Ch 1 - Conceptual & Regulatory Framework Flashcards
What 2 concepts does financial accounting consist of?
- Recording transactions as they take place
2. Summarising all transactions that have taken place in a period of account
Why should transactions be recorded as they take place?
To provide up to date info for management
Why should transactions be summarised?
Provides useful info about a company for interested parties. It is done through FS preparation
Describe what the bal sheet does
Looks at position at 1 point in time
What is the bal sheet known as for IFRS?
Statement of Financial Position (SFP)
Describe the statement of comprehensive income?
it’s the P&L and other comprehensive income
Looks at performance over the year
What does the statement of cash flows show?
Separates operating, financing and investment activities
What are the full set of fin statements made up of?
- Bal sheet
- Stat of comprehensive income
- Statement of changes in equity
- Statement of cash flows
- Notes to the FS
What does the FRC do?
It is the body responsible for issuing Financial Reporting Standards (FRSs) in the UK
What does FRS 102 Section 2 Concepts and Pervasive Principles do?
Sets out the basic concepts that under-lie the preparation and presentation of the FS
What does FRS 102 Section 2 deal with?
- The objective of general purpose financial reporting
- The qualitative characteristics that determine the usefulness of info in the FS
- The definition, recog and measurement of the elements from which the FS are constructed
- The concepts of capital and capital maintenance
What is the objective of general purpose financial reporting?
- Provide info to FS users about the financial position and perf of entity to allow them to make economic decisions
- Usually done by focusing on the needs of investors and potential investors, financial info will also be useful to other users
- Financial reporting helps man to fulfil its stewardship role
How does financial reporting help man fulfil its stewardship role?
Helps them be accountable to SH and other stakeholders for the safe-keeping of the entity’s resources and their proper, efficient and profitable use
Who uses FS and why?
Customers (Uphold warranty)
Suppliers (Pay what owed?)
Gvmt (complying with reg/paying correct tax)
Competitors (benchmarking/better strategy)
Stock market analysts and inv (helps w job)
The Public (nosey)
Employees (job security/ pay rise etc)
Management (helps to run bus, targets/payrises)
Investors (likely return)
What are the qualitative characteristics of FRS Section 102?
Understandability Relevance Materiality Reliability Substance over form Prudence Completeness Comparability Timeliness
What is the idea behind understandability?
Info must be understandable to users who have reasonable knowledge of bus and acc
What is the idea behind relevance?
Fin info is relevant if it helps users’ decision making by
- Helping them evaluate past, present or future events or
- Confirming/correcting their existing valuations
What value can relevant info provide?
- Predictive value = helps users in assessing the future of the business
- But note: still using historic figures - Confirmatory value = helps users in confirming past predictions
Why is it important for historic figures to be used for relevant info?
As this
- Removes judgement
- Note, provisions are the exception, but they are still based on past events
Define materiality
- Info is material if its mission or misstatement could influence the econ decisions of users taken on the basis of the FS
- Depends on the size and nature of the item or error judge in the circ of its omission or misstatement
What does materiality depend on?
Depends on the size and nature of the item or error judge in the circ of its omission or misstatement
Give e.g. of when the nature of materiality may mean the value can be v small
If they are close to prof/loss barrier or a loan covenant, smaller items may become more important
Define reliability
Free from material error and bias
Faithfully represents effects of transactions and other events
Define substance over form
Transactions must be presented according to their economic substance rather than their legal form
Classic example are leases- but act like one, not just be called one
Give an example of using substance over form
Leases- act like one, not just be called one
Define prudence
- Caution must be exercised in preparing FS and estimating the outcomes of uncertain events
- Avoids misleading investors/users
- Goes against neutrality
- But justification is that it is better to understate prof than overstate
What is the controversy with prudence?
- Goes against neutrality
- But justification is that it is better to understate prof than overstate
Define completeness
Should be complete, subject to the constraints of materiality and cost
Define comparability
- Info should be produced on a consistent basis
- Consistent presentation is crucial
- FS should be comparable to FS of
- Other entities
- The same entity for earlier periods
What should FS be comparable to?
- Other entities
- The same entity for earlier periods
Define timeliness
Info may become less useful if there is a delay in reporting
Note: this is done with reference to the balance between benefit and cost
Which are the most important characteristics of useful financial info?
Relevance
Reliability
What are the 5 key elements in each set of FS?
