Chapter 2 Flashcards
Why is a conceptual framework is needed?
to:
1. Create standards based on established concepts
- Increase user’s understanding of and confidence in financial reporting
- Enhance comparability of different companies’ financial statements
- Solve new and emerging practical problems more quickly
The objective of financial reporting is to communicate information that is:
- useful to investors, creditors, and other users
- Useful in making decisions about how to allocate resources
Decision usefulness
Determining the amount and types of information to present requires choosing alternatives that provide the most useful information
Fundamental qualities that make accounting information useful for decision-making
relevance and representational faithfulness
What is relevance?
To be relevant, information must be capable of making a difference in a decision
- Has predictive value - helps users make predictions about past, present and future events
- Has feedback/confirmatory value - helps users confirm or correct previous expectations
- Is material - how important the information is; would it make a difference to the decision-maker?
What is representational Faithfulness?
- Transparency - represents economic reality
- Completeness - include all information needed to portray underlying events and transactions
- Neutrality - information does not favour one set of interested parties over another; supported by the concept of conservatism/prudence
- Freedom from error - reliability; arises form good information systems and strong internal controls
3 steps to ensure information has relevance and representational faithfulness
- Identify the economic event or transaction
- Identify the type of information that would be relevant and can be faithfully represented
- Assess whether the information is available (cost/benefit) and can be faithfully represented.
Enhancing qualitative characteristics
- Comparability
- Verifiability
- Timeliness
- Understandability
Comparability (def)
information is measured and reported in a similar way - company to company and year over year
Verifiability (def)
knowledgeable, independent users achieve similar results
Timeliness (def)
information is available in sufficient time to influence decisions
Understandability (def)
information must be of sufficient quality and clarity so reasonably informed users can see its significance
Cost-Benefit relationship
cost of providing information is weighed against the benefits of providing it
Elements of FS
Assets
Liabilities
Equity
Revenues/Income
Expenses
Gains/Losses
Assets: 3 essential characteristics
- They represent a present economic resource - a right to use an asset that produces economic benefit or that has the potential to produce economic benefits
- Entity has control over that resource - entity’s ability to decide how to use the asset and receive economic benefits (through legal ownership or a contractual or other right)
- Resource results from a past transaction or event
Liabilities: 3 essential characteristics
- They represent a present duty or responsibility - and there is no practical ability to avoid them
- Entity is obligated to transfer an economic resource
- Obligation results from a past transaction or event
Types of liability obligations
- Contractual or statutory requirements
- Constructive - acknowledging a potential burden
- Equitable - from moral or ethical considerations
Equity
A residual interest in an entity that remains after deducting liabilities form assets
How is revenue/income defined in ASPE compared to IFRS
ASPE: revenue is defined as increases in economic resources, which result form ordinary operations
IFRS: Income is defined as increases in assets or decreases in liabilities, that result in increases to equity, other than those relating to contributions from shareholders
How are expenses defined in ASPE compared to IFRS
ASPE: decreases in economic resources that result from ordinary revenue-generating activities
IFRS: No distinction between ordinary revenue-generating activities and losses. Focuses on decreases in assets or increases in liabilities, that result in decreases in equity.
How are gains/losses defined in ASPE compared to IFRS
ASPE: increases/decreases in equity from an entity’s peripheral or incidental transactions except revenues/expenses and owner’s activity.
IFRS: revenues and gains are grouped together under income (they are not separately defined), and expenses and losses are grouped together under expenses.
Items included in FS (IFRS vs ASPE)
IFRS
1. statement of financial performance
OR
Statement of profit and loss and statement of other comprehensive income (OCI)
2. Statement of financial position
3. Statement of changes in shareholders’ equity
4. statement of cash flows
ASPE:
1. Income statement (OCI does not exist)
2. Balance sheet
3. Statement of retained earnings
4. Cash flow statement
What is other comprehensive income (OCI)
includes all changes in equity except for net income and owner’s investments and distribution
10 Foundational Principles
Recognition/Derecognition
1. Economic entity assumption
2. control
3. revenue recognition and realization principles
4. matching principle
Measurement
5. periodicity assumption
6. monetary unit assumption
7. going concern assumption
8. historical cost principle
9. Fair value principle and value in use
Presentation/Disclosure
10. Full disclosure principle
Recognition (def)
the act of including something on the statement of financial position or income statement
When are elements of FS recognized ASPE VS IFRS
ASPE:
1. meet the definition of an element
2. are probable
3. are reliably measurable
IFRS: is it useful
1. meet the definition of an element
2. provide relevant information that faithfully represents the underlying transaction or event
Derecognition (def)
the act of taking something off the statement of financial position or income statement
When are elements derecognized
Assets: when control is given up
Liabilities: when the obligation is extinguished
- Economic Entity Assumption
means an economic activity can be identified with a particular unit of accountability.
Determining factor: who has control?
