Indicate the usefulness and describe the main components of a conceptual framework for financial reporting Identify the qualitative characteristics of accounting information Define the basic elements of financial statements ID: 627305
Download Presentation The PPT/PDF document "Wiley CHAPTER 2 2 After studying this ch..." is the property of its rightful owner. Permission is granted to download and print the materials on this web site for personal, non-commercial use only, and to display it on your personal computer provided you do not modify the materials and that you retain all copyright notices contained in the materials. By downloading content from our website, you accept the terms of this agreement.
Slide1Slide2
Wiley
CHAPTER 2
2Slide3
After studying this chapter, you should be able to:Indicate the usefulness and describe the main components of a conceptual framework for financial reporting.
Identify the qualitative characteristics of accounting information.
Define the basic elements of financial statements.
Describe the foundational principles of accounting.Explain the factors that contribute to choices and/or bias in financial reporting decisions. Discuss current trends in standard setting for the conceptual framework.
3
Chapter 2: Conceptual Framework Underlying Financial ReportingSlide4
Conceptual Framework Underlying Financial Reporting
4Slide5
Usefulness of a Conceptual Framework
The framework is like a constitution; it is a “Coherent system of interrelated objectives”
Aids in creation of standards for the accounting profession
Increases financial statement users’ understanding of and confidence in financial reporting
Enhances comparability of financial statements of different companies
5Slide6
Objectives of the Conceptual Framework
The framework is the foundation for building a set of accounting concepts and objectives
The framework is a reference of basic accounting theory for solving new and emerging practical problems of reporting
6Slide7
Conceptual Framework for Financial Reporting
7Slide8
Objective of Financial Reporting
The overall objective of financial reporting is to provide information that is:
Useful to users (e.g. investors, creditors, etc.), and
Decision relevant (resource allocation)
Resource allocation decisions are assumed to include assessment of management stewardship (i.e. management role in maximizing shareholder value)
Conceptual building blocks (second level) include:
Qualitative characteristics, and
Elements of financial statements
8Slide9
Fundamental Qualitative CharacteristicsThe Fundamental Qualitative Characteristics are:
Relevance
Makes a difference in a decision
Has predictive and feedback/confirmatory valueIncludes all material information (i.e. information that makes a difference to the decision-maker)Representational FaithfulnessComplete
NeutralFree from material error
9Slide10
Enhancing Qualitative Characteristics
Enhancing Qualitative Characteristics are:
Comparability
Information measured and reported in a similar way (company to company, and year to year)Allows users to identify real economic similarities and differencesVerifiabilitySimilar results achieved if same methods are used
TimelinessUnderstandabilityAllows reasonably informed users to see the significance of the information
Provides “enough” information so that it is clear
10Slide11
Trade-offs and Cost/Benefit
Trade-Offs
It is not always possible to have all fundamental and enhancing qualitative characteristics
Trade-offs happen when one qualitative characteristic is sacrificed for another
Cost versus Benefits
Benefits of using the information should outweigh the costs of providing that information
11Slide12
Elements of Financial Statements
Basic elements of financial statements include the following:
Assets
Liabilities
Equity
Revenues
Expenses
Gains
Losses
12Slide13
Elements of Financial Statements: Assets
Assets
have three key characteristics:
They involve some economic benefit to the entity
Entity has a control over that benefit
Benefit results from a past transaction or event
13Slide14
Elements of Financial Statements: Liabilities
Liabilities
have three key characteristics:
They represent a present duty or responsibility
Entity is obligated and has little or no discretion to avoid the duty or responsibility
Obligation results from a past transaction or event
14Slide15
Elements of Financial Statements: EquityEquity (net assets) represents residual interest in assets, after all liabilities are deducted
15Slide16
Elements of Financial StatementsRevenues
Increases in economic resources, resulting from ordinary activities
Expenses
Decreases in economic resources, resulting from ordinary revenue-generating activitiesGainsIncreases in equity (net assets), resulting from incidental transactionsLosses and OCIDecreases in equity (net assets), resulting from incidental transactions
Other comprehensive incomeRevenues, expenses, gains, and losses that are recognized in comprehensive income, but are not included in net income (e.g. unrealized holding gains and losses on certain securities)
16Slide17
Foundational Principles
Foundational concepts and constraints help explain which, when, and how financial elements and events should be recognized/derecognized, measured, and presented/disclosed
They act as guidelines for developing rational responses to controversial financial reporting issues
17Slide18
Foundational Principles
Recognition / Derecognition
1.
