Prevent Violating Faithful Representation

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Prevent Violating Faithful Representation

^{Lucubrate Magazine, Issue 32, July 13th, 2018}

IAS 2 is structured and formularized to prevent misrepresentative data from violating faithful representation in order to manipulate net income. 

• Accounting Series – article No: 13
• Accounting Theory – Advanced Part 3

By Peter Welch, Georgia, CEO GlobalCfo.LLC.

Finally to wrap-up, a very important aspect of inventory accounting under IAS 2 is the selection of which finished products are transferred to cost of goods sold. It may seem intuitively obvious but it is based on the identification by date order as to when a product became part of inventory ready for sale. Unlike the US, IFRS permits ‘weighted-average’ and ‘FIFO’ (First-In, First-Out).

LIFO (Last-in, First-Out) is not allowed under IFRS. Additionally, in certain circumstance, the only specific cost is capitalized that falls outside ‘date criteria’. Also, as referenced, IAS 2, states emphatically that management may not arbitrarily use weighted-average or FIFO to serve net income purposes. In other words, maintain consistent treatment for inventory with similar use and nature.

Courtesy of IFRSbox

Depending upon price changes (inflation) the election of FIFO vs Weighted Average could have a marked difference to net income as well as taxes. FIFO assumes that the first items bought/converted are the first items sold. Therefore, at the end of the period, any items in inventory are the items purchased (or produced) most recently. As CGS is a Dr or effectively an expense, the smaller the CGS, the greater is net income and the higher is taxes. Given the function of taxation, the selection of an inventory methodology has a direct effect on macroeconomic variables.

Photo: rawpixel.com

These examples demonstrate the effect of selecting either FIFO or Weighted-Average approached. Consider the closing inventory tax differences, (14.500 – 13.500) @ tax rate!

Acknowledgment: IFRS Workbook 2017 Inventory

The weighted-average cost is calculated from the inventory at the start of the period, plus any items bought (or produced) during the period.

Acknowledgment: IFRS Workbook 2017 Inventory

Conclusion, IAS 2 is structured and formularized to prevent misrepresentative data from violating faithful representation in order to manipulate net income.

The Statement of Cash Flows

Now, let’s turn to The Statement of Cash Flows, IAS 7.  Given the natural disconnect between net income and cash (net income ≠ cash), it behooves to create a reconciliation between opening and closing cash (bank and cash equivalents). Every week, even more frequently perhaps, the financial accountants/treasury should generate a bank reconciliation statement. Remember, the bank is a 3rd party thus providing solid credibility to the financial statements, devoid of any attempts to manipulate/fraudulent management behavior.

As a backdrop to IAS 7, there are still many opportunities to bypass ‘transparency and comparability’ by management. Let it be perceived that there are too many negative comments about management, just read ‘Financial Shenanigans, 3rd Edition (Howard M. Schilit/Jeremy Perler)’ and many others along with the daily press, NY Times, Financial times to understand unfortunately the frequency of occurrences of fraud and corruption. Oh also read the daily FCPA tracker (https://fcpatracker.com/) published by ‘Foreign Corrupt Practices Act’. (The Foreign Corrupt Practices Act of 1977 (FCPA) (15 U.S.C. § 78dd-1, et seq.) is a United States federal law that prohibits bribery of foreign officials and addresses accounting transparency and internal controls requirements under the Securities Exchange Act of 1934.) Contrast to the requirements of the Framework, discussed many times, especially faithful representation and an interesting picture emerge regarding the accounting standards and disclosure requirements and the synergy with the FCPA.

Photo. Fox

The Statement of Cash Flow, IAS 7, as seen above (IFRSbox) is comprised of 3-sections:

Relative to the IASB, and the official standard of IAS 7 – Statement of Cash Flows “Definitions

Let’s first discuss ‘Operating’ and the options for disclosure/presentation, the direct vs indirect method.

Courtesy of IFRSbox

Acknowledgments:

IFRS Workbook 2017 Inventory. The set of books provides a book for every standard. Our acknowledgment to Mr. Prof. Robin Joyce.

Thanks also to IFRSbox and Silvia for her valuable contribution as a reference source. Ms. Silvia Mahútová runs the website  www.ifrsbox.com dedicated to helping people understand and learn IFRS in an easy way.  In 2018, her website has over 130 000 visits per month and students come from more than 130 countries around the world.

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