Question Tag: Faithful Representation

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  • 10 Marks

FR – April 2022 – L2 – Q5a – Conceptual Framework for Financial Reporting

Justify how qualitative characteristics of financial information apply to tangible non-current assets using examples.

The IASB’s Conceptual Framework identifies, among others, the qualitative characteristics of relevance, faithful representation, comparability, and understandability.

Required:
Justify with an example each how the qualitative characteristics will apply to the treatment of tangible non-current assets. (10 marks)

Qualitative characteristics as applicable to tangibles non-current assets illustrated by IAS 16
Relevance:
Example: Choosing the revaluation model for tangible non-current assets like property provides relevant information as it reflects the current market value, aiding users in decision-making based on up-to-date information. For instance, if a company chooses to revalue its land and buildings to their fair value, it provides information that is more relevant for users assessing the company’s financial position.

Faithful Representation:
Example: Using the cost model ensures faithful representation as it records assets based on historical cost, which is verifiable and objective. For example, if a company uses the cost model for its machinery, the value in the financial statements reflects the original purchase cost less accumulated depreciation, representing the actual cash spent.

Comparability:
Example: Adopting the same depreciation method for all tangible non-current assets within a class enhances comparability. For example, if a company uses the straight-line method to depreciate all its machinery, users can compare the performance of different years and other companies using the same method.

Understandability:
Example: Disclosing the depreciation method and rate for each class of assets in the financial statements improves understandability. For instance, explaining that buildings are depreciated over 20 years on a straight-line basis helps users understand the impact of depreciation on financial performance.
(10 marks)

  • 5 Marks

CR – May 2016 – L3 – Q4b – Accounting and reporting concepts

Discuss the concepts of relevance, faithful representation, and comparability, and how they make financial information useful to users of financial statements.

The qualitative characteristics of relevance, faithful representation and comparability identified in the IASB’s Framework for the preparation and presentation of financial statements (Framework) are some of the attributes that make financial information useful to the various users of financial statements.

Required: Discuss the concept of relevance, faithful representation and comparability and how they make financial information useful.

i) Relevance

Information has the quality of relevance when it can influence, on a timely basis, users’ economic decisions. It helps to evaluate past, present and future events by confirming or perhaps correcting past evaluations of economic events. There are many ways of interpreting and applying the concept of relevance, for example, only material information is considered relevant as, by definition, information is material only if its omission or misstatement could influence users. Another common debate regarding relevance is whether current value information is more relevant than that based on historical cost. An interesting emphasis placed on relevance within the Framework is that relevant information assists in the predictive ability of financial statements.

That is not to say the financial statements should be predictive in the sense of forecasts, but that (past) information should be presented in a manner that assists users to assess an entity’s ability to take advantage of opportunities and react to adverse situations. A good example of this is the separate presentation of discontinued operations in the income statement. From this users will be better able to assess the parts of the entity that will produce future profits (continuing operations) and users can judge the merits of the discontinuation ie has the entity sold a profitable part of the business (which would lead users to question why), or has the entity acted to curtail the adverse effect of a loss making operation.

(ii) Faithful representation

The Framework states that for information to be useful it must be reliable. The quality of reliability is described as being free from material error (accurate) and a faithful representation of that which it purports to portray (i.e. the financial statements are a faithful representation of the entity’s underlying transactions). There can be occasions where the legal form of a transaction can be engineered to disguise the economic reality of the transaction. A cornerstone of faithful representation is that transactions must be accounted for according to their substance (i.e. commercial intent or economic reality) rather than their legal or contrived form. To represent faithfully, information must be neutral (free from bias). Biased information attempts to influence users (perhaps to come to a predetermined decision) by the manner in which it is presented. It is recognized that financial statements cannot be absolutely accurate due to inevitable uncertainties surrounding their preparation. A typical example would be estimating the useful economic lives of non-current assets. This is addressed by the use of prudence which is the exercise of a degree of caution in matters of uncertainty. However prudence cannot be used to deliberately understate profit or create excessive provisions (this would break the neutrality principle). Reliable information must also be complete, omitted information (that should be reported) will obviously mislead users.

(iii) Comparability

Comparability is fundamental to assessing an entity’s performance. Users will compare an entity’s results over time and also with other similar entities. This is the principal reason why financial statements contain corresponding amounts for previous period(s). Comparability is enhanced by the use (and disclosure) of consistent accounting policies such that users can confirm that comparative information (for calculating trends) is comparable and the disclosure of accounting policies at least informs users if different entities use different policies. That said, comparability should not stand in the way of improved accounting practices (usually through new Standards); it is recognized that there are occasions where it is necessary to adopt new accounting policies if they would enhance relevance and reliability.

  • 5 Marks

CR – Nov 2016 – L3 – Q5d – Regulatory framework and ethics

Explain two constraints on relevance and faithful representation of financial statements.

