Chapter 1

Part A: Framework

The regulatory framework

Last updated November 202613 sectionsabout 14 min read

Key takeaways

Financial reporting in Kenya rests on statute and on the profession: the Accountants Act gives ICPAK's pronouncements legal force, and ICPAK adopts IFRS and IPSAS for use in Kenya.
Profit-oriented entities apply IFRS and the older IASs still in force; governments and public sector entities apply IPSAS, issued by the IPSAS Board.
The Conceptual Framework is not a standard: it guides the IASB in writing standards and preparers where no standard applies, and a specific IFRS prevails where the two conflict.
Useful information must be relevant and faithfully represented; comparability, verifiability, timeliness and understandability make it more useful still.
Equity is the residual interest in assets after deducting all liabilities, and a complete set of statements under IAS 1 has five components, each with comparatives.

This chapter moves from the mechanics of bookkeeping to the framework that makes financial statements trustworthy: who has the legal and professional authority to set the rules, what the rules are built on, and who the resulting statements are actually written for.

Legal sources of regulation

Financial reporting in Kenya is not left to individual judgement alone. It is anchored in statute, so that every reporting entity of a given type is bound by the same minimum requirements regardless of who prepares its accounts.

The Accountants Act

The Accountants Act, 2008 (which replaced the former Accountants Act, Cap 531) is the primary statute governing the accountancy profession in Kenya. It establishes the Institute of Certified Public Accountants of Kenya (ICPAK) and the Accountants Board, defines who may practise as a Certified Public Accountant, and sets out the disciplinary regime for professional misconduct. It is the Act that gives ICPAK's pronouncements, including its adoption of international standards, legal force within Kenya.

Professional sources of regulation

Alongside statute, the profession itself sets and enforces technical and ethical standards.

Local

ICPAK is the local professional body: it admits and licenses members, issues practice notes, adopts IFRS and IPSAS for use in Kenya, and runs the disciplinary process for breaches of its code of ethics.

International bodies

The International Federation of Accountants (IFAC), of which ICPAK is a member body, sets the International Code of Ethics through its Ethics Board and coordinates standard-setting globally; the International Accounting Standards Board (IASB) is the body ICPAK looks to directly for IFRS and IAS.

Accounting standards

A reporting entity applies one of three related sets of standards depending on what kind of entity it is and whether it is profit-oriented.

International Financial Reporting Standards (IFRS)

The current generation of standards issued by the IASB for profit-oriented entities, IFRS 15 (revenue), IFRS 16 (leases) and IFRS 9 (financial instruments) among them.

International Accounting Standards (IASs)

The standards issued by the IASB's predecessor body before 2001, several of which, IAS 1 (presentation), IAS 16 (property, plant and equipment) and IAS 2 (inventories) among them, remain in force today, renumbered but not replaced by later IFRSs.

International Public Sector Accounting Standards (IPSAS)

Standards issued by the IPSAS Board specifically for governments and public sector entities, adapting IFRS principles to the non-exchange transactions, budgets and accountability relationships that characterise public bodies. The chapter on public entities returns to these in detail.

The Conceptual Framework

The Conceptual Framework for Financial Reporting is not itself a standard; it is the set of underlying concepts the IASB draws on when writing standards, and that preparers draw on when no standard covers a particular transaction.

Purpose and status

Its purpose is to give the IASB a consistent basis for developing new standards, to help preparers make accounting policy choices where no standard applies, and to help users interpret financial statements. Where a specific IFRS conflicts with the Framework, the IFRS prevails; the Framework is not itself mandatory, but a body of underlying reasoning.

The objective of financial reporting

The objective of general purpose financial reporting is to provide information about the reporting entity's financial performance and position that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.

Accounting theory

Accounting theory is the body of principles and reasoning, largely built up through the Conceptual Framework and the standards themselves, that explains why particular transactions are recognised, measured and presented the way they are, rather than simply prescribing what to do. It is what lets a preparer reason through a transaction no standard addresses directly.

Accounting concepts

Eight underlying concepts recur throughout the standards and give a preparer a defensible basis for a treatment even before checking the detailed rule.

Accrual principle

Transactions are recognised when they occur, not when cash is received or paid, so revenue and the expenses incurred in earning it fall in the same period.

Conservatism principle

Where there is genuine uncertainty, expenses and liabilities are recognised as soon as they are reasonably possible, but income and assets only once they are reasonably assured.

