the accrual basis of accounting. Under the accrual basis of accounting, an entity recognises the elements of the financial statements (items such as assets, liabilities, income and expenses) when they meet the definition and recognition criteria for those elements in the Conceptual Framework. Consequently, transactions and events are recognised when they occur, and they are recorded in the accounting records and presented in the financial statements in the periods when they occur (and not when cash is received or paid). For example, revenues are recognised when earned and expenses are recognised when incurred, without regard to the time of receipt or payment of cash.

Materiality and aggregation

An entity should present separately each material class of similar items as well as present separately material items of a dissimilar nature or function. If a line item is not individually material, it is aggregated with other items either in the financial statements or in the notes. An item which is not considered sufficiently material to justify separate presentation in the financial statements may warrant separate presentation in the notes. It is not necessary for an entity to provide a specific disclosure required by an IFRS if the information is not material.

In general, an item presented in the financial statements is material—and therefore is also relevant—if as a result of omitting, misstating or obscuring it, would reasonably be expected to influence or change the economic decisions of the primary users made on the basis of the financial statements. Materiality depends on the relative size and nature of the item or error, judged in the particular circumstances. For example, preparers and auditors sometimes adopt the rule of thumb that anything under 5% of total assets or net income is considered immaterial. Although the US SEC indicated that a company may use this percentage for an initial assessment of materiality, other factors—quantitative as well as qualitative—must also be considered. For example, the fact that an environmental law (or indeed any law) has been broken could be significant in principle, even if the amount involved is small.

Financial statements are the result of processing, aggregating and classifying many transactions or other events based on their nature or function, and presenting condensed and classified data which are comprised within individual line items. If a line item is not individually material, it can be aggregated either in the financial statements or in the notes (for example, disaggregating total revenues into wholesale revenues and retail revenues), but only to the extent that this will enhance the usefulness of the information in predicting the entity's future cash flows. An entity should disaggregate similar items which are measured on different bases and present them on separate lines; for example, an entity should not aggregate investments in debt securities measured at amortised cost and investments in debt securities measured at fair value.

IFRS Practice Statement 2 Making Materiality Judgements was issued in September 2017 for application from September 14, 2017. It provides non‐mandatory guidance on making materiality judgements for entities preparing general‐purpose financial statements in accordance with IFRS.

The practice statement further notes that information is material if omitting it, misstating or obscuring it could reasonably influence decisions that primary users make on the basis of financial information about a specific reporting entity. In other words, materiality is an entity‐specific aspect of relevance based on the nature or magnitude, or both, of the items to which the information relates in the context of an individual entity's financial report.

With the 2018 amendments and the addition of the word ‘obscuring’ to the definition of materiality widens the scope of the definition to include vague, unclear, scattered, inappropriately aggregated or disaggregated and hidden information.

The need for judgements about materiality is pervasive in the preparation of financial statements. Such judgements apply when making decisions about recognition, measurement, presentation and disclosure. The entity is only required to apply IFRS requirements in these areas when their effect is material.

In making materiality judgements, the entity should consider its own specific circumstances and how the information presented in the financial statements serves the needs of the primary users (defined as existing and potential investors, lenders and other creditors). It is necessary for the entity to consider the types of decision made by the primary users, and what information they need to make those decisions. This in turn leads to consideration of what information is available to primary users from sources other than the financial statements.

The practice statement suggests a four‐step process for making materiality judgements:

1. Identify information that has the potential to be material.
2. Assess whether the information identified in Step 1 is, in fact, material.
3. Organise the information within the draft financial statements in a way that communicates the information clearly and concisely to primary users.
4. Review the draft financial statements to determine whether all material information has been identified and materiality considered from a wide perspective and in aggregate, on the basis of the complete set of financial statements.

Identifying information which is potentially material involves considering the requirements of relevant IFRS standards alongside the common information needs of the primary users.

Assessing what is material is judged on the basis of both quantitative and qualitative factors. From the quantitative point of view, this involves considering the size of the impact of transactions, other events or conditions against measures of the entity's financial position, financial performance and cash flows. Qualitative factors are characteristics of transactions, other events or conditions which, if present, make information more likely to influence the decisions of primary users. In judging whether particular items of information are material, it is often necessary to take several factors, both quantitative and qualitative, into account.