Assets Liabilities Equity Income Expenses
Define an asset
Resources control by the entity
As a result of a past event
Even w/ a provision
from which future econ benefits are expected to flow to the enterprise
i.e. can use it/sell it
Note: employee’s aren’t assets as you can’t control them
Define a liability
Present obligation of an entity
To transfer econ benefits
As a result of past transactions or events
Define equity
Residual amount found by deducting all liabilities of the entity from all of the entity’s assets
i.e. the amount owed back to business owners
Define income
An increase in economic benefits during the accounting period in the form of inflows or enhancements of assets/decreases in liabilities
Transactions that result in increases in equity, other than those relating to contributions from equity participants
i.e. profits/reserves
Define expenses
Decreases in economic benefits during the acc period in the form of outflows or depletions of assets or increases of liabilities
Transactions that result in decreases in euity, other than those relating to distributions to equity participants
When is an asset recognised?
It is probable that future economic benefits will flow to the entity
It has a cost or value that can be measured reliably
When is a liability recognised?
It will result in a probable outflow of econ benefits
The outflow of econ benefits can be measured reliably
When is income recognised?
An increase in future economic benefits arises from an increase in an asset (or reduction in a liability)
It can be measured reliably
When are expenses recognised?
A decrease in future econ benefit arises from a decrease in an asset or an increase in a liability
It can be measured reliably
What are the 2 measurement bases in FRS 102 Section 2?
Historical cost = original cost of asset / proceeds in return for an obligation
Fair value = amount for which an asset could be exchanged, a liability settled or an equity instrument granted between knowledgeable, willing parties in an arm’s length transaction
Historical costs =
= original cost of asset / proceeds in return for an obligation
Fair value =
= amount for which an asset could be exchanged, a liability settled or an equity instrument granted between knowledgeable, willing parties in an arm’s length transaction
If a company offers a warranty with every washing machine it sells to customers, are the costs of providing this warranty a liability to the company?
- Yes, as they have agreed to the warranty once the sale has been made, so an obligation to incur the costs is made.
- Providing the company can reliably measure the costs of fulfilling the warranties, the costs should be recognised as a liability
What regulations must FS be produced in accordance with?
CA 2006
Acc standards (FRS or FRS 100-105)
Note: Companies whose shares or debt are traded on a regulated securities exchange must prepare their FS in acc with IFRS
- But other companies can choose whether to follow IFRS or UK GAAP
What must companies whose shares or debt are traded on a regulated securities exchange must prepare their FS in acc with?
IFRS
What standards have been released by FRC since 2012 to replace UK acc standards?
FRS 100: Application of Financial Reporting Requirements
FRS 101 Reduced Disclosure Framework
FRS 102 The Financial Reporting Standard Applicable in the UK and Republic of Ireland
FRS 103 Insurance Contracts
FRS 104 Interim Financial Reporting
FRS 105 The Financial Reporting Standard Applicable to the Micro-entities Regime
Why has there been a drive to harmonise global acc standards over the last few decades?
- Globalisation
- Management of global companies wish for consistent fin reporting across the group
- Investors are increasingly diversified globally so want to maximise comparability - Technology developments
- Harmonisation has become a more practical possibility
Why has globalisation led to harmonisation of acc standards?
- Management of global companies wish for consistent fin reporting across the group
- Investors are increasingly diversified globally so want to maximise comparability
Why has technology developments led to harmonisation of acc standards?
- Harmonisation has become a more practical possibility
How have the US and UK worked together to aid convergence?
In 2002, the US FASB and the IASB issued the Norwalk Agreement, aiming to encourage harmonisation through the IASB Convergence Project
What are the inherent limitations to FS produced?
Presentation based upon set formats
Aggregation of info
Backwards looking
Excludes non-fin info
What has been released to reduce the impact of inherent limitations to FS?
In Dec 2013, the International Integrated Reporting Council (IIRC) released the Integrated Reporting Framework, which aims to communicate the full range of factors that affect an organisations ability to create value over time
What guidance has the FRC released based on the Integrated Reporting Framework ?
Companies should include info of their
- Human rights approach
- Gender representation
- Greenhouse gas emissions
What are the key diffs between profit and non-profit orgs?
Profit:
Financial aim is to make prof and increase SH wealth
Directors are accountable to SH
External finance is freely available, e.g. loans/share capital
Non-profit
Financial aim is to achieve value for money/provide a service
Man are acc to trustees/gvmt/public
Finance is limited to donations/gvmt subsidy
What are acc standards designed to do?
