Chapter 1 Flashcards
Objective of financial reporting
The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.
Users of financial statements
Internal users include company directors and managers, employees.
External users include existing and potential shareholders, lenders, suppliers and customers, competitors, government agencies, the public, etc.
Conceptual framework for financial reporting
Users of financial information
- Investors, both existing and potential
- Lenders
- Other creditors
Underlying assumptions: define going concern
Going concern means that financial statements are prepared on the assumption that the entity will continue in business for the foreseeable future.
Qualitative characteristics of useful financial information:
Fundamental qualitative characteristics: define relevance
Relevance: information that is capable of making a difference in the decisions made by users. It has predictive value, which helps users to predict future outcomes; and confirmatory value, which helps users to confirm previous evaluations.
Qualitative characteristics of useful financial information:
Fundamental qualitative characteristics: define faithful representation
Faithful representation: information must correspond to the effect of transactions or events and, as far as possible, must be complete (to include all information necessary for a user), neutral (without bias), and free from error (no errors in the description or process).
Underlying assumptions: define accrual accounting
Accrual accounting means that the effects of transactions are recognised when they occur (and not when cash is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate.
Qualitative characteristics of useful financial information:
Enhancing qualitative characteristics: comparability
Comparability: enables users to identify and understand similarities in, and differences among, items for other years and other companies – a comparison relates to at least two items.
Qualitative characteristics of useful financial information:
Enhancing qualitative characteristics: Verifiability
Verifiability: helps assure users that information is faithfully represented – can be direct (e.g. counting cash) or indirect (e.g. calculating inventory valuations using a method such as first-in, first-out).
Qualitative characteristics of useful financial information:
Enhancing qualitative characteristics: Timeliness
Timeliness: means having information available to decision-makers in time to be capable of influencing their decisions – generally the older the information is the less useful it is.
Qualitative characteristics of useful financial information:
Enhancing qualitative characteristics: Understandability
Understandability: means that information is classified, characterised and presented clearly and concisely – financial reports are prepared on the basis that users and their advisers have a reasonable knowledge of business and economic activities.
Qualitative characteristics of useful financial information: Materiality
Materiality: Information is material if omitting it or misstating it could influence the decisions that users make on the basis of financial information about a specific reporting entity
The elements of financial statements
Financial position – the statement of financial position
asset
An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.
The elements of financial statements
Financial position – the statement of financial position
liability
A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.
The elements of financial statements
Financial position – the statement of financial position
Equity
Equity is the residual interest in the assets of the entity after deducting all its liabilities. It includes funds contributed by shareholders, retained earnings, and other gains and losses.
The elements of financial statements
Financial performance – the statement of profit or loss
Profits or losses
Profits or losses are increases or decreases in equity not resulting from contributions from shareholders. They are the result of comparing income and expenses. Profit is frequently used as a measure of performance.
The elements of financial statements
Financial performance – the statement of profit or loss
Income
Income is an increase in economic benefits in the form of inflows or enhancements in assets that increase equity.
The elements of financial statements
Financial performance – the statement of profit or loss
Expenses
Expenses are decreases in economic benefits in the form of outflows or depletions of assets or the incurring of liabilities that decrease equity.
What is recognition in financial statements?
Recognition is the process of including an element (i.e. assets, liabilities, equity, income, expenses) in the statements of financial position or profit or loss.
Measurement bases - definition
Measurement is the process of determining the money amounts at which the elements are to be recognised and carried in the financial statements.
ACCOUNTING CONCEPTS: Business entity
Business entity: financial statements record and report on the activities of one particular entity. They do not include the personal assets and liabilities of those who play a part in owning or running the entity.
ACCOUNTING CONCEPTS: Materiality
Materiality: some items are of such low value that it is not worth recording them separately in the accounting records.
ACCOUNTING CONCEPTS: Going concern
Going concern: this presumes that the entity to which the financial statements relate will continue in the foreseeable future. There is no intention to reduce significantly the size of the entity or to liquidate it. Values based on break-up (realisable) amounts tend not to be relevant to users seeking to assess the entity’s ability to generate cash or to adapt to changing circumstances.
