Understanding the IFRS Framework: A Simple Breakdown – Part 1

 

The Framework – What’s It For?

The Framework exists to help the International Accounting Standards Board (IASB) create and update International Financial Reporting Standards (IFRSs) that are consistent and logical. It also guides accountants in coming up with accounting policies for areas that aren’t covered by existing standards or where they have a choice to make. Plus, it helps everyone understand and interpret IFRS better!

If there isn’t a specific standard for a transaction, accountants have to use their judgment. But their judgment isn’t random! They should follow the definitions and rules laid out in the Framework for assets, liabilities, income, and expenses.

However, the Framework isn’t a law or standard itself – so if the IASB makes a new rule that disagrees with the Framework, they just need to explain why they’ve done that.

What Does the Framework Cover?

The Framework talks about things like:

- The goal of financial reporting,

- What makes financial info useful,

- What goes in financial statements,

- How things like assets and liabilities are recognized and measured, and

- Concepts like capital and how it’s maintained.

I. Why Do We Have Financial Reporting?

Financial reports exist to help a specific group of people: current and future investors, lenders, and creditors. These people use the reports to decide whether to invest, lend, or get involved with a company. They want to know two things: how much money the company will likely bring in (net cash flow) and how well management is using the company’s resources. That second point is what’s called "stewardship."

However, not everything an investor needs to know is in the financial reports. They might have to look elsewhere too! And while regulators might find the reports helpful, they aren’t the main audience for them.

Info About a Company’s Resources and What’s Owed

Knowing what a company owns (its resources) and what it owes (its claims) helps people figure out how strong the company is. This info is found in the company’s financial position statement.

Changes in What a Company Owns and Owes

When a company’s resources or claims change, it’s either because of how the company is performing or because of things like taking out a loan or issuing new shares. Investors need to know the difference. Changes from performance are reflected in the statement of comprehensive income, while changes from cash flows (like borrowing money) are shown in the cash flow statement.

Financial Performance and Cash Flow

A company’s performance shows how well it’s done over a certain period. This helps predict how much money the company might bring in (net cash flow) in the future. Meanwhile, the cash flow statement tells us how the company has handled its money – where it’s come from and where it’s gone.

Economic Changes That Aren’t Related to Performance

Sometimes, changes happen that have nothing to do with how the company is performing – like issuing shares or paying dividends. These changes show up in the statement of changes in equity.

II. What Makes Financial Info Useful?

For financial info to be useful, it needs to be relevant and faithfully represent what’s happening in the business. It’s even better if it’s comparable (so you can compare it across time or with other companies), verifiable, timely, and understandable.

 The Two Key Traits of Useful Financial Info

1. Relevance: The information should help people make decisions. That means it should either predict what might happen or confirm something that has already happened.

2. Faithful Representation: The information should reflect the real-world situation; not just what things look like on paper.

Making Information More Useful

- Comparability: It’s helpful to compare one company’s info to another’s or to the company’s info from a different time.

-  Verifiability: Other experts should be able to look at the information and agree that it’s accurate.

- Timeliness: The info needs to be available when people are making decisions – not after it’s too late.

- Understandability: It should be clear and straightforward, though some complex information can’t be simplified too much without losing accuracy.

Costs vs. Benefits

There’s a balance between how much it costs to provide detailed financial info and how useful that info is. The IASB tries to make sure that the benefits of financial reporting outweigh the costs, and they look at this issue for all companies, not just big ones.

There you have it, in this first part– the Framework in a nutshell!