Chapter 2: The Conceptual Framework Flashcards
Objective of the conceptual framework
To lessen the different circumstances that lead to the use of various definitions and recognition criteria which are used for the preparation of financial statements.
Objective of general purpose financial reporting
To provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors (primary users) in making decisions about providing resources to the entity.
Qualitative characteristics of useful financial information
Features that make information in financial statements useful for the users.
Name two fundamental qualitative characteristics
- Relevance
- Faithful representation
Relevance
- Predictive value (can be used to make one’s own predictions)
- Confirming value (provides feedback on previous evaluations)
Faithful representation
- Completeness
- Neutrality
- Free from error
4 enhancing qualitative characterisitics
- Comparability
- Verifiability
- Timeliness
- Understandability
Comparability
Users want comparable information to judge tendencies over time and between similar entities to evaluate their own relative financial position.
Verifiability
Verifiability helps assure users that information faithfully represents the economic events it purports to represent.
Timeliness
Information must be available on a timely basis for users to influence their decisions.
Understandability
Information must be reasonably understandable to users.
Underlying assumptions to the preparation of financial assumptions.
- Accrual basis
- Going concern
Accrual basis
Transactions and other events are accounted for when they occur and not as late as the date on which cash is received or paid.
Going concern
Financial statements are prepared with the assumption that the entity will continue to be in business in the foreseeable future.
Five elements of financial statements
- Assets
- Liabilities
- Equity
- Income
- Expenses
Asset
A resource that is controlled by the entity as a result of events in the past and from which future economic benefits will flow to the entity.
Two broad groups of assets
- Non-current assets (property, vehicles etc.)
- Current assets (cash, inventory, etc.)
Liability
A present obligation of an entity arising from past events, the settlement of which is expected to result in an outflow of resources from the entity.
Two broad groups of liabilities
- Non-current liabilities (long-term loans)
- Current liabilities (creditors, bank overdrafts, provisions).
Equity
The residual interest in the assets of the entity after deducting all its liabilities.
Two subdivisions of equity
- Capital (Contributions minus withdrawals
- Profit/loss
Income
Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets, or decreases in liabilities that result in increase in equity, other than those relating to contributions by equity participants.
Revenue
Income that arises in the course of ordinary activities of an entity (sales, fees, interest, dividends, royalties, rent).
Gains
Income that doesn’t necessarily arise from the ordinary activities of an entity.
(profit on sales of assets, etc.)
Recognition
The process of including an item in the balance sheet or income statement.
The item complies with the definition of an element that satisfies the criteria for recognition.
Recognisable item
- it is probable that future economic benefits, closely related to the item, will flow to or from the entity
- the item has a cost or value which could be measured reliably
Fair value
The amount for which an asset could be exchanged, or a liability settled, between two knowledgeable, willing parties in an arm’s length transactions.
Conditions for recognising revenue from the sale of goods:
- The entity has transferred to the buyer the significant risks and rewards of ownership of the goods.
- The entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold.
- The amount of revenue can be measured reliably
- It is probable that economic benefits associated with the transaction will flow to the entity
- The costs incurred or to be incurred in respect of the transaction can be measured reliably
Conditions for the reliable estimation for the outcome of a transaction:
- The amount of revenue can be measured reliably.
- It is probable that the economic benefits associated with the transaction will flow to the entity.
- The stage of completion of the transaction can be measured reliably.
- The costs incurred for the transaction and the costs to complete the transaction can be measured reliably.
Measurement
The process of determining the amount at which the elements of the financial statements are recognised and reflected in the balance sheet and the income statement.
Measurement bases used in financial statements
- Historical cost
- Current cost
- Realisable value
- Present value
Historical cost of assets
Cash/cash equivalents paid to acquire the asset.
Historical cost of liabilities
Settlement amount
Current cost of an asset
Cash/cash equivalents to acquire the same asset currently
Current cost of a liability
Undiscounted cash/cash equivalents needed to settle the obligation currently.
Realisable value of an asset
Cash/cash equivalents that could currently be obtained by selling the asset in an orderly disposal.
Realisable value of a liability
Cash/cash equivalents expected to be paid to settle the liability in the ordinary course of business.
Present value of assets
Present discounted value of the future net cash inflows expected to be generated in the normal course of business.
Present value of liabilities
Present discounted value of the future net cash outflows required to settle the liabilities in the normal course of business.
The entity concept
The fundamental concept in accounting:
The difference between the enterprise/entity and its owners/shareholders.
A separate set of financial records and financial statements are required for each entity as well as for the owners of the entity.
