The Importance of Financial Statements and the Key Principles of Their Preparation

When preparing financial statements, it is important to correctly identify the applicable accounting standard, the required components of the financial statements, and the principles governing the presentation of information.

IFRS and IFRS for SMEs

IFRS stands for International Financial Reporting Standards. These standards establish the rules and principles that entities follow when preparing financial statements, so that information about their financial position and performance is understandable, reliable, and comparable with that of other entities.

IFRS for SMEs is the International Financial Reporting Standard for Small and Medium-sized Entities. It is designed for entities that do not have public accountability and prepare general purpose financial statements for external users. The standard sets out simplified requirements tailored to their needs.

Compared with full IFRS, it:

• Omits certain topics that are not relevant to a typical small or medium-sized entity;

• Offers fewer accounting policy options;

• Simplifies many recognition and measurement requirements;

• Requires fewer disclosures;

• Is written in simpler language.

In Georgia, Category II and III entities generally apply IFRS for SMEs, although they may also choose to apply full IFRS.

Full IFRS is mandatory for public interest entities (PIEs) and Category I entities. Category IV entities generally apply the standard established by SARAS, although they may choose to apply IFRS for SMEs or full IFRS.

The Nature and Components of Financial Statements.

Financial statements are a set of reports that present an entity’s financial position, financial performance, cash flows, and changes in equity, together with explanatory notes.

Under full IFRS, the main components of financial statements are:

1. Statement of Financial Position (Balance Sheet) — presents an entity’s assets, liabilities, and equity at a specific date.

2. Statement of Profit or Loss and Other Comprehensive Income — presents income and expenses for the period, profit or loss, and items of other comprehensive income. This information may be presented in a single statement or in two separate statements.

3. Statement of Cash Flows — presents inflows and outflows of cash and cash equivalents, classified into operating, investing, and financing activities.

4. Statement of Changes in Equity — presents changes in an entity’s equity during a specific reporting period.

5. Notes to the Financial Statements — include material accounting policy information, explanations of items presented in the financial statements, and other information necessary to understand the financial data properly.

   
   

Financial statements also include comparative information for the preceding period. In certain circumstances, full IFRS requires an additional statement of financial position as at the beginning of the preceding comparative period. The exact composition of the financial statements and any permitted simplifications are determined by the applicable standard.

Key Principles for the Preparation of Financial Statements.

The two fundamental qualitative characteristics of useful financial information are relevance and faithful representation.

When preparing financial statements, it is important to consider the following principles and requirements:

Accrual basis of accounting — Income and expenses are recognised in the period in which they arise, regardless of when cash is received or paid. The statement of cash flows presents actual cash flows.

Relevance and materiality — Information should help users make decisions. Material information must not be omitted, misstated, or obscured. Materiality is assessed by considering the nature and magnitude of the items concerned.

Faithful representation — Information should be complete, neutral, and free from error, and should reflect the economic substance of transactions. This does not preclude the use of reasonable estimates, provided that the estimation methods and associated uncertainty are adequately explained.

Prudence — Estimates should be made cautiously under conditions of uncertainty, without deliberately overstating or understating amounts.

Consistency and comparability — Accounting methods should be applied consistently to similar transactions, facilitating comparisons across reporting periods and between entities.

Verifiability, timeliness, and understandability — Information should be verifiable, provided in a timely manner, and presented clearly.

Reporting period and disclosures — Financial statements are prepared at least annually and include comparative information for the preceding period and important disclosures, including those relating to estimates and risks.

Going concern assumption — Financial statements are normally prepared on the assumption that the entity will continue operating. Material uncertainties relating to its ability to continue as a going concern must be disclosed. If another basis of preparation is used, that basis and the reason for using it must be explained.

Financial statements may cover a single entity or a group comprising a parent and its subsidiaries.

Consolidated financial statements — Combine the financial information of a parent and its subsidiaries and present the group’s financial position, financial performance, and cash flows as if they were those of a single entity. Intragroup transactions and balances are eliminated on consolidation.

Separate financial statements — present the financial information of a parent or other investor, with investments in subsidiaries, associates or joint ventures accounted for in accordance with the applicable standard. In a parent’s separate financial statements, the assets, liabilities, income and expenses of its subsidiaries are not consolidated; instead, the parent recognises its investments in those subsidiaries.

Where consolidated financial statements are required, separate financial statements cannot replace them.