KAS 1 – PRESENTATION OF FINANCIAL STATEMENTS
EXPLANATORY NOTES

Explanatory Notes to Kosovo Accounting Standards are intended to provide additional understanding of the Standards and technical guidance as to their use and application. In case of any divergence between Explanatory Notes and Standards, the Standards prevail.

1. KAS 1 prescribes the form and content of financial statements of business enterprises that are required to prepare financial statements for external users (KAS 1.1).

2.The requirements of KAS 1 are based on the International Accounting Standards Committee (IASC), now the International Accounting Standards Board (IASB), Framework for the Preparation and Presentation of Financial Statements (KAS 1.2).

3.The Framework deals with:

  • The objective of financial statements;
  • Underlying Assumptions
  • The qualitative characteristics that determine the usefulness of information in financial statements;
  • The definition recognition, and measurement of the elements from which financial statements are constructed; and

Objectives of Financial Statements

4.The objectives of financial statements (KAS 1.4) are to provide information:

  • about financial position, financial performance and changes in financial position;
  • about management’s use of enterprise assets and resources;
  • to investors for decisions regarding whether to hold or sell investments; and
  • useful in making economic decisions based on the reported financial results and cash flows of the enterprise.

Underlying assumptions

5.Two basic assumptions underlie the preparation of financial statements: the use of the accrual basis of accounting and the going concern concept.

Accrual Accounting

6.In order to meet their objectives, financial statements, except for cash flow information, are prepared on the accrual basis of accounting (KAS 1.15). This affects financial reporting as follows:

  • The effects of transactions and other events are recognized when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate.
  • The right to receive cash or other financial resources is reported as an asset on the balance sheet.
  • Obligations to pay cash or provide services are reported as liabilities on the balance sheet.
  • Revenues and expenses in the income statement are reported in the period to which they relate.

7.Financial statements prepared on the accrual basis inform users not only of past transactions involving the payment and receipt of cash, but also of obligations to pay cash in the future and of resources that represent cash to be received in the future. Costs and expenses that have been incurred by the end of the period, but have not been recognized in the accounts, need to be accrued – as also the related liabilities. In some instances, however, it may be necessary to estimate the amounts involved.

8.To determine net income under the accrual method, adjustments may be necessary before financial statements are prepared. Such adjustments include the following:

  • prepaid or deferred items,
  • accrued items, and
  • estimated items.
Prepaid or deferred expenses

9.Prepaid or deferred expenses arise when cash is paid before an item, service, or benefit is used. These items are initially recorded as assets, with the value of the asset decreasing and the related expense recognized during the period of benefit.

Illustration

10.On 1 November 20XX, payment of 120€ is made in advance for a one-year insurance contract and the total amount paid is recorded as an asset.

Debit: Prepaid asset…. 120

Credit: Cash………….. 120

During the year of insurance coverage, the value of the asset is systematically reduced, with a corresponding entry to match the expense to the period it relates. On 30 November 20XX, for example, the following entry would be made:

Debit: Insurance expense…….10
Credit: Prepaid asset…………10

Deferred revenues

11,Deferred revenues arise when payment is received in advance before the revenue on an item, service or benefit is actually earned.

12.These items are initially recorded as liabilities; the liability is removed and revenue recorded during the period or periods in which the item, service, or benefit is actually earned.

Illustration

13.On 1 December 20XX, payment of 240€ is received in advance for a six-month rental contract and the total amount received is recorded as a liability.

