Chapter 2 Flashcards
What is the conceptual framework?
Conceptual framework is a system of interrelated objectives and fundamentals that leads to consistent standards and prescribes the limitations and functions of financial statements.
Why is the conceptual framework useful?
- Standards must be built on an established concepts and objectives that the framework provides.
- Increases the users’ understanding and confidence in financial reporting and enhances the comparability of different companies’ statements.
- it is easier to solve new and emerging problems.
What are the three levels of a conceptual framework?
First Level: Objectives -identify the goals and purposes of accounting.
Second Level: Qualitative Characteristics that make accounting information useful and the elements of the financial statements.
Third Level: Foundational principles used in establishing and applying accounting standards.
What is the objective of financial reporting and the usefulness of the financial information?
Financial reporting objective is to be able to communicate information useful to investors, creditors and other users.
This financial information is then used to make decisions on how to allocate resources effectively.
What is the purpose of qualitative characteristics in financial reporting? What are the two sub-categories?
The Qualitative characteristics help ensure that the information on the statements are useful to the user.
There is Fundamental and Enhancing Qualitative Characteristics.
What are the Fundamental Qualitative Characteristics? Define them.
Relevance and Representational Faithfulness
Relevance is information that can make a difference in the decision of the user.
Representational Faithfulness means that the information in the statements faithfully reflect the company and the underlying economic substance (beyond the numbers)
What are characteristics of relevant information? How is it achieved?
Relevant information have predictive value, confirmatory value, and materiality.
Predictive value means that if a user was to look at the information they can somehow predict the outcome of the company’s past, present and future event. Predictive value is achieved by separating income from continuing operations from discontinued operations.
Feedback/Confirmatory Value means that if the user looks at the information they can confirm their expectations with the company because they can see where the numbers are coming from.
Materiality: this is when information is important enough to make a difference in the decision of the user.
What are the characteristics of information that is represented faithfully?
Completeness, Neutral, and Free from Error
Completeness is when the statements has all information needed to fully portray the underlying events and transactions.
Neutrality is when information is not selected to favor a specific party over another. Most importantly, estimates must be unbiased.
Freedom of Error means that the information is reliable.
What are the steps to ensure that the fundamental characteristics of useful information are present?
- Identify the economic event or transaction.
- Identify the type of information about that transaction or event that would be relevant and can be faithfully represented.
- Assess whether the information is available and can be faithfully represented.
What are the Enhancing Qualitative Characteristics?
Comparability, Verifiability, Timeliness and Understandability.
Comparability means that you can compare the performance of a company from year to year but also with the performance of other companies.
Verifiability means that users can get the same results if they record the transactions themselves.
Understandability means taht users that have reasonable knowledge of business and accounting can understand the information because of its quality and clarity.
Timeliness means that information must be available to users when users are needed to make a decision based on the information.
What is the main difference between fundamental and enhancing characteristics? And what is its effect on trade-offs?
Fundamental characteristics must always be present in all financial statements, however, it is not always possible to have all of the enhancing characteristics.
That is the trade-off.
For example, in order to get better information, a company might switch accounting policies to better reflect revenue. The pursuit for relevant information is at the cost of comparability.
What are the basic elements of financial statements?
Assets, Liabilities, Equity, Revenue, Expenses, Gains and Losses.
What are the three characteristics of an asset? Define Control.
- represents a present economic resources - a right that has the potential to produce benefits.
- The entity recording the asset has control over it. This means that the company has the ability to decide how to use the asset and receive the benefits.
- The resource was acquired from a past transaction or event.
What are the three characteristics of liabilities?
- They represent a present duty or responsibility.
- The duty or responsibility obligates the company to transfer an economic resource.
- The liability resulted from a past transaction or event.
Define constructive and equitable liability.
Constructive Liability: liabilities that arise through past or present practice that the company acknowledges as a potential economic burden.
Example: promising people that they will accept returns of a product.
Equitable obligations: arise due to moral or ethical considerations.
Example: promising people that they will be trained if they get laid off.
What is Equity?
considered a residual interest that remains after deducting liabilities from assets. This represents an ownership interest.
What are Revenues/Income and what is the difference in ASPE and IFRS.
Under ASPE, it is called revenues. it is defined as an increase in economic resources. Either by inflow, enhancements of assets or settlement of liabilities that results from the company’s ordinary activities.
Under IFRS, it is called income, and is defined as increases in assets or decreases in liabilities other than those relating to contributions from shareholders.
What are Expenses?
Expenses are decreases in economic resources, either by outflows, reduction of assets, and incurrence of liabilities that result from an entity’s ordinary revenue-generating activities.
What are Gains and Losses?
Gains are increases in equity (net assets) from activities outside the company’s ordinary activities.
Losses are decreases in equity from activities outside the company’s ordinary activities.
What is the purpose of the foundational principles?
These principles help explain, which, when and how financial elements should be recognized, measured and presented by the accounting system.
What are the 3 subcategories of foundational principles and assumptions? Define them.
Recognition/Derecognition
Measurement
and Presentation.
Recognition: this is the act of including elements on the entity’s financial statements.
Measurement: measurement refers to what number we will put in the financial statement and why.
Presentation: how we should present that information into the statements.
