Conceptual Framework for Financial Reporting, Objective, Assumption, Constraint, Elements Flashcards
According to standard setters, what is the conceptual framework? What does it ensure?
The conceptual framework is “a coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function, and limits of financial accounting statements.” In other words, the conceptual framework of accounting guides decisions about what to present in financial statements, alternative ways of reporting economic events, and appropriate ways of communicating this information.
The conceptual framework ensures that existing standards are clear and consistent, provides guidance in responding to new issues and developing new standards, assists accountants in the application of accounting standards, and increases financial statement user’s understanding of and confidence in the financial statements.
Why don’t all countries use the same conceptual framework or set of accounting standards? Why was IASB formed?
They can, and do, differ significantly from country to country. This lack of uniformity has arisen over time because of differences in legal systems, in processes for developing standards, in government requirements, and in economic environments.
The International Accounting Standards Board (IASB)- the standard-setting body responsible for developing International Financial Reporting Standards- was formed to try to reduce these areas of difference and unify global standard setting. Currently, nearly 125 countries either require or permit the use of IFRS. p.71 for the rest.
What 5 of many selected portions of the conceptual framework ?
Objective of financial reporting, Underlying assumption, cost constraint, Elements of financial statements, Qualitative characteristics of useful financial information, and Measurement and recognition criteria of the elements of financial statements.
~Take note that some of these conceptual frameworks are still being finalized.
What is the Objective of Financial Reporting? Who are the main users of financial reporting?
It is to provide financial information about a company that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the company. Those decisions involve buying, selling, or holding equity and debt instruments and providing or settling loans and other forms of credit.
Although a wide variety of users rely on financial reporting, investors, lenders, and other creditors are identified as the main users of financial reporting.
What is the economic entity concept? What is an economic (reporting) entity?
The concept that the accounting for n economic entity’s activities be kept separate and distinct from the accounting for the activities of its owner and all other economic entities.
An economic (reporting entity) could be one company or a collection of companies consolidated under common ownership.
Businesses require cash to start up, maintain operations and grow. Cash or capital comes from?
Cash or capital comes from investors, lenders, and the company’s revenue-generating activities.
To make decisions about allocating capital (such as about investing or lending), users look for what information? How do they assess this ability? Financial statements must give what sorts of information?
Users look for information in the financial statements about a company’s ability to earn a profit and generate future cash flows.
To assess this ability, users read the financial statements to determine whether or not management acquired and used the company’s resources in the best way possible.
Consequently, financial statements must give info about:
- Economic resources (assets) and claims on the economic resources (liabilities and equity)
- Changes in economic resources and in claims on the economic resources
- Economic performance
Financial statements are prepared using the Accrual basis of Accounting. Define and provide an example.
Under the accrual basis of accounting, the effects of transactions on a company’s economic resources and claims are recorded in the period when a transaction occurs and not when cash is received or paid. For example, a law firm would record revenue in the accounting period when the legal services are provided to the client and not necessarily in the accounting period when the client pays for the services.
UNDERLYING ASSUMPTION:
A key assumption, the Going Concern Assumption, creates a foundation for the financial reporting process. Define it.
The going concern assumption assumes that the company will continue operating for the foreseeable future; that is, long enough to carry out its existing objectives and commitments. Although there are many business failures, if a business has a history of profitable operations and access to financial resources, it is reasonable to assume that it will continue operating long enough to carry out its existing objectives and commitments.
UNDERLYING ASSUMPTION:
If the company is a going concern then? If it’s not a going concern, then?
If a company is assumed to be a going concern, then financial statement users will find it useful for the company to report assets, such as buildings and equipment, at their cost minus accumulated depreciation (carrying amount).
If the company is not a going concern, then the carrying amount will not be relevant. Instead, the financial statement user would want to know what the assets can be sold for or their net realizable value. Furthermore, if the company is not a going concern, the classification of assets and liabilities as current or non-current would not matter. Labelling anything as non-current would be difficult to justify. The only time the going concern assumption should not be used is when liquidation is likely. If it cannot be assumed that the company is a going concern, this needs to be explicitly stated in the financial statement.s
COST CONSTRAINT:
What is the cost constraint?
The cost constraint is a pervasive constraint that ensures the value of the information provided is greater than the cost of providing it. That is, the benefits of financial reporting information should justify the costs. For example, in the section on the qualitative characteristics of useful financial information, we will recognize that to be useful, the financial information must be complete. To achieve completeness, accountants could record or disclose every financial event that occurs and every uncertainty that exists.
COST CONSTRAINT:
Why did the AcSB applied this constraint? How do ASPE conceptual framework refer to this constraint?
The AcSB applied this constraint when it adopted IFRS for public companies and ASPE for private companies. Users of private companies’ financial statements generally require less information that users of public companies’ financial statements. The aboard recognized that the cost to private companies of providing financial statements prepared under IFRS was greater than the benefits. Consequently, the board developed ASPE, which is simpler and requires less disclosure than IFRS.
The ASPE conceptual framework refers to this constraint as the benefit versus const constraint.
ELEMENTS OF FINANCIAL STATEMENTS:
The elements of financial statements include? Define each.
Assets, liabilities, equity, revenues and expenses.
Assets: an asset is a resource controlled by a business as a result of a past event that is expected to provide future economic benefits to the company.
Liabilities: 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.
Equity: Equity is the residual interest in the assets of the entity after deducting all its liabilities (Assets - Liabilities = Equity)
Revenues: Revenue is an increase in assets or a decrease in liabilities that results in an increase in equity, other than those relating to contributions from owners, including both revenue and gains. Under IFRS, revenue also includes gains. Revenue arises in the course of the company’s ordinary activities, while gains may or may not arise from ordinary activities.