Organising information requires classifying, characterising and presenting it clearly and concisely to make it understandable. There is a trade‐off between the need to ensure that all material information is included while avoiding unnecessary detail which would hinder understandability.

Finally, a review is necessary to determine whether information is material both individually and in combination with other information included in the financial statements. An item of information which appears to be individually immaterial may nonetheless be material in conjunction with other items presented in the financial statements.

Offsetting

Assets and liabilities, or income and expenses, may not be offset against each other, unless required or permitted by an IFRS. Offsetting in the statement of comprehensive income (or statement of profit or loss, if presented separately) or statement of financial position is allowed in rare circumstances when it more accurately reflects the substance of the transaction or other event. For example, IAS 37 allows warranty expenditure to be netted against the related reimbursement under a supplier's warranty agreement. There are other examples when IFRS “require or permit” offsetting; for example, in IFRS 15 the amount of revenue is reduced by any trade discounts or volume rebates the entity allows. An entity undertakes, in the course of its ordinary activities, other transactions that do not generate revenue but are incidental to the main revenue‐generating activities. An entity presents the results of such transactions, when this presentation reflects the substance of the transaction or other event, by netting any income with related expenses arising on the same transaction (see Chapter 20). In addition, an entity can present on a net basis certain gains and losses arising from a group of similar transactions, for example foreign exchange gains and losses or gains and losses on financial instruments held for trading (unless material).

In general, the IASB's position is that offsetting detracts from the ability of users both to understand the transactions and other events and conditions that have occurred, and to assess the entity's future cash flows. However, procedures such as the reduction of accounts receivable by an expected credit loss allowance, or of property, plant and equipment by the accumulated depreciation, are acts which reduce these assets to the appropriate valuation amounts and are not in fact offsetting assets and liabilities.

Frequency of reporting

An entity should present a complete set of financial statements (including comparative information) at least annually. If the reporting period changes such that the financial statements are for a period longer or shorter than one year, the entity should disclose the reason for the longer or shorter period and the fact that the amounts presented are not entirely comparable.

There is a presumption that financial statements will be presented annually, as a minimum. The most common time period for the preparation of financial statements is one year. However, if for practical reasons some entities prefer to report, for example, for a 52‐week period, IAS 1 does not preclude this practice.

Comparative information

Unless IFRS permit or require otherwise, comparative information of the previous period should be disclosed for all amounts presented in the current period's financial statements. Comparative narrative and descriptive information should be included when it is relevant to an understanding of the current period's financial statements. As a minimum, two statements of financial position, as well as two statements of comprehensive income, changes in equity, cash flows and related notes, should be presented.

Comparability is the quality of information which enables users to compare the financial statements of an entity through time (i.e., across periods), to identify trends in its financial position and performance, as well as across entities. Comparability should not be confused with uniformity; for information to be comparable, similar elements must look alike and dissimilar elements must look different, and users should be able to identify similarities in and differences between two sets of economic phenomena.

In addition, users must be aware of the accounting policies applied in the preparation of the financial statements as well as any changes in those policies and the effects of such changes. Consequently, an entity is required to include a statement of financial position as at the beginning of the preceding period whenever an entity retrospectively applies an accounting policy, or makes a retrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements. In those limited circumstances, an entity is required to present, as a minimum, three statements of financial position and related notes, as at:

1. The end of the current period;
2. The end of the preceding period (which is the same as the beginning of the current period); and
3. The beginning of the preceding period.

When the entity changes the presentation or classification of items in its financial statements, the entity should reclassify the comparative amounts, unless reclassification is impracticable. In reclassifying comparative amounts, the required disclosure includes:

1. The nature of the reclassification;
2. The amount of each item or class of items that is reclassified; and
3. The reason for the reclassification.

In situations where it is impracticable to reclassify comparative amounts, an entity should disclose:

1. The reason for not reclassifying those amounts; and
2. The nature of the adjustments that would have been made if the amounts had been reclassified.

It should be noted that IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, sets out the adjustments to comparative information needed if changes constitute a change in accounting policy or correction of an error (see Chapter 7).

Note, however, that in circumstances where no accounting policy change is being adopted retrospectively, and no restatement (to correct an error) is being applied retrospectively, the statement of financial position as at the beginning of the preceding period included is not required to be presented. Nonetheless, there is no prohibition on doing so.