Consistency principle

An accounting policy, once chosen, is applied the same way period after period, so figures stay comparable; a change is only justified by a more reliable presentation, and must be disclosed.

Cost principle

Assets are initially recorded at historical cost, the amount actually paid to acquire them, before any subsequent measurement basis (for example revaluation) is applied.

Economic entity principle

The reporting entity's transactions are accounted for separately from the personal transactions of its owners, even where, as in a sole proprietorship, the two are not legally distinct.

Full disclosure principle

Financial statements disclose everything material to a user's understanding, whether on the face of the statements or in the accompanying notes.

Going concern principle

Financial statements are prepared on the assumption the entity will continue operating for the foreseeable future; where that assumption fails, a different basis of preparation applies entirely.

Matching principle

Expenses are recognised in the same period as the revenue they helped generate, regardless of when cash moves, cost of sales against the sales revenue it produced, for example.

Qualitative characteristics

The Conceptual Framework identifies two fundamental qualitative characteristics that information must have to be useful at all, and four enhancing characteristics that make already-useful information more useful still.

Relevance (fundamental)

Information is relevant if it is capable of making a difference to a user's decisions, either by confirming or changing their prior expectations.

Faithful representation (fundamental)

Information faithfully represents what it purports to represent when it is complete, neutral and free from error.

Comparability (enhancing)

Information is more useful when it can be compared with the same entity's figures from an earlier period, or with another entity's figures for the same period.

Verifiability (enhancing)

Different knowledgeable, independent observers could reach consensus that a depiction is a faithful representation.

Timeliness (enhancing)

Information is available to decision-makers before it loses its capacity to influence their decisions.

Understandability (enhancing)

Information is classified, characterised and presented clearly and concisely, for users with a reasonable knowledge of business and accounting.

Users of financial information

General purpose financial statements are written for a primary user group, but in practice a much wider set of people rely on them. The syllabus lists eleven, running from clearly external readers through to people who sit inside the business.

Creditors

Suppliers and lenders who have extended credit, checking that the entity can meet its obligations as they fall due.

Investors

Existing and prospective shareholders, assessing whether to buy, hold or sell their stake and what return to expect.

Government

Tax authorities such as KRA assessing tax liability, and other government agencies compiling economic statistics or monitoring compliance.

Trading partners

Customers and suppliers assessing whether the entity is a reliable party to continue dealing with, particularly on a long-term contract.

Regulatory agencies

Bodies such as the Capital Markets Authority or the Central Bank of Kenya, checking compliance with reporting, capital or governance requirements.

International standardisation agencies

Bodies such as the IASB and IPSASB, which issue the standards financial statements are prepared under and monitor how consistently they are applied worldwide.

Journalists (Internal users)

Financial journalists and analysts read published statements to inform the wider public, an external use in itself, but the syllabus groups them at the hinge point before the list turns to users who sit inside the entity and see far more than any published statement.

Owners

Assess how well the business they have invested capital in is being run, and what return that capital is earning.

Directors

Are accountable to owners for the entity's performance, and use the accounts, alongside far more detailed internal reports, to discharge that duty.

Managers

Use accounting information, often at a level of detail no outsider ever sees, to plan, control costs and make day-to-day operating decisions.

Employees

Assess job security and pay prospects, and, where a union is involved, the entity's capacity to meet wage demands.

The reporting entity

A reporting entity is one that is required, or chooses, to prepare general purpose financial statements: an entity engaged in economic activity for which there is a demand for that information from users who cannot compel it to report to them directly. It need not be a single legal entity; a reporting entity can be a portion of an entity or a group of entities under common control, provided its boundary can be clearly defined. Financial statements are the structured representation of that entity's financial position and performance, built to be useful to the widest reasonable range of the users listed above.

The elements of financial statements

Every figure that ever appears in a set of financial statements belongs to one of six elements.

Incomes

Increases in economic benefit during the period that increase equity, other than contributions from owners, covering both revenue from ordinary activities and gains.

Expenses

Decreases in economic benefit during the period that decrease equity, other than distributions to owners, covering both the costs of ordinary activities and losses.

Assets

Present economic resources controlled by the entity as a result of past events, from which future economic benefit is expected to flow to it.

Liabilities

Present obligations of the entity, arising from past events, whose settlement is expected to require an outflow of resources embodying economic benefit.