- Control (ASPE vs IFRS)
ASPE: control is the continuing power to determine strategic decisions without the cooperation of others
criteria:
1. whether the entity can be unilaterally dissolved by the company
2. whether others have more than 10% ownership
IFRS: investors have control over an investee when it has:
1. power over the investee
2. rights to returns from its involvement with the investor
3. ability to affect the amount of the investors’ returns
control is assessed through exposure to the risks and rewards of the entity - not just be ownership of the shares
- Revenue recognition principle (ASPE)
income statement approach - revenue is recognized when
1. risks and rewards have passed and/or the earnings process is substantially complete
2. revenue is measurable
3. revenue is collectible
- Revenue recognition principle (IFRS)
Balance sheet approach - transaction occurs when entity enters the contract
5 step approach
1. Identify the contract with the customer
2. Identify the performance obligations
3. Determine the transaction price
4. Allocate the price to each performance obligation
5. Recognize revenue when each performance obligation is satisfied
- Revenue realization principle (realized vs realizable)
revenues are realized when products, merchandise or other assets are exchanged for cash
revenues are realizable if the assets received or held can be readily converted into cash or claims to cash
When are assets readily convertible
if they can be sold or interchanged in an active market
1. at a price that is readily determinable and
2. there is no significant additional cost
- Matching principle
Cause and effect relationship between money spent to earn revenues and the revenues themselves
the effort (expenditure) is matched to the accomplishments (revenues)
Measurement uncertainty
when a value cannot be objectively measured due to
1. existence uncertainty: difficulty in determining whether an asset or liability exists or not
2. Outcome uncertainty: difficulty in determining future outflows and inflows
Measurement basis (ex)
historical cost, current cost
- Periodicity Assumption
economic activity of an entity can be divided into artificial time periods for reporting purposes
ex: one month, one quarter, one year
- Monetary Unit Assumption
money is the common unit of measure of economic transactions
- Going concern Assumption
Assumption that a business enterprise will continue to operate in the foreseeable future
- Historical Cost Principle
Transactions are measured at the amount of cash (or equivalents) paid or received, or the fair value of the initial transaction
3 basic assumptions of historical cost
- represents a value at a point in time
- results from a reciprocal exchange
- Exchange includes an outside arm’s-length party
When can historical cost cannot be used
- Nonmonetary or barter transactions (no cash or monetary consideration)
- Nonmonetary, non-reciprocal transaction (no exchange)
- related party transactions
- Fair value principle
reflects the current cash equivalent
At acquisition, historical cost =
fair value
Fair value (IFRS)
price that would be received to sell an asset or paid to transfer a liability in a orderly transaction between market participants at the measurement date
Fair value (ASPE)
amount of consideration that would be agreed upon in an arm’s length transaction between knowledgeable, willing parties who are under no compulsion to act
Market-based vs entity specific value
market based value - how market participants would value the item in question (IFRS)
entity-specific value - PV of the future cash flows expected from the asset (entity-specific)
- Full Disclosure Principle
general practice of providing information that is important enough to influence an informed user’s judgement and decisions
6 disclosure principles for the MD&A
- view through management’s eyes
- supplement and complement information in the FS
- fair, complete, and balanced information that is material to decision-makers
- outline key trends, risks, and uncertainties that may effect the company in the future
- Explain management’s plan for long- and short-term goals
- be understandable, relevant, comparable, verifiable, timely
levels of the conceptual framework
First level: objectives
Second level: qualitative characteristics and elements
Third level: 10 Fundamental principles
Differences between ASPE and IFRS
- Less stringent standards under ASPE
- Naming conventions for FS
- Definitions for the elements
- Criteria for revenue recognition
- Definition of control
- Definition of fair value
Which quality of financial information makes it possible for users to confirm or correct prior expectations
feedback value
Qualitative factors
- Relevance
- Representational faithfulness
- Completeness
- Neutrality
- Freedom from error
- Comparability
- Verifiability
- Timeliness
- Understandability
What is relevance
Must make a difference in a decision
verifiability
demonstrates that independent measurers, using the same measurement measures, obtain similar results
freedom from error
information is accurate and unaffected by opinions of stakeholders
feedback value
relevant information helps users confirm or correct prior expectations
representational faithfulness
A qualitative characteristic of accounting information that represents economic reality. It is transparent, complete, neutral, and free from material error and bias.
Understandability
The quality of information that permits reasonably informed users to perceive its significance.
Comparability
What occurs when information that has been measured and reported in a similar manner for different companies is considered comparable.
Predictive value
A characteristic of accounting information that helps users make predictions about the ultimate outcome of past, present, and future events.
neutrality
The quality of accounting information that ensures faithful representation by being factual, truthful, and unbiased.
Completeness
The quality of accounting information that makes it reliable by including all information necessary to provide an accurate portrayal of events and transactions.
Timeliness
A characteristic of relevance that states that information should be available for decision-makers before it loses its capacity to influence their decisions.
Consistency
What occurs when a company applies the same accounting treatment to similar events from period to period.
4 qualitative characteristics that are related to both relevance and representational faithfulness
- comparability
- verifiability
- timeliness
- understandability