In May 2012, the IASB issued the Annual Improvements to IFRSs 2009–2011 Cycle of Changes. The Annual Improvements Project provides the vehicle to make non‐urgent but necessary changes which are not part of any other project. The amendment made in the Annual Improvements Project clarified that a statement of financial position as at the beginning of the earliest comparative preceding period is required when an entity applies an accounting policy retrospectively or makes a retrospective restatement of items or reclassifies items in its financial statements. Related notes should accompany current and prior year statements of financial position but notes in respect of the opening statement of financial position need not be presented. However, where an entity voluntarily elects to provide an additional statement of financial position, all supporting notes for the items included in the statements of financial position must be presented regardless of any changes. The changes were effective for periods beginning on or after January 1, 2013, with early application being permitted.

The related footnote disclosures must also be presented on a comparative basis, except for items of disclosure which would not be meaningful, or might even be confusing, if set out in such a manner. Although there is no official guidance on this issue, certain details, such as schedules of debt maturities as at the end of the preceding reporting period, would seemingly be of little interest to users of the current statements and would largely be redundant when presented alongside information provided for the more recent year end. Accordingly, such details are often omitted from comparative financial statements. Most other disclosures, however, continue to be meaningful and should be presented for all years for which basic financial statements are displayed.

To increase the usefulness of financial statements, many companies include in their annual reports 5‐ or 10‐year summaries of condensed financial information. This is not required by IFRS. These comparative statements allow investment analysts and other interested readers to perform comparative analysis of pertinent information. The presentation of comparative financial statements in annual reports enhances the usefulness of such reports and brings out more clearly the nature and trends of current changes affecting the entity.

Such presentation emphasises the fact that financial statements for a series of periods convey far more understanding than those for a single period and that the accounts for one period are simply an instalment of an essentially continuous history.

Consistency of presentation

The presentation and classification of items in the financial statements should be consistent from one period to the next. A change in presentation and classification of items in the financial statements may be required when there is a significant change in the nature of the entity's operations, another presentation or classification is more appropriate (having considered the criteria of IAS 8), or when an IFRS requires a change in presentation. When making such changes in presentation, an entity should reclassify its comparative information and present adequate disclosures (see Comparative information above). Consistency refers to the use of the same accounting policies and procedures, either from period to period within an entity or in a single period across entities. Comparability is the goal and consistency is a means of achieving that goal.

Notes

In accordance with IAS 1, the notes should: (1) present information about the basis of preparation of the financial statements and the specific accounting policies used; (2) disclose the information required by IFRS which is not presented elsewhere in the financial statements; and (3) provide information which is not presented elsewhere in the financial statements but is relevant to an understanding of any of them.

An entity should present notes in a systematic manner and should cross‐reference each item in the statements of financial position and of profit or loss and other comprehensive income, or in the separate statement of profit or loss (if presented), and in the statements of changes in equity and of cash flows, to any related information in the notes.

An entity should normally present notes in the following order, to help users to understand the financial statements and to compare them with financial statements of other entities:

1. Statement of compliance with IFRS;
2. Summary of significant accounting policies applied;
3. Supporting information for items presented in the financial statements in the order in which each financial statement and each line item is presented; and
4. Other disclosures, including contingent liabilities and unrecognised contractual commitments, and non‐financial disclosures (e.g., the entity's financial risk management objectives and policies).

Statement of compliance with IFRS

IAS 1 requires an entity whose financial statements comply with IFRS to make an explicit and unreserved statement of such compliance in the notes. Financial statements should not be described as complying with IFRS unless they comply with all of the requirements of IFRS.

An entity might refer to IFRS in describing the basis on which its financial statements are prepared without making this explicit and unreserved statement of compliance with IFRS. For example, the EU mandated a carve‐out of the financial instruments standard and other jurisdictions have carved out or altered other IFRS standards. In some cases, these differences may significantly affect the reported financial performance and financial position of the entity. This information should be disclosed in the notes.

Accounting policies

The policy note should begin with a clear statement of the nature of the comprehensive basis of accounting used. A reporting entity may only claim to follow IFRS if it complies with every single IFRS in force as at the reporting date. The EU made certain amendments to IFRS when endorsing them (a carve‐out from IAS 39), and those EU companies following these directives cannot claim to follow IFRS, and instead will have to acknowledge compliance with IFRS as endorsed by the EU.

