Chapter 2 Flashcards
conceptual framework
coherent system of interrelated objectives and fundamentals
the conceptual framework can lead to
consistent standards and prescribe the nature, function and limits of financial accounting statements
Benefits of conceptual framework
- Standard setters (IASB, AcSB, FASB) can issue more useful and consistent standards in the future
- problems should be served more consistently and rapidly with reference to the framework for theory
- understanding and confidence in financial reports increased
- comparability between financial statements will increase
Framework is used by
- standard setters to divide new standards
2. people in the industry when applying professional judgement
Pillars of conceptual framework
- Objectives (take into account reporting environment, regulations)
- Qualitative Characteristics (Primary and enhancing)
- Elements of financial statements
- Foundational principles
IFRS and ASPE have different frameworks because
IFRS: more regulations, users
ASPE: smaller companies, framework towards owners and lenders
Objectives
influenced by a number of factors: reporting and regulatory environment, competition, stakeholder requirements
Qualitative Characteristics
Overriding criterion is that it is useful, must be understandable
Primary qualities
Relevance and Representational Faithfulness (reliability)
Relevance
Capable of making a difference in a decision.
Relevant if it has:
- predictive value
2. Feedback value (confirmatory value)
Representational faithfulness
information is transparent, reflects economic reality go event or transaction: shows what its supposed to show, no more no less
Representational if it is
- complete
- neutral: can be independently verified, free from material error or bias (if someone came in to verify would get the same amount)
Enhancing qualities
- Comparability (sometimes sacrificed for consistency)
- Verifiability
- Timeliness (necessary for relevance)
- Understandability (anyone with reasonable understanding would comprehend the statements)
Asset
resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity
Liability
A liability is a present obligation of entity arising from past events, the settlement of which will result in outflow of resources embodying economic benefit
Equity
residual interest in assets after deducting liabilities
Elements of statements relating to performance
- revenues, sales
- expenses
- gains and losses
Revenues/sales
income increased in economic benefit in form of inflows/enhancements of assets or decrease in liabilities
–> increase in equity excluding investment from equity
Expenses
decreases in economic benefits in form of outflows or depletion of assets or incurrence of liability –> decrease in equity excluding dividends
Gains and losses
revenues and expenses that result from peripheral activities (outside of main line of business)
Recognition of the elements of financial statements
process of incorporating in B/S or I/S an item that meets the definition of an element and satisfies criteria for recognition
criteria for recognition
- it is probable that any future economic benefit associated with item will flow to or from the entity
- item’s cost or value can be measured with reliability
An asset is recognized on the B/S when
probable that the future economic benefit, controlled by the entity, arising from past transactions
Definition of asset is changing
- asset must be a present economic resource
- company must have a right to access to this resource where others don’t
Impairment of assets
assets should be tested for impairment (loss in value) regularly. If the value is less than in the books –> must be written down
A liability is recognized on B/S when
probable that outflow of resources embody economic benefit will result from the settlement of a present obligation and amount measured reliably : an unavoidable duty arising from past transaction
Definition of liability is changing
- present obligation
- obligation is enforceable (legally or constructively)
Income is recognized on I/S when
increase in future economic benefit related to an increase in an asset or decrease of liability can be measured reliably (simultaneous with recognition of increase in asset or decrease in liabilities)
Expenses are recognized on I/S when
decrease in future economic benefit relating to a decrease in asset or increase in liabilities and measured reliably. (simultaneous with recognition of decrease in asset or increase in liabilities)
obligations may be
financial or non-financial
i.e. financial obligations
accounts payable
i.e. non-financial obligations
conditional pending lawsuit; result of performance obligations
Conditional obligations
may or may not become liabilities
Under IFRS, another obligations is added
constructive obligations
Constructive obligations
not legally enforceable, seen as a moral obligation, when past practice has created expectation from customer that certain obligations will be honoured (warranty)
Comprehensive Income and Accumulated other comprehensive income IFRS
Income statement + OCI
OCI
unrealized gains and losses on certain items that bypass the income statement on available for sale securities, when sold they get reclassified as income
Net income from I/S goes to
retained earnings on B/S on IFRS and ASPE
OCI elements go to
AOCI section of shareholder equity on B/S
Foundational principles
- Economic entity
- Control
- Revenue recognition
- matching
- Periodicity
- Monetary unit
- Going concern
- Historical cost
- Fair value
- Full disclosure principle
Control
assets not controlled by entity not recognized since company may not have access to the benefits
Revenue recognition
generally recognized when 1) risks and rewards were passed on or earnings process is complete, 2) measurement is reasonably certain and 3) collectability is reasonably assured
Matching
efforts (expenses) should be matched with the revenues
Practical rules for expense matching
- when direct association, costs expenses against related revenues
- When association exists but difficult to determine, rational and systematic allocation
- when little or any association –> expense
- when a cost does not meet definition of asset –> expense
Periodicity
activities of an enterprise can be divided into artificial time periods
Monetary unit
money is common denominator = appropriate accounting measurement
Going concern
assumption that business will continue in operations for foreseeable future and use assets and pay off liabilities in a normal manner
If a company has going concern issues
bring assets to their fair values at the balance sheet date
Accruals and deferrals are justified on basis of
the going concern approach
Historical cost
recognized at amount paid when received (verifiable)
Fair value
today’s adjusted value.. slowly more prevalent now when it is more relevant
Full disclosure
revealing everything in financial statements, if sufficient importance to influence the judgement and decision of informed reader –> use of notes and supplementary information
Some tradeoffs when applying the conceptual framework
- reliability and relevance (historical value)
- relevance for conservatism (value lower than fair value)
- timeliness for verifiability: accruals are not verifiable but made on time
- comparability for consistency
Auditor focus on
verifiability
balance between benefit and cost
benefits derived from information should exceed cost of providing it
balance between qualitative characteristics
aim is to achieve proper balance to meet objective of financial statements
Accrual accounting is application of
matching principle
Depreciation expense is application of
matching principle and justified by going concern
deferrals like prepaid expenses and unearned revenues are justified by
the going concern principle
bad debt expense based on
matching principle
adjusting entries based on
matching principle
closing entries justified on
periodicity concept
information must be timely to be relevant but
timeliness does not imply relevant
accruals are said to be
matched but not paid/collected
prepaid expenses are said to be
paid but not matched to a given period
Measurement bases
- historical cost
- current cost (to replace it)
- Net realizable (settlement)value
- Present value (discounted)
