FinancialReporting
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Concepts and pervasive principles
Fundamental to financial statements, Steve Collings unpicks the key points you need to know about concepts and pervasive principles
Illustration: Jackie Parsons
FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland contains the Concepts and Pervasive Principles in Section 2. This is an important section as it underlies the financial statements that are prepared under FRS 102. The Appendix to Section 2 also contains guidance on determining fair value.
This article looks at some of the fundamental aspects of FRS 102, Section 2 to ensure preparers have a sound understanding of how the Concepts and Pervasive Principles has a direct correlation to the preparation of the financial statements.
It should be noted that FRS 102 (September 2024), which incorporates the periodic review amendments finalised by the Financial Reporting Council (FRC) on 27 March 2024, includes a new Section 2 Concepts and Pervasive Principles. This aligns the Concepts and Pervasive Principles with the Conceptual Framework for Financial Reporting issued by the International Accounting Standards Board. The remainder of this article examines the Concepts and Pervasive Principles in FRS 102 (January 2022). A future article will review the new FRS 102, Section 2.
FRS 102, Section 2 does not have the force of any other section in FRS 102. In other words, if there are any inconsistencies between the principles in Section 2 and the specific requirements of another section, the specific requirements of the other section within the FRS take precedence.
Objective of financial statements
FRS 102, paragraph 2.2 states that the objective of financial statements is to provide information about the financial position, performance and cash flows of an entity that is useful for economic decision-making by a broad range of users who are not in a position to demand reports tailored to meet their particular information needs. In addition, FRS 102, paragraph 2.3 then clarifies that financial statements show the results of the stewardship of management (i.e. the accountability of management for the resources entrusted to it).
Management’s stewardship responsibilities including using the resources entrusted to it for the benefit of the business. In other words, among other things, protecting against non-compliance with laws and regulations (which may result in fines and penalties being levied by the legislating authorities) and ensuring the most favourable prices are paid for goods and/or services.
If there are any inconsistencies between the principles in Section 2 and the specific requirements of another section, the specific requirements of the other section within the FRS take precedence.
Qualitative characteristics in the financial statements
Qualitative characteristics make the information in the financial statements useful to the users. Not every qualitative characteristic will be of equal importance in every situation; the ranking of how important each characteristic is will all depend on the specific circumstances of the entity and professional judgment. There are 10 qualitative characteristics that are discussed as follows:
>Understandability
FRS 102, paragraph 2.4 requires financial information to be presented in a way that makes it comprehensible by users who have a reasonable knowledge of business. Section 2 does not allow relevant information to be omitted on the grounds that it may be too difficult for some users to understand.
>Relevance
Information is relevant when it has the capability of influencing the economic decisions of users by helping them to evaluate past, present or future events, or confirming, or correcting, their past evaluations.
>Materiality
Materiality is a subset of relevance (left). Information is said to be material, hence having relevance, if its omission or misstatement, individually or collectively, could influence the economic decisions of users taken on the basis of the financial statements.
While accounting standards only deal with material items, it would be inappropriate to leave immaterial misstatements uncorrected to achieve a particular outcome in the financial statements.
>Reliability
Financial information must, of course, be reliable. Information is said to be reliable when it is free from material error and bias and represents faithfully that which it either purports to represent or could reasonably be expected to represent.
>Substance over form
The term ‘substance’ means ‘economic or commercial reality’. In most cases, substance and legal form will both be the same. However, there are some transactions that cause specific issues such as consignment stock, factored debts and the use of special purpose entities. Hence, the correct application of substance over form is crucially important because a failure to apply the concept correctly will result in the financial statements becoming misleading.
>Prudence
Prudence is the inclusion of a degree of caution in the exercise of judgments needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated, and liabilities and expenses are not understated.
While prudence involves a degree of caution, it does not mean that it is acceptable for an entity to deliberately manipulate the financial statements to achieve a desired outcome.
>Completeness
Completeness is related to reliability. In order for financial statements to be reliable, they must be complete within the boundaries of materiality and cost. Any omissions may have a detrimental impact on the decision-making process.
>Comparability
Users must be able to compare the financial statements of an entity through time to identify trends in its financial position and performance. In addition, users must be able to compare the financial statements of different entities to evaluate their relative financial position, performance and cash flows.
>Timeliness
To be relevant, financial information must be able to influence the economic decisions of users. This involves providing the information within the decision timeframe. Any undue delays could impact on the relevance of the financial information. However, it may be that some financial information continues to be timely long after the reporting date has passed as users may, for example, need to identify and assess trends.
Balance between benefit and cost
The benefits derived from information should not exceed the cost of providing it and this is a judgmental process.
It is accepted that there are costs associated with reporting financial information and these costs do need to be balanced within the benefits of providing the financial information.
Reporting financial information
FRS 102, Section 2 describes the means of presenting financial information, notably within the:
· statement of financial position (balance sheet)
· income statement (profit and loss account).
FRS 102, paragraph 2.15 provides definition of an ‘asset’, ‘liability’ and ‘equity’, and provides guidance on how items meet the recognition criteria of such.
FRS 102, paragraphs 2.23 to 2.26 describe how transactions are recognised in the performance statement (i.e. the income statement/profit and loss account); notably, income (revenue and gains) and expenses (expenses and losses).
Subsequent measurement bases
FRS 102, Section 2 clarifies that ‘measurement’ is the process of determining the monetary amounts at which an entity measures assets, liabilities, income and expenses in the financial statements. Essentially, FRS 102 recognises two measurement bases:
· historic cost
· fair value.
For example, some items of property, plant and equipment may be measured under the revaluation model per Section 17 Property, Plant and Equipment. This involves revaluing the asset to fair value at the date of revaluation. The term ‘fair value’ is defined as: “The amount for which an asset could be exchanged, a liability settled, or an equity instrument granted could be exchanged, between knowledgeable, willing parties in an arm’s length transaction. In the absence of any specific guidance provided in the relevant section of this FRS, the guidance in the Appendix to Section 2 Concepts and Pervasive Principles shall be used in determining fair value.”
Accruals basis of accountings
All financial statements prepared under FRS 102 must be prepared using the accruals basis of accounting. The only primary statement that is not prepared using the accruals basis is the statement of cash flows.
The accruals basis of accounting recognises income and expenditure on an arising basis, and allows a user to assess future cash flows receivable from debtors and payable to creditors. This concept is consistent with company law that requires transactions to be brought into account regardless of the timing of receipt or payment.
Conclusion
The Concepts and Pervasive Principles are important because they underpin the preparation of the financial statements. In the absence of any specific guidance on an accounting treatment, management may need to refer to FRS 102, Section 2 when developing an accounting policy.