Financial statements should include clear and concise disclosure of all significant accounting policies that have been used in the preparation of those financial statements. Management must also indicate the judgements that it has made in the process of applying the accounting policies that have the most significant effect on the amounts recognised. The entity must also disclose the key assumptions about the future and any other sources of estimation uncertainty which have a significant risk of causing a subsequent material adjustment to need to be made to the carrying amounts of assets and liabilities.

IAS 1 requires an entity to disclose in the summary of significant accounting policies:

1. The measurement basis (or bases) used in preparing the financial statements; and
2. The other accounting policies applied that are relevant to an understanding of the financial statements.

Measurement bases may include historical cost, current cost, net realisable value, fair value or recoverable amount. Other accounting policies should be disclosed if they could assist users in understanding how transactions, other events and conditions are reported in the financial statements.

In addition, an entity should disclose the judgements which management has made in the process of applying the entity's accounting policies and which have the most significant effect on the amounts recognised in the financial statements. Examples of such judgements are when management makes decisions on whether lease transactions transfer substantially all the significant risks and rewards of ownership of financial assets to another party or whether, in substance, particular sales of goods are financing arrangements and therefore do not give rise to revenue.

Determining the carrying amounts of some assets and liabilities requires estimation of the effects of uncertain future events on those assets and liabilities at the end of the reporting period. This is likely to be necessary in measuring, for example, the recoverable values of different classes of property, plant and equipment, or the future outcome of litigation in progress. The reporting entity should disclose information about the assumptions it makes regarding the future and other major sources of estimation uncertainty at the end of the reporting period, which have a significant risk of resulting in a material adjustment to the carrying amount of assets and liabilities within the next financial year. The notes to the financial statements should include the nature and the carrying amount of those assets and liabilities at the end of the period.

Financial statement users must be made aware of the accounting policies used by reporting entities so that they can better understand the financial statements and make comparisons with the financial statements of others. The policy disclosures should identify and describe the accounting principles followed by the entity and methods of applying those principles which materially affect the determination of financial position, results of operations or changes in cash flows. IAS 1 requires that disclosure of these policies be an integral part of the financial statements.

IAS 8 (as discussed in Chapter 7) sets out criteria for making accounting policy choices. Policies should be relevant to the needs of users and should be reliable (representationally faithful, reflecting economic substance, neutral, prudent and complete).

Fairness exception under IAS 1

Accounting standard setters have commonly recognised the fact that even full compliance with promulgated financial reporting principles may, on rare occasions, still not result in financial statements which are accurate, truthful or fair. Therefore many, but not all, standard‐setting bodies have provided some form of exception whereby the higher demand of having fair presentation of the entity's financial position and results of operations may be met, even if doing so might require a technical departure from the codified body of GAAP.

In the US, this provision has historically been found in the profession's ethics literature (the “Rule 203 exception”), but under various other national GAAP there was commonly found a “true and fair view” requirement which captured this objective. Under revised IAS 1, an approach essentially identical to the true and fair view requirement (which is codified in the EU's Fourth Directive) has been formalised as well. The rule under IFRS should be narrowly construed, with only the most exceptional situations dealt with by permitting departures from IFRS to achieve appropriate financial reporting objectives.

This matter has been addressed in greater detail above. In the authors’ view, having such a fairness exception is vital for the goal of ensuring accurate and useful financial reporting under IFRS. However, extreme caution must be applied in reaching any decision to depart from the formal requirements of IFRS, for example, because these exceptions may not have been transposed into any relevant stock exchange regulations.

Other disclosures required by IAS 1

The reporting entity is required to provide details of any dividends proposed or declared before the financial statements were authorised for issue but not charged to equity. It should also indicate the amount of any cumulative preference dividends not recognised in the statement of changes in equity.

If not otherwise disclosed within the financial statements, the following items should be reported in the notes:

1. The domicile and legal form of the entity, its country of incorporation and the address of the registered office (or principal place of business, if different);
2. A description of the nature of the reporting entity's operations and its principal activities;
3. The name of the parent entity and the ultimate parent of the group; and
4. If it is a limited life entity, information regarding the length of its life.

These disclosures (which have been modelled on those set out by the Fourth and Seventh EU Directives) are of relevance given the multinational character of many entities reporting in accordance with IFRS.