Economic entity assumption
2. Control
3. Revenue recognition and realization principle
4. Matching principle
Measurement
5. Periodicity assumption
6. Monetary unit assumption
7. Going concern assumption
8. Historical cost principle
9. Fair value principle
Presentation and Disclosure
10. Full disclosure principle
18Slide19
Recognition/Derecognition
Recognition
Process of including an item on entity’s balance sheet or income statement
Elements of financial statements have historically been recognized when:
They meet the definition of an element (e.g. asset)
They are probable, and
They are reliably measurable
Derecognition
Process of ‘removing’ something from the balance sheet or income statement
19Slide20
Recognition/Derecognition
Economic Entity Assumption
(Also called Entity Concept)
The economic activity can be identified with a particular unit of accountabilityThe business activity is separate and distinct from its owners (and any other business unit)
An individual, departments or divisions of an entity, or an entire industry may be considered separate entities
Does not necessarily refer to a legal entity
Legal entity concept is used for tax and legal purposes
20Slide21
Recognition/DerecognitionEconomic Entity Assumption
21Slide22
Recognition/Derecognition
Control
Important factor in determining entities to be consolidated and included in the economic entity
Some concepts of control include:
Under IFRS
Having power over investee
Exposure, or rights, to variable returns from involvement with investee; and
Ability to use power over investee to affect amount of investor’s returns
Under ASPE
Continuing power to determine strategic decisions without the co-operation of others
22Slide23
Recognition/Derecognition
Revenue Recognition Principle
Revenue is recognized when:
Risks and rewards have passed or the earnings process is substantially complete
Revenue is measurable and
Revenue is collectible (realized or realizable)
Revenues are realized when products (goods or services), merchandise, or assets are exchanged for cash (or claims to cash)
IFRS 15 contract based approach uses five-step approach to revenue recognition (See Chapter 6)
23Slide24
Recognition/Derecognition
Matching Principle
Expenses are matched with revenues that they produceIllustrates a “cause and effect relationship” between money spent to earn revenues, and the revenues themselves
If the expense benefits the future periods and meets the definition of asset, it is recorded as an asset
This asset’s cost is then systematically and rationally matched to future revenues
24Slide25
Measurement
All elements must be measurable to be recognized
Because of accrual accounting, many elements of financial statements require the use of estimates (and include uncertainty)
Therefore, we must
Determine the level of uncertainty that is acceptable for recognition
Use appropriate measurement tools, and
Disclose sufficient information to indicate/describe the uncertainty
25Slide26
Measurement
Periodicity Assumption
Economic activity of an entity can be divided into artificial time periods for reporting purposes
Most common: one month, one quarter, and one yearFor shorter time periods, more difficult to determine proper net income (i.e. the more likely errors become due to more estimates)
With technology, investors want more on-line, real-time financial information to ensure relevant information
26Slide27
Measurement
Monetary Unit Assumption
Money is the common unit of measure of economic transactions
Use of a monetary unit is relevant, simple and understandable, universally available, and useful
In Canada and the United States, the dollar is assumed to remain relatively stable in value (effects of inflation/deflation are ignored i.e. price-level change is ignored)
Monetary unit is relevant only as long as it is assumed that quantitative data are useful in communicating economic information
27Slide28
Measurement
Going Concern Assumption
Assumption that a business enterprise will continue to operate in the foreseeable future
There is an expectation of continuing long enough to meet their objectives and commitments
Management must look out at least 12 months from balance sheet date
If liquidation of the company is assumed to be likely, use liquidation accounting (at net realizable value)
Full disclosure is required of any material uncertainties of continuing as a going concern
28Slide29
Measurement
Historical Cost Principle
Three basic assumptions of historical cost
Represents a value at a point in time
Results from a reciprocal exchange
(i.e. a two-way exchange)
Exchange includes an outside arm’s-length party
Initial recognition: for non-financial assets, record all costs incurred to get the asset “ready” for sale or for use (e.g. includes transportation and installation costs)
29Slide30
Measurement
Historical Cost Principle (continued)
Measurement is especially challenging for :
1. Non-monetary transactions (as no cash/monetary consideration exchanged)
2. Non-monetary, non-reciprocal transactions (e.g. donations)
3.
Related party transactions
– not acting at “arm’s length” (use exchange value or cost)
Applies also to financial instruments (e.g. bonds, notes, accounts payable, and receivable)
30Slide31
Measurement
Fair Value Principle
Fair value has been defined (under IFRS) as
“The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date”
Subsequent to initial recognition, historical cost and fair value often differ
Fair value is often considered more relevant for certain assets/liabilities (e.g. financial instruments)
IFRS allows the use of fair value measurement in more situations than ASPE
31Slide32
Measurement
Fair Value Principle (continued)
Fair value (under IFRS) is a market-based measure
32Slide33
Presentation and Disclosure
Full Disclosure Principle
The practice of providing information that is important enough to influence an informed user’s judgement and decisions
Disclosure may be made:
Within the main body of the financial statements
As notes to the financial statements
As supplementary information, including Management Discussion and Analysis (MD&A)
33Slide34
Presentation and Disclosure
Full Disclosure Principle
(continued)
Disclosed information should:Provide sufficient detail of the occurrence
Be sufficiently condensed to remain understandable, and appropriate in terms of costs of preparing/using it
Full disclosure is not a substitute for proper accounting practice
Notes to financial statements are essential to understanding the enterprise’s performance and position
34Slide35
Management Discussion and Analysis (MD&A)
Management’s explanation of the financial information and the significance of the information
Five key elements that should be included:
Company’s vision, core businesses, and strategy
Key performance drivers
Capital and other resources
Historical and prospective results
Risks
35Slide36
Expanded Conceptual Framework
36Slide37
Financial Reporting Issues
IFRS and ASPE are principles-based
Therefore, selecting and interpreting accounting principles and rules relies on application of professional judgment
Legally structuring transactions so that they meet the company’s financial reporting objectives (while complying with GAAP) is known as financial engineering
When pressures for reaching specific financial reporting objectives are high, risk of fraudulent financial reporting increases
37Slide38
Choice in Accounting Decision-Making
38Slide39
Looking Ahead
IASB issued an Exposure Draft relating to the conceptual framework in 2015. Some items included were:
Measurement
Presentation
Elements
Recognition
Reporting Entity
Objectives and qualitative characteristics
39Slide40
Looking Ahead
It is hoped that the revised conceptual framework will be released in
2017
The IASB is currently working on two research projects
:
Identifying and developing a set of disclosure principles
Clarification of the concept of materiality by adding key characteristics for materiality
40Slide41