Ch 2.3 Framework for Preparing Financial Statements Flashcards
fundamental qualitative characteristics
relevant and faithful representation
how cna acct info have relevance
if the info will impact a users decision (investor/amagner/ supplier etc.)
Relevant info has what types of value
predicictive value (helps us make predictions)
confirmatory value (helps us confirm beliefs)
Materiality
-component of ‘relevance’
What is materiliaty
Information is material if its omission or misstatement could influence the decisions of users.
Materiality is determined in terms of magnitude (normally dollar value) and/or nature (what the i
Magnitude by itself, without regard to its nature, is not a sufficient basis for a materiality judgement. For example, if a company official receives a bribe, the amount involved may not be large but, because of the importance of its ethical and legal nature, we would consider it a materialevent.
Faithful represenation meaning
accounting info should represent realiy
how cna info be faithfully represented
1) complete (nothing important is omitted)
2) neuttral (unbiased)
3) free from material error (no mistakes)
what are the 4 enhancing qualitative characteristics of financial info
(1) comparability, (2) verifiability, (3) timeliness, and (4) understandability.
Comparabilitiy
when different companies use the same principles and apply them
APPLES TO APPLES
Verifiability
independant observors can use the same methods to get the same result
timeliness
the info is released on a timely manner
understandability
the info must be clear and concise, conveying importance to the reader
The cost constraint arises when the cost of preparing financial information outweighs the value of that information to users. Therefore, the benefits of financial reporting information should justify the costs of providing and using it
The cost constraint arises when the cost of preparing financial information outweighs the value of that information to users. Therefore, the benefits of financial reporting information should justify the costs of providing and using it
going concern assumption
asusming that the ocmpany will continue to be operating
Elements of financial statmenets
assets
liabilities
expenses
revenue/income
equity
what are the sorts of measurmenet of acct elements
historical cost
fair value
Historical cost
states that we initially record assets and liabilities at their cost at the time of acquisition or recognition and continue to do so during the time when we hold an asset or liability.
f a company bought land for $3 million, it would record this asset on the statement of financial position at $3 million at the time of purchase. One year later, if the value of the land had increased to $4 million, the company would still report the land at $3 million because that was its historical cost. The company would not report the land at fair value if it exceeds cost, because it considers the value of the land at $4 million to be a less reliable measure than the cost of the land at $3 million. This is because no transaction at the end of the second year can verify the land’s value at $4 million. Therefore, the company would continue to report the land at cost until it sells it. The only exception to this will occur if the fair value of the land is less than $3 million. In that case, it would be misleading to report the land at an amount that is higher than its fair value, so the company would report the land at fair value.
Fair Value
The fair value basis of accounting states that a company can report certain assets and liabilities at fair value (see Alternative Terminology): the price that the company would pay to purchase the same asset or to settle the same liability today. It is worth noting that, at the acquisition date, cost and fair value are generally the same. It is only as time passes that these two values diverge. For example, if a company buys land for $100,000, the cost and fair value are equal at that time, but one year later the land may have a fair value of $120,000, while the cost remains at $100,000. Because of this, a company may prefer (if the applicable accounting standard allows it) to report certain types of assets and liabilities at their fair value, deeming that value to be a more useful measure than cost. For example, certain investments in the shares of large publicly traded companies like Aritzia are assets that some companies will report on their statement of financial position at fair value for two reasons. First, the fair value of these shares is available and reliable because they trade on a stock exchange. Second, readers of the financial statements will prefer fair value information to cost because they believe fair value provides relevant information for making decisions.
In choosing between cost and fair value, companies must consider the two fundamental qualitative characteristics: relevance and faithful representation. Aritzia, our feature company in this chapter, measures all its assets, except for the investments mentioned above, at cost.In determining which basis of measurement to use, companies weigh the reliability of cost amounts against the relevance of the fair values. In general, standard setters require that most assets be recorded using historical cost because fair values may not always be reliable. Only in situations where similar or identical assets held by a company frequently trade in an active market is the fair value basis of accounting applied.The financial measurement issues discussed here are important, but financial results are not all that users want to know today. In recent years, users have started demanding information about a company’s performance in other areas, such as social issues and the environment (see Accounting and the Environment).
do we use historical cost or what?
yes historical cost!