Expenses: Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to owners. Under IFRS, expenses also includes losses. Expenses arise from the company’s ordinary activities. Losses may or may not arise from the company’s ordinary activities.
(Decreases of assets or increases in liabilities that result in decreases in equity [other than owner’s withdrawals], including losses).
Under ASPE, gains and losses are defined in separate categories from revenues and expenses, but the basic definitions are similar to those under IFRS.
Describe the conceptual framework of accounting and explain how it helps financial reporting.
The conceptual framework is a coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribe the nature, function, and limits of financial accounting statements. It guides choices about what to present in financial statements, decisions about alternative ways of reporting economic events, and the selection of appropriate ways of communicating such information.
Is the conceptual framework applicable to companies reporting under IFRS, under ASPE, or both?
The conceptual framework is applicable to companies reporting under IFRS and ASPE.
What is the main objective of financial reporting?
Although there are many users of financial statements, why does the objective identify the specific users?
The main objective of financial reporting is to provide information that is useful for decision-making. More specifically, the conceptual framework states that the objective of general purpose financial reporting is to provide financial information that is useful to present and potential investors, lenders, and other creditors in making decisions about a business.
The objective identifies the specific users to ensure that all possible points of view are included in fulfilling the needs of users.
Explain the going concern assumption.
How does the going concern assumption support the use of the cost basis of accounting and the classification of assets and liabilities as current and non-current?
Going Concern: The company will continue operating for the foreseeable future – long enough to achieve its goals and respect its commitments. The going concern assumption is necessary because many accounting principles require us to assume that a company is going to continue to operate in the future. For example, if a company was not going to continue to operate into the future, depreciation of long-lived assets would not be justifiable and appropriate.
The going concern assumption supports reporting the cost of an asset because if a company is not going to sell its assets, cost (the amount given up to acquire the asset) becomes more relevant than fair values. When a company is no longer a going concern, assets would be valued at fair or liquidation values rather than at historical cost. The timing of when the asset will be converted to cash or used in operations and when liabilities are to be paid determines their classification on the statement of financial position. Since the business is expected to remain in operation for the foreseeable future, these elements can continue to be reported in accordance with their respective current or non-current classifications.
Describe the cost constraint on financial reporting.
The cost constraint means that the costs of obtaining the accounting information should not exceed the benefits derived from it. For example, a small company could issue interim statements monthly instead of quarterly, but the benefits provided to users would probably be outweighed by the additional costs associated with preparing and presenting the extra information.
Isabelle believes that the same GAAP should be used by every company, whether large or small and whether public or private. Do you agree? Explain.
I disagree. The costs of applying IFRS to small or non-publicly traded companies exceed the benefits. As a result, a simplified version of GAAP has been developed and set in place for these companies, referred to as ASPE.
Identify and explain the two fundamental qualitative characteristics of accounting information.
The fundamental qualitative characteristics are relevance and faithful representation.
Accounting information has relevance if it makes a difference in a decision. Relevant information has predictive value or confirmatory value. Faithful representation shows the economic reality of events rather than just their legal form. Faithful representation is achieved if the information is complete, neutral and free from material error. Complete information includes all information necessary to show the economic reality of the transaction. Accounting information is neutral if it is free from bias intended to attain a predetermined result or encourage a particular behaviour. Accounting estimates must also be based on the best available information and be reasonably accurate to be considered free from material error.
Explain the concept of materiality.
How is materiality related to the qualitative characteristic of relevance?
The concept of materiality means that an item may be so small that failure to follow generally accepted accounting principles will not influence the decision of a reasonably prudent investor or creditor. For example, the expensing of a $20 calculator would not be in accordance with GAAP since the calculator will probably have a useful life beyond one year. However, the cost is so insignificant that it will have no impact on users’ decisions and therefore, this GAAP deviation is not considered to be material.
In order to be relevant to a financial statement user, a transaction or amount must make a difference to the user when making a decision. If an omission or misstatement does not influence a user, it is said to be immaterial or not material. Materiality is not only a matter of size, but also has to do with the nature of the omission or misstatement (for instance, illegal acts).
Identify and explain the four enhancing qualitative characteristics of accounting information.
The four enhancing qualitative characteristics are comparability, verifiability, timeliness and understandability.
Accounting information about a company is most useful when it can be compared with accounting information about other companies. Comparability results when different companies use the same accounting principles. Comparability is easier when accounting policies are used consistently by a business from one accounting period to the next. Information is verifiable if two knowledgeable and independent people would agree that it faithfully represents the economic reality. The usefulness of accounting information is enhanced when it is provided on a timely basis, when it is still highly useful for decision-making. Information in financial statements must be capable of being understood by users. Understandability is enhanced by classified, clear, and concise presentation. It is assumed that the average user has a reasonable understanding of accounting concepts and procedures, and general business and economic conditions.
The qualitative characteristics should be applied in a certain order. Identify the order and explain why it matters.
The two fundamental qualitative characteristics should be applied first before the four enhancing characteristics. Relevance should be applied first, followed by faithful representation. Relevance is applied first to identify which information would impact a user’s decision. Faithful representation is applied second to ensure the relevant information represents its substance. Comparability, verifiability, timeliness and understandability enhance the communication of information that is relevant and representationally faithful.
Identify the differences between the qualitative characteristics identified in the conceptual framework for IFRS and the conceptual framework for ASPE.
While the conceptual framework for IFRS identifies two fundamental and four enhancing characteristics, the framework for ASPE identifies four principal qualitative characteristics: understandability, relevance, reliability, and comparability. ASPE also recognizes conservatism as a qualitative characteristic of financial information.
