Friday, March 26, 2010

ACCA | What is meant by faithful representation and how it enhances reliability?

Question of the Day: Dear Hasaan, thank you for providing us such a meaningful platform to ask difficult question about which we get relevant answers pretty swiftly. While going through the study guide (syllabus) of ACCA - F7 we are asked about what is faithful representation. Please elaborate it for me.

Huda Shah

HEY! you have a question? Why not you too ask the way i - asked

 Relevance: CAT - T6 | ACCA - F7, P2 and equivalent exams

Answer: Management of the company is responsible for producing such set of financial statements which shows true and fair view of the business.

Now there are two very basic and important questions
to answer before we understand what is faithful representation.

By "VIEW of the business" we mean its:
  1. Financial Position (as provided in balance sheet or statement of financial position SOFP)
  2. Financial Performance (as provided in income statement)
  3. Status of owners' equity and changes therein (as provided in statement of changes in equity SCIE)
  4. Cash flows (as provided in Statement of Cash Flows)
As per revision of ISA 1, it now requires income and expenses to be disclosed in either ONE statement i.e. Statement of comprehensive income or TWO statements i.e. income statement and statement of comprehensive income.
By "True and Fair view" we mean set of financial statements are providing exact picture of the business which it is in reality and thus the figures given in the financial statement are reported based on factual information without any bias.

This true and fair view will be achieved if management make faithful representation of every elements of financial statement i.e. Asset, Liability, Income and Expense.

Faithful representation of elements of financial statements implies that income statement should faithfully represent the incomes and expenses and balance sheet should faithfully represent such assets, liabilities and equity which meets the definition of respective element of financial statement and  recognition criteria at the reporting date.

Every element of financial statement is defined in the IASB conceptual framework in great detail. Also the general rule of recognition and then specifically giving guidance on recognition of elements is dealt in framework.

If, as discussed, everything is faithfully reported in financial statement than it automatically ensures one of the fundamental quality criteria of i.e. Reliability.

Framework requires that information presented in the financial statement must fulfill FOUR principal qualitative characteristics:
  1. Understandability
  2. Relevance
  3. Reliability
  4. Comparability
 Hope it helped you understand the connection of different concepts with each other.

Does reliability encompass just faithful representation? If no, than what are the other factors?
Write your answer in comment box below!
Hasaan Fazal
[Teaching accounting and auditing subjects to CAT & ACCA students at ACCALIVE]

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