Two key constraints on relevance and faithful representation in financial statements are:

  1. Timeliness:
    • Information must be provided in a timely manner to be useful. However, if there is a delay in reporting, the relevance of the information diminishes. To achieve timeliness, financial statements may need to be prepared before all details of a transaction or event are fully known, which can impair faithful representation. Hence, there is often a trade-off between timeliness and accuracy.
  2. Cost vs. Benefit:
    • There is a balance between the cost of providing financial information and the benefit derived from it. In some cases, the cost of collecting and reporting detailed information may outweigh the benefits to users. This constraint limits how much detail can be provided, potentially affecting both the relevance and faithfulness of the representation of financial data.

Two key constraints on relevance and faithful representation in financial statements are:

  1. Timeliness:
    • Information must be provided in a timely manner to be useful. However, if there is a delay in reporting, the relevance of the information diminishes. To achieve timeliness, financial statements may need to be prepared before all details of a transaction or event are fully known, which can impair faithful representation. Hence, there is often a trade-off between timeliness and accuracy.
  2. Cost vs. Benefit:
    • There is a balance between the cost of providing financial information and the benefit derived from it. In some cases, the cost of collecting and reporting detailed information may outweigh the benefits to users. This constraint limits how much detail can be provided, potentially affecting both the relevance and faithfulness of the representation of financial data.
  • 20 Marks

FA – Mar 2023 – L1 – Q1 – Double entry bookkeeping | Inventory | The IASB’s Conceptual Framework

Explains going concern assumption, inventory valuation, faithful representation, and prepares various day books and cash book.

a) The Conceptual Framework for Financial Reporting is a set of principles which underpin the foundation of financial accounting. The Conceptual Framework sets out the going concern concept as one of the important underlying assumptions for the preparation of financial statements.

Required:
Explain what is meant by ‘the assumption that an entity is operating under the going concern concept’. Support your answer with a suitable example. (3 marks)

b) A trader who trades in Machines commences business on 1 Jan 2021 and buys 200 machines, each costing GH¢50,000. During the year, he sells 150 machines at GH¢60,000 each.

Required:
How should the remaining machines be valued at the end of the year if:
i) He is forced to close down his business at the end of the year and the remaining machines will realise only GH¢30,000 each in a forced sale. (2 marks)
ii) He intends to continue the business into the next year. (2 marks)

c) One of the fundamental qualitative characteristics of useful financial information in the Conceptual Framework for Financial Reporting is ‘faithful representation’.

Required:
Explain what is meant by ‘faithful representation’. (3 marks)

d) Davidco is a trader who commenced business on January 1, 2021. He introduced capital of GH¢50,000. He bought Vehicle worth GH¢30,000 out of the capital introduced. The following transaction took place in the month of January (Jan) 2021:

  • Jan 5: Davidco bought goods on credit from the following:
    • Tradco: GH¢2,500, Trade Discount 10%
    • Vamco: GH¢8,000, Trade Discount 10%
  • Jan 8: Davidco Sold goods on credit to the following:
    • Markcom: GH¢5,000, Trade Discount 20%
    • Kathrine: GH¢2,000, Trade Discount 5%
  • Jan 12: Davidco returned defective goods worth GH¢200 to Tradco.
  • Jan 15: Davidco paid all amounts outstanding to Tradco and Vamco less cash discount of 5%.
  • Jan 22: Kathrine returned spoiled goods worth GH¢300.
  • Jan 24: Davidco received payment from Markcom and Kathrine of all outstanding debt less cash discount of 5%.

Required:
Prepare the following:
i) Sales day book
ii) Purchase day book
iii) Cash book
iv) Purchase returns
v) Sales returns

(10 marks)

a) The financial statements are normally prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future. Hence, it is assumed that the entity has neither the intention nor the need to liquidate or curtail materially the scale of its operations. Example: inventory is valued at the lower of cost or net realizable value.

(3 marks)

b) Machines:

Quantity Price (GH¢) Value (GH¢)
Purchase 200 10,000,000
Sales 150 9,000,000
Closing Inventory 50

i) If the business is forced to close down, the machines will be valued at:

Quantity Price (GH¢) Value (GH¢)
50 30,000 1,500,000

(2 marks)

ii) If the business continues, the machines will be valued at:

Quantity Price (GH¢) Value (GH¢)
50 50,000 2,500,000

(2 marks)

c) Faithful representation:

  • The information gives full details of its effect on the financial statements and is only recognized if its financial effects are certain.
  • Financial reports represent economic phenomena in words and numbers. To be useful, financial information must not only represent relevant phenomena but must faithfully represent the phenomena that it purports to represent.
  • To be faithful, financial information must be complete, neutral, and free from error. A complete report must include all information necessary for the user to understand, neutral is without bias, and finally, free from error means there should be no errors or omissions in the report.

(3 marks)

d)
i) Sales Day Book

Date Customer Invoice No. Gross Amount (GH¢) Trade Discount (GH¢) Net Amount (GH¢)
Jan 8 Markcom 5,000 1,000 4,000
Jan 8 Kathrine 2,000 100 1,900

Total Sales: GH¢5,900

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