Question

As a professional accountant who is concerned about the qualitative characteristics of preparing financial statements.

(a) You are required to:

1. Explain five (5) qualitative characteristics of IFRS that is used to prepare financial statements to your colleagues at the meeting.                                                  
2. Explain the difference between profit and profitability.                                                             
3. Explain the concept of going concern and the implication of revocation of going concern assumption when financial statements are prepared.                               

Answer 1

1.
Relevance

    To be useful, information must be relevant to the decision-making needs of users. Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations.

Materiality

The relevance of information is affected by its nature and materiality. In some cases, the nature of information alone is sufficient to determine its relevance. For example, the reporting of a new segment may affect the assessment of the risks and opportunities facing the entity irrespective of the materiality of the results achieved by the new segment in the reporting period. In other cases, both the nature and materiality are important, for example, the amounts of inventories held in each of the main categories that are appropriate to the business.

Faithful representation

General purpose financial reports represent economic phenomena in words and numbers. To be useful, financial information must not only be relevant, it must also represent faithfully the phenomena it purports to represent. Faithful representation means representation of the substance of an economic phenomenon instead of representation of its legal form only.

Understandability

Classifying, characterising and presenting information clearly and concisely makes it understandable. While some phenomena are inherently complex and cannot be made easy to understand, to exclude such information would make financial reports incomplete and potentially misleading. Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information with diligence.

Substance over form

    If information is to represent faithfully the transactions and other events that it purports to represent, it is necessary that they are accounted for and presented in accordance with their substance and economic reality and not merely their legal form. The substance of transactions or other events is not always consistent with that which is apparent from their legal or contrived form. For example, an entity may dispose of an asset to another party in such a way that the documentation purports to pass legal ownership to that party; nevertheless, agreements may exist that ensure that the entity continues to enjoy the future economic benefits embodied in the asset. In such circumstances, the reporting of a sale would not represent faithfully the transaction entered into (if indeed there was a transaction).

2.

Definition of Profit

Profit is an absolute number determined by the amount of income or revenue above and beyond the costs or expenses a company incurs. It is calculated as total revenue minus total expenses and appears on a company's income statement. No matter the size or scope of the business or the industry in which it operates, a company's objective is always to make a profit.

Definition of Profitability

Profitability is closely related to profit – but with one key difference. While profit is an absolute amount, profitability is a relative one. It is the metric used to determine the scope of a company's profit in relation to the size of the business. Profitability is a measurement of efficiency – and ultimately its success or failure. A further definition of profitability is a business's ability to produce a return on an investment based on its resources in comparison with an alternative investment. Although a company can realize a profit, this does not necessarily mean that the company is profitable.

There are a few different profitability ratios you can use that measure aspects of your business’s success:

• Profit margin ratio- (Revenue – Expenses) / Revenue
• Gross margin ratio- (Revenue – Cost of Goods Sold) / Revenue
• Return on investment ratio -(Gain from Investment – Cost of Investment) / Cost of Investment

To determine the worth of an investment in a company, investors cannot rely on a profit calculation alone. Instead, an analysis of a company’s profitability is necessary to understand if the company is efficiently utilizing its resources and its capital.

If a company is deemed to have a profit but is unprofitable, there are tools for increasing profitability and overall company growth. Failing projects can quickly bog down a company, which directly leads to sunk costs. Companies can explore a profitability index to determine whether a project is worth pursuing to reduce the occurrence of project failures. This metric provides company management with insight into the costs versus the benefits of a project, and it is calculated by dividing the present value of future cash flows by a project's initial investment.

Although they sound similar, profit and profitability are handled almost exclusively when it comes to investing and business management. Rearranging of product lines and increasing prices are two theories that hold the most sway over whether a company has a profit or can experience future profitability.

3.

The going concern concept is a fundamental principle of accounting. It assumes that during and beyond the next fiscal period a company will complete its current plans, use its existing assets and continue to meet its financial obligations. Simply put, it is an assumption that the company will stay in business and that the value of its assets will endure. This underlying principle is also known as the continuing concern concept.

Should a company go out of business, its assets often lose the value they once held on the balance sheet. This happens because certain company-specific assets (for example, custom software) can be worth less in resale to others than the cost it took to get it. Or if a company has to sell its assets in a hurry, it may not be able to wait for an optimal selling price. If an accountant has reason to doubt the ability of a business to continue as a going concern and meet its obligations and protect its assets, they are duty-bound to include this in their audit report.

Implications for the Auditor’s Report

Use of Going Concern Basis of Accounting Is Inappropriate
.23 If the financial statements have been prepared using the going con-
cern basis of accounting but, in the auditor's judgment, management's use of
the going concern basis of accounting in the preparation of the financial state-
ments is inappropriate, the auditor should express an adverse opinion. (Ref:
par.

When Adequate Disclosure About an Entity's Ability to Continue as a Going Con-
cern Is Not Made in the Financial Statements
If adequate disclosure about an entity's ability to continue as a going
concern for a reasonable period of time is not made in the financial statements,
the auditor should express a qualified opinion or adverse opinion, as appro-
priate, in accordance with section 705A, Modifications to the Opinion in the
Independent Auditor's Report.

Communication With Those Charged With Governance

Unless all those charged with governance are involved in managing
the entity, 7 the auditor should communicate with those charged with gover-
nance regarding conditions and events, considered in the aggregate, that raise
substantial doubt about an entity's ability to continue as a going concern for a
reasonable period of time. Such communication with those charged with gover-
nance should include the following:
a.Whether the conditions or events, considered in the aggregate,
that raise substantial doubt about an entity's ability to continue
as a going concern for a reasonable period of time constitute sub-
stantial doubt
b.The auditor's consideration of management's plans
c.Whether management's use of the going concern basis of account-
ing, when relevant, is appropriate in the preparation of the finan-
cial statements
d.The adequacy of related disclosures in the financial statements
e.The implications for the auditor's report