Debit: Cash………………………. 240

Credit: Deferred revenue liability ….. 240

During the rental period, the amount of the liability is systematically reduced, with a corresponding entry to match the revenue to the period it is earned. On 31 December 20XX, for example, the following entry would be made:

Debit: Deferred revenue liability…….40

Credit: Rental income………………. 40

Accrued expenses

14.Accrued expenses arise when an expense is incurred in a period before payment is made. These items are recorded as expenses when incurred, with a corresponding liability, in order to match the expense to the period of benefit. When payment is made, the liability is eliminated.Examples include utilities, telephone, bank interest, and wages

Illustration

15.As of 31 December 20XX, the office staff have earned 600€ but their next pay day will occur on 3 January 20X1 when they will receive their full week’s pay of 800€. On 31 December 20XX, the accrued salary expense will be recorded as follows:

Debit. Accrued salaries expense….. 600

Credit. Accrued salaries liability …. 600

On 3 January 20X1, the following entry would be made to record the payment of salaries:

Debit. Accrued salaries liability……. 600

Debit. Salaries expense …………… 200

Credit. Cash ………………………… 800

16.All liabilities that are of a material amount and have not yet been recorded in the accounting system should be accrued. This practice applies the principles of completeness and prudence in compliance with the Conceptual Framework.

Accrued revenues

17.Accrued revenues arise when revenue is earned in a period before payment is received. These items are recorded as revenues when earned, with a corresponding receivable, in order to match revenue to the period of benefit. When payment is received, the receivable amount is eliminated.

Illustration

18.An enterprise has placed interest-bearing deposits in a bank. Although the interest earned, of 600€ has not yet been received when preparing financial statements on 31 December 20XX, the enterprise must recognize the revenue, as follows:

Debit: Interest receivable……600

Credit: Interest income……… 600

When the interest payment is received, the following entry is made:

Debit: Cash ………………….. 600

Credit: Interest receivable …. 600

19.An enterprise must make estimates as necessary in order to match expenses with revenues in the period in which the revenues are earned. For example, prior to preparing financial statements, an enterprise must make an estimate of the amount of its receivables that will not be collected. The estimated amounts will be recognized as bad debts expense.

Illustrations of Applying Accrual Accounting

20.(a) On 1 October, XXX1, an enterprise pays 12,000€ for insurance coverage for the period 1 October, XXX1 through 30 September, XXX2. As of 31 December XXX1, 3,000€ of insurance expense is recognized for XXX1 and the balance of the asset account prepaid insurance as of 31 December, XXX1 is 9,000€.

The accounting entries are as follows:

1 October, XXX1:

DT. Prepaid insurance ………………12,000

CT. Cash………………………………12,000

31 December, XXX1

DT. Insurance expense ……………. 3,000

CT. Prepaid insurance …………….. 3,000

21.(b) An enterprise receives 18,000€ in advance on 1 September, XXX1 for six months of future services from 1 September, XXX1 until 1 March, XXX2, 6,000€ of service revenue will be recognized for the second year, XXX2.

The accounting entries are as follows:

1 September, XXX1

DT. Cash …………………………….. 18,000

CT. Revenue received in advance ..18,000

(NOTE: This is a liability account)

31 December, XXX1

DT. Revenue received in advance … 12,000

CT. Service revenue ………………..12,000

28 February, XXX2

DT. Revenue received in advance .. 6,000

CT. Service revenue ………………. 6,000

22.(c) An enterprise borrowed 60,000€ from a bank on 1 December, XXX1 for three months at an annual interest rate of 20%. Interest expense of 1,000€, and an interest payable liability of 1,000€, would be recognized as of December 31, XXX1.

The accounting entries are as follows:

1 December, XXX1:

DT. Cash ………………………………. 60,000

CT. Bank loan payable ……………… 60,000

31 December, XXX1:

DT. Interest expense ………………… 1,000

CT. Interest payable ………………… 1,000

Accrual Checklist

23.A checklist is a valuable tool for ensuring consistency and accuracy in the preparation of accounting entries. To prepare a checklist, the enterprise should analyze and list the types of activity that are both common to its operations and require accounting entries. The checklist can be used as both a reminder of transactions to be recorded and as a review mechanism to confirm that necessary entries have been made to the appropriate accounts.

24.For expenses, the enterprise should accrued for items that have been incurred but are not yet reflected in the accounts, such as wages expense for any time that the employees have worked but for which they have not yet been paid.