Measure fin perf accurately and consistently
Report the fin position accurately and consistently
Account for the stewardship of the directors of the resources and assets
Do non-prof orgs have to produce FS for the public?
Often do not have to produce FS for the public
But in many cases may do so
What acc measurement standards will be applicable/not applicable to non-prof orgs?
Relevant - those relating to - Inventory - NCAs - Leases Non-relevant - others relating purely to reporting won’t be so relevant - Such as earnings per share
What must not for prof orgs have to comply with?
Charities Act 2006
To give a good answer in an exam re ethics, what are the questions you should cover?
- Which ethical principles are being threatened?
- Describe the nature of the threat, including a consideration of the parties affected
Note: if the indiv is a chartered accountant, should follow ICAEW code of ethics - How could this impact the FS?
Describe the safeguards/actions that should be undertaken
What is the ICAEW Code of Ethics based on?
International Federation of Accountants (IFAC) Code of Ethics
What are the 5 fundamental principles of ethics?
Integrity Objectivity Professional competence and due car Confidentiality Professional behaviour
Define integrity
Prof acc should be straightforward and honest in all prof and bus relationships
Define objectivity
Prof acc shouldn’t allow bias, conflict of interest or undue influence of others to override professional or business judgements
Define prof behaviour and due care
Prof acc has a continuing duty to maintain prof knowledge and skill at level required to ensure client/employer receives competent prof service based on current developments in practice, legislation and techniques
Prof acc should act diligently and in acc w/ applicable technical and prof standards when providing prof services
Define confidentiality
Prof acc should respect confidentiality of info requires as result of prof/bus relationships
Shouldn’t disclose any such info to third parties without proper and specific authority unless there is legal/prog duty or right to do so
Confidential info acquired as a result of prof/bus relationships can’t be used for personal adv of prof acc or third parties
Define prof behaviour
Prof acc should comply with relevant laws and regs
Must avoid any action that discredits the profession
What is the issue with judgement in acc concepts application?
Different people exercising their judgement on the same facts could arrive at v diff conclusions
Give examples of judgemental areas in acc reporting
Valuation of buildings in times of changing property prices
R&D
Brands
What must underpin judgements in acc reporting?
Ethical principles
What does the ICAEW CoE state?
Chartered Acc are expected to demonstrate the highest standards of prof conduct and take into consideration and public interest and must maintain the reputation of the acc profession
Who does the ICAEW CoE apply to?
Members Students Affiliates Employees of member firms Member firms themselves
When must appropriate indivs follow guidance of ICAEW CoE?
In all of their prof and bus activities
- Whether carried out with/without reward and in other circa where to fail to do so would bring discredit to the prof
Must follow the spirit as well as the guidance
- i.e. a specific matter being excluded from the guidance doesn’t mean acts don’t have to think about it
- Must determine if the spirit of guidance would also apply in that situation
What are the key threats to the fundamental principles?
Self-threat interest Self review interest Advocacy threat Familiarity threat Intimidation threat
Define the self-interest threat
A financial or other interest of prof acc or of an immediate/close family member will inappropriately influence the prof acc judgement/behav
Define the advocacy threat
Prof acc will promote a client’s or employer’s position to the point that the prof acc’s objectivity is compromised
Define the self-review threat
Prof acc won’t appropriately evaluate the results of a prev judgement made by a prof acc
Define familiarity
Due to long/close relationship with a client/employer, a prof acc will be too sympathetic to the interests/too accepting of their work
Define the intimidation threat
A prof acc will be deterred from acting objectivity by threats, either actual or perceived
When you have identified an ethical error, what must you consdier
The reasons for them
The actions necessary
Why do errors occur?
Deliberate manipulation of figures
Genuine error
Give examples of deliberate manipulation of figures
Bonus scheme
Potential listing
Bank covenants
Domineering manager
What do deliberate manipulation of figures threaten?
Integrity
Objectivity
What threats are created by deliberate manipulation of figures?
Self-interest
Intimidation
What does a genuine error threaten in terms of ethics?
Professional competence of the preparer
How can genuine error in accounts be dealt with?
Additional training
What actions can be taken to deal with errors found?
Gather facts to ensure full understanding of the situation
Discuss with individuals affected
Escalate internally
- E.g. with a more senior level of management, board or audit committee
Take external advice from the ICAEW Ethics helpline
If the matter can’t be resolved, consider resignation