Equity

The residual interest in the entity's assets after deducting all its liabilities, that is, Assets minus Liabilities.

Profits etc.

Profit or loss for the period, the residual of income minus expenses, and, where an entity presents it, total comprehensive income, which adds any other comprehensive income recognised directly in equity.

Statement of profit or loss

The statement of profit or loss reports an entity's financial performance over a period by matching income against the expenses incurred in earning it. Revenue, less cost of sales, gives gross profit; less other operating expenses and finance costs, and less any tax charge for an entity liable to it, gives profit or loss for the period. It is the statement lenders and investors read first to judge whether the entity is trading profitably.

Statement of financial position

The statement of financial position reports an entity's assets, liabilities and equity as at a specific date, a snapshot rather than a period's activity. Non-current assets plus current assets equal equity plus non-current liabilities plus current liabilities. Assets and liabilities are conventionally split between current (expected to be realised or settled within twelve months, or within the entity's normal operating cycle) and non-current.

Asset recognition and measurement

Recognition

An asset is recognised once it meets the definition of an asset and recognising it provides users with relevant information and a faithful representation, in practice, once it is probable a future economic benefit will flow to the entity and its cost or value can be measured reliably.

Measurement

The Conceptual Framework identifies two broad measurement bases: historical cost, the amount paid to acquire the asset, and current value, which includes fair value, value in use and current cost. A standard specifies which basis applies to a given class of asset.

Derecognition

An asset is derecognised, removed from the statement of financial position, when the entity loses control of it, typically on disposal, or when it no longer meets the definition of an asset, for example because it is fully consumed or written off.

Presentation and disclosure

IAS 1 requires financial statements to present fairly the entity's financial position, financial performance and cash flows. Fair presentation is achieved by applying IFRS, with additional disclosure wherever compliance with the standards alone would be insufficient for a user to understand a transaction.

A complete set of financial statements comprises the following, each carrying comparative figures for the preceding period.

A statement of financial position.
A statement of profit or loss and other comprehensive income.
A statement of changes in equity.
A statement of cash flows.
Notes, comprising material accounting policy information and other explanatory information.

Two presentation rules follow from this and are examined more often than the list itself. Assets and liabilities, and income and expenses, are not offset against each other unless a standard specifically permits it. And any information material to a user's understanding must be disclosed even where no line item elsewhere in the statements would otherwise reveal it.

Sustainability accounting

Definition

Sustainability accounting is the measurement, recording and disclosure of an entity's environmental, social and governance (ESG) performance alongside its financial performance, reporting how the entity affects, and is affected by, sustainability matters such as carbon emissions, resource use, labour practices and governance structure. The IFRS Foundation's IFRS S1 and S2 are the emerging global baseline for this reporting, developed by the International Sustainability Standards Board (ISSB).

Benefits and limitations

Sustainability reporting gives investors and lenders a fuller picture of long-term risk, for example exposure to changing climate regulation, and can improve an entity's access to capital and its standing with regulators and customers. Its limitations are practical: much of the underlying data is harder to measure reliably than a financial transaction, standards are still maturing and comparability across entities and jurisdictions remains weaker than for financial reporting proper.

Exam tip

Questions on this chapter are usually short-answer or definition-style rather than computational. Be able to name and briefly explain each of the eight accounting concepts and each of the two fundamental qualitative characteristics without hesitation, they are the two lists ATD examiners return to most often.

Self-check

(a) State the two fundamental qualitative characteristics of useful financial information, and define each. (4 marks)

(b) A company continues to value inventory using the same costing method it used last year, even though a competitor changed methods. Identify the accounting concept this illustrates. (2 marks)

(d) Distinguish an asset from a liability, per the Conceptual Framework's definitions. (3 marks)

Show worked answer

(a) Relevance: information is capable of making a difference to a user's decisions, by confirming or changing their prior expectations. Faithful representation: information is complete, neutral and free from error (4 marks).

(b) The consistency principle, an accounting policy, once chosen, is applied the same way period after period so figures stay comparable (2 marks).

(c) A statement of financial position; a statement of profit or loss and other comprehensive income; a statement of changes in equity; a statement of cash flows; notes (5 marks).

(d) An asset is a present economic resource controlled by the entity as a result of past events, from which future economic benefit is expected to flow to it; a liability is a present obligation of the entity, arising from past events, whose settlement is expected to require an outflow of resources embodying economic benefit (3 marks).