25.Listed below are many of the items that commonly require accruing or adjusting transactions.

  • Allowance for bad debts
  • Bank fees and charges
  • Depreciation
  • Discount and premium amortization on investments
  • Dividends receivable
  • Finance expense on financial leases
  • Finance income on financial leases
  • Insurance expense
  • Interest expense
  • Interest income on deposits
  • Interest income on loans
  • Interest income on investments
  • Rental expense
  • Rental income
  • Tax expense
  • Telephone and communication expense
  • Utility expense
  • Wage expense

The Going Concern Concept

26.Financial statements should be prepared on the assumption that the entity is a going concern, and will continue in operation for the foreseeable future (KAS 1.14). This implies the following:

  • Assets intended for resale, such as inventories, will be sold in accordance with normal operations.
  • Assets purchased with the intention of being used in operations, such as fixed assets, will be used over their full useful life to the enterprise.
  • Amounts payable to other parties will be paid in accordance with the creditor agreement.

27.If the enterprise management intends to cease operations, or has no other feasible alternative, financial statements should be prepared on a basis other than going concern. In this event, the basis used should be disclosed together with the reasons why the enterprise is not considered to be a going concern (KAS 1.14)

Qualitative characteristics

28.Qualitative characteristics are the attributes that make information provided in financial statements useful to users. The four principal qualitative characteristics are:

  • Understandability
  • Relevance
  • Reliability; and
  • comparability

Understandability

29.Financial information is not useful unless it is understandable. The level of understandability assumed under KAS1 is that the reader has a basic knowledge of business, economics and accounting and has the ability to analyze the financial information presented.

Relevance

30.Financial information must be pertinent to a decision in order to be relevant. Information is relevant when it influences economic decisions by helping users to evaluate past, present or future events or allow them to confirm or correct their past evaluations.

31.In order for information to have relevance, the data must be presented to users on a timely basis and the data must be material to the decision maker. If there is unreasonable delay in the reporting of information it may lose its relevance. For example, if the enterprise’s financial statements for XXX1 are not available until XXX3 the financial information is so outdated that it is no longer relevant.

32.Information is material if its omission or misstatement could influence economic decisions made on the basis of financial statements. KAS1 does not specify amounts that are considered material or immaterial in the preparation of financial statements. It is a matter of judgment. Materiality depends upon the size of the item or error as is judged in the particular circumstances of the enterprise’s financial reporting and activities.

Illustrations of Materiality

33.KAS requires that certain items be separately disclosed in notes to the financial statements if they are material.

  1. A restaurant discovered that its employees had embezzled a total of 1,000€ over a two year period. The company’s yearly net income averages 500,000€. The amount of embezzlement is not material to the financial statements and does not require separate disclosure.
  2. A company discovered on January 10 that a major customer who purchases 25% of their product has gone into bankruptcy. The customer had made large purchases on credit as of 5 January and the company does not anticipate that it will recover any of the amount due. This situation is material and should be disclosed in notes to the financial statements.

Reliability

34.To be useful, information must also be reliable. Information is reliable when it is free of material error and bias and can be depended upon by users to represent faithfully that which it claims to represent. Qualities of reliability include

  • faithful representation,
  • substance over form,
  • neutrality,
  • prudence, and
  • completeness.

Faithful representation

35.To be reliable, information must represent faithfully the transactions and other events it either purports to represent or could reasonably be expected to represent. For example, an enterprise’s balance sheet should, at the reporting date, represent faithfully the transactions and other events that result in assets, liabilities and equity that meet the recognition criteria.

Substance over form

36.If information is to represent faithfully the transactions and other events 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. For example, a legal document is drawn up in the form of a rental agreement. A close inspection of the terms of the underlying transaction, however, discloses that it is actually an installment purchase. The transaction should be accounted for as an installment purchase and not as a rental.