ACCOUNTING CONCEPTS: Accruals
Accruals: this means that income and expenses are matched so that they concern the same goods or services and the same time period. The statement of profit or loss shows the amount of income that should have been received and the amount of expense that should have been incurred.
ETHICAL PRINCIPLES
Fundamental principles: Integrity
Integrity: being straightforward and honest in all professional and business relationships.
ETHICAL PRINCIPLES
Fundamental principles: Objectivity
Objectivity: not allowing bias, conflict of interest or the undue influence of others to override professional or business judgements.
ETHICAL PRINCIPLES
Fundamental principles: Professional competence and due care
Professional competence and due care: an accountant should maintain professional knowledge and skill at the level required to ensure that an employer or client receives a competent professional service. The accountant should act diligently in accordance with current developments in practice, legislation and techniques.
ETHICAL PRINCIPLES
Fundamental principles: Confidentiality
Confidentiality: information acquired as a result of professional and business relationships should not be disclosed to third parties except when proper and specific authority is given or there is a legal or professional right to disclose. Such confidential information should not be used for personal advantage or be passed to third parties.
ETHICAL PRINCIPLES
Fundamental principles: Professional behaviour
Professional behaviour: accountants should ensure that their behaviour complies with relevant laws and regulations and avoids bringing the accountancy profession into disrepute.
Threats to the fundamental ethical principles: Self-interest threats
Self-interest threats: these may occur where a financial or other interest will inappropriately influence the accountant’s judgement or behaviour.
Threats to the fundamental ethical principles: Self-review threats
Self-review threats: these may occur when an accountant has to re-evaluate a judgement or data that he/she has previously made or produced.
Threats to the fundamental ethical principles: Familiarity threats
Familiarity threats: these may occur when, because of a close or personal relationship, an accountant becomes too sympathetic to the interests of others.
Threats to the fundamental ethical principles: Intimidation threats
Intimidation threats: these may occur when an accountant may be deterred from acting objectively because of real or perceived threats.
Threats to the fundamental ethical principles: Advocacy threats
Advocacy threats: these may occur when an accountant promotes a position or opinion (normally of a client) to the point that his/her objectivity may be compromised in the future.
Measurement bases: Historical cost
Historical cost: assets are recorded at the amount paid, or the fair value at the time of acquisition; liabilities are recorded at the amount expected to be paid.
Measurement bases: Current cost
Current cost: what it would cost to replace assets and liabilities at today’s prices.
Measurement bases: Realisable (settlement) value
Realisable (settlement) value: what the assets could be sold for, and the amount to settle the liabilities, today.
Measurement bases: Present value
Present value: assets and liabilities are valued at the present discounted values of their future cash inflows and outflows.
Underlying assumptions
1) Going concern
2) Accrual accounting
Fundamental qualitative characteristics
1) Relevance:
2) Faithful representation: complete, neutral and free from error
Enhancing qualitative characteristics
1) Comparability:
2) Verifiability:
3) Timeliness:
4) Understandability:
Qualitative characteristics of useful financial information
Fundamental qualitative characteristics
Enhancing qualitative characteristics
Materiality
When an item should be recognised in the financial statements?
An item should be recognised if:
1) it is probable that future economic benefits will flow to or from the entity; and
2) it has a cost or value that can be measured reliably.
Measurement bases
1) Historical cost:
2) Current cost:
3) Realisable (settlement) value:
4) Present value:
ACCOUNTING CONCEPTS
1) Business entity:
2) Materiality:
3) Going concern:
4) Accruals:
ETHICAL PRINCIPLES:
Fundamental principles
1) Integrity:
2) Objectivity:
3) Professional competence and due care:
4) Confidentiality:
5) Professional behaviour:
ETHICAL PRINCIPLES:
Threats to the fundamental ethical principles
1) Self-interest threats:
2) Self-review threats:
3) Familiarity threats:
4) Intimidation threats:
5) Advocacy threats:
