Subject matter, objective and principles of financial reporting, conceptual framework

With this article we start a series of articles on the new Accounting Act.  Although current developments make it unlikely that the new Accounting Act will come into force in 2027, we believe that, given the scope of the forthcoming changes, it is advisable to inform about their potential impact on accounting entities in advance.

The subject of the new Accounting Act is:

• reporting of financial and non-financial information,
• the application of international accounting standards,
• the verification of the information reported and its publication and disclosure,
• the use of the reported information for government financial reporting purposes; and
• bookkeeping.

The new Accounting Act brings a fundamental change in the view of accounting and financial reporting.  While the current Accounting Act puts greater emphasis on bookkeeping (which is also in the first place in the subject of the current Accounting Act), the new Accounting Act puts the reporting of financial and non-financial information above bookkeeping.  Accounting is viewed as a means of preparing financial statements properly, whereby an accounting entity provides external users with accounting information useful for their economic decision-making,

and predicting future cash flows.

In the first part, the new Accounting Act provides a comprehensive conceptual framework including:

• requirements for the quality of accounting information, such as relevance, true and fair presentation, timeliness, understandability, verifiability, comparability
• principles for the preparation of financial statements, which include true and fair presentation, going concern basis, topicality, materiality, prohibition of offsetting, balance sheet continuity, consistency
• accounting methods – including the display of accounting method changes, estimates and error corrections, which are now only in the decree
• elements of the financial statements, which are discussed in greater detail below.

For the first time, the Accounting Act contains definitions and rules for reporting the individual elements of financial statements, which are:

1. assets,
2. debt,
3. equity,
4. revenues and
5. cost

At the same time, through these provisions, the new Accounting Act brings a new perspective on the principle of accrual, where the “apparent” connection to a given period is overridden by the fulfilment of the definition for reporting an asset or debt. Furthermore, there is a fundamental change in how reporting of provisions is viewed.

For completeness, we add that non-business entities have the definitions below tailored to their needs.

An asset is an existing economic resource over which an entity has control as a result of a past transaction or other event. An economic resource is a resource that has the potential to yield economic benefits. The accounting entity has control over an economic resource to the extent that it is able to influence:

• the use of this resource and prevent others from using it; and
• obtaining economic benefit from that resource and preventing others from obtaining it.

For accounting purposes, a debt is an existing obligation to give up an economic resource that arises from a past transaction or other event and that an accounting entity cannot unilaterally discharge without it having at least the same economic consequences as meeting the respective obligation.

A debt arises from a contract of consideration only to the extent that the contract has been performed by the other party, unless the consideration is a loss to the entity, in which case the debt arises to the extent of the loss.

A reserve is a debt for which it is uncertain whether, at what time or in what amount the economic resource needed to meet the debt will decrease. If the reserve is a debt, then a past event must have occurred that causes decrease in economic resources of the entity.  Thus, this definition will no longer allow entities to report, for example, reserves for repairs of assets because there is no past event that would give rise to a decrease of an economic resource.  This does not, however, preclude the possible tax deductibility of the costs of future repairs of assets, unless the Reserves Act, too, is amended in this context.  This item would then probably only be reflected in the tax return as an item reducing the tax base.

Another balance sheet item defined by the new Accounting Act is the right of use – the right to use or enjoy a tangible asset that is not the property of the accounting entity for an agreed period of time, if that period is longer than one year.  This provision relates to the obligation to recognise in the balance sheet assets that the entity uses under a lease agreement.

An asset and debt are eligible for recognition if:

• they are reliably measurable,
• the generation of future economic benefits, or their loss in the case of debt, is probable; and
• it meets the conditions set out in the accounting regulation.

A revenue is a change in financial position or a change in a balance sheet item that results in an increase in equity, excepting:

• the receipt of capital from a person with an equity interest in the accounting entity or a person in a similar position; and

changes in financial position excluded from income by an accounting regulation.

A cost is a change in financial position or a change in a balance sheet item that results in a decrease in equity, excepting:

• distributions of capital to a person with an equity interest in the accounting entity or to a person in a similar position; and
• changes in financial position excluded from costs by an accounting regulation.

In this context, the new Accounting Act includes a mandate for the Ministry of Finance to determine by decree which changes in balance sheet values will not be recognised in profit or loss but through equity. 

The following provisions are also essential for the recognition of income and expense:

Revenue is eligible for recognition if the related:

• asset becomes eligible for recognition or its accounting value increases; or
• debt ceases to be eligible for recognition or its accounting value is reduced.

A cost is eligible for recognition if the related:

• asset ceases to qualify for recognition or its accounting value is reduced; or
• debt becomes eligible for recognition or its accounting value increases.

These provisions significantly affect the timing of revenue and cost recognition.  It is now newly not sufficient to test only the timing of the revenue or cost, but also if the related asset or debt is meet the condition for recognition.  Let us illustrate these provisions using the following example:

The entity uses the services of a tax adviser to prepare its tax return.  Previously, an accounting entity recognised an accrual entry in the financial statements for a cost related to the preparation of a tax return because it believed that the cost was related to the period. However, in the light of the new provisions, the definition of debt will not be fulfilled at the date of the financial statements because the tax advisor did not provide any service to the entity at the date of the financial statements and the cost of preparing the tax return will thus be a cost only in the following period.

We believe that the correct application of the above definitions can affect the timing of recognition of assets, debts, revenues and costs for accounting entities.  In some cases, it may also be interesting to recognise a accrued comprehensive costs that cease to exist as a separate item and are either recognised as a separate asset (for example, an intangible asset) or do not meet the definition of an asset and have to be derecognised from the balance sheet (probably through other comprehensive income).

In the next article we will discuss the definition of an accounting unit.