Neutrality

37.To be reliable, the information contained in financial statements must be neutral, that is, free from bias. Financial statements are not neutral if, by the selection or presentation of information, they influence the making of a decision or judgment in order to achieve a predetermined result.

Prudence

38.Prudence means exercising judgment cautiously when making estimates under conditions of uncertainty such that assets or income are not overstated, and liabilities and expenses are not understated.

39.Prudence does not equate with undue conservatism. If, for example, an enterprise is overly pessimistic about the collectibility of receivables, the net realizable value of the receivables on the balance sheet will be understated and the bad debts expense on the income statement will be overstated, thereby understating income. The financial statements would not be neutral and would not, therefore, have the quality of reliability.

Illustration of Prudence

40.An enterprise owns a machine with a carrying amount of 40,000€ and a customer offered to buy it for its fair value of 60,000€. The enterprise exercises prudence by not recognizing, as income, the difference between the carrying amount and the fair value (refer to KAS 3, Property, Plant, and Equipment). It will, however, recognize any gain or loss on the eventual disposal of the machine.

Completeness

41.To be reliable, the information in financial statements must be complete, within the bounds of materiality and cost. An omission can cause information to be false or misleading and thus unreliable and deficient in terms of its relevance.

Comparability

42.Users must be able to compare the financial statements of an enterprise through time in order to identify trends in its financial position and performance. Users must also be able to compare the financial statements of different enterprises in order to evaluate their relative financial position, performance, and changes in financial position. It is important, therefore, that the financial statements show corresponding information for the preceding periods (KAS 1.21).

Components of Financial Statements

43.A complete set of financial statements includes the following components (KAS 1.6):

  • A balance sheet;
  • An income statement;
  • A statement showing all changes in equity;
  • A cash flow statement; and
  • Accounting policies and explanatory notes.

44.Small enterprises, that is, those that are not subject to the profit tax regulation, are not required to prepare a cash flow statement or a statement of changes in equity (KAS 1.8).

45.Enterprises are encouraged to present, outside the financial statements, a financial review by management that describes and explains the main features of the enterprise’s financial performance and financial position and the principal uncertainties that it faces (KAS 1.7).

The Elements of Financial Statements

46.Financial statements portray the financial effects of transactions and other events by grouping them into broad classes, known as financial statement elements, according to their economic characteristics.

47.The elements directly related to the measurement of performance in the income statement are income and expenses. The presentation of these elements in the balance sheet and the income statement involves a process of sub-classification.

Financial position

48.The elements directly related to the measurement of financial position in the balance sheet are assets, liabilities, and equity. These are defined as follows:

An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.

A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.

Equity is the residual interest in the assets of the enterprise after deducting all its liabilities.

Assets

49.An enterprise usually employs its assets to produce goods or services capable of satisfying the wants or needs of customers who pay for them and thereby contribute to the enterprise’s cash flow.

50.The future economic benefits embodied in an asset may flow to the enterprise in a number of ways. An asset may, for example, be:

  • Used singly or in combination with other assets in the production of goods or services to be sold by the enterprise;
  • Exchanged for other assets;
  • Used to settle a liability; or
  • Distributed to the owners of the enterprise.

51.Many assets, such as property, plant, and equipment, have a physical form but this is not essential to an asset’s existence. Patents and copyrights are examples of intangible assets if future economic benefits are expected to flow from them to the enterprise and if they are controlled by the enterprise.

52.Many assets are associated with legal rights, including the right of ownership. However, the right of ownership is not essential in determining the existence of an asset. Leased property, for example, can meet the definition of an asset if the enterprise controls the benefits that are expected to flow from the property. (Refer to KAS 13, Leases.)

53.An enterprise’s assets result from past transactions or other past events. Enterprises usually obtain assets by purchasing or producing them, but other transactions or events may generate assets. For example, an enterprise may obtain government assistance in the form of a grant related to assets. (Refer to KAS 7, Accounting for Government Grants and Disclosure of Government Assistance.)