Day 2 - Chapter 5 Flashcards
What is the objective of financial statement?
to provide financial information about reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions relating to resources to the entity
What are the two fundamental characteristics?
relevance
faithful representation
Relevance
Financial information is useful if it can assist users decision-marking by helping them evaluate past, present and future events or by confirming, or correcting their existing valuation
What does relevence mean?
info must have:
predictive value
confirmatory value
Predictive Value
helps users in assessing the future of the business
Confirmatory Value
helps users in confirming past predictions
When can the information of relevance be helpful in?
nature or materiality
What does the information need to be to be Faithful Representation?
complete
neutral - prudent
free from error
showing substance over form- transactions must be presented according to their economic substance rather than legal form - commercial reality overrides legal reality - eg leased assets
What is the prudent approach in accounting?
we recognise expenses and liability earlier than recognising income and assets
we recognise assets/income only when certain
we recognise liability/expenses when we know its a possibility
Enhancing Characteristics
nice to have
Examples for enhancing characteristics - qualitative
comparability - can compare info year on year and to other businesses
verifiability - info can be backed up by independent 3rd party
timeliness - up to date info is more useful
understandability - info must be understandable to be useful
What is an underlying assumption?
going concern - business with continue for the foreseeable future - at least 12 months from reporting date
Why do we follow a pro forma?
to provide a summary of transactions over a period of time
What do we do if we haven’t followed one?
we have to disclose it - reasons why
if we think that there is a better way to disclose - there is a true and fair override
have to estimate to financial information
What is comparative information?
we have to list last years balance along with this years
What is the accruals concept?
accruals concept requires that transactions and events have occurred are recognised when they occur and not when the business receives or pays cash
What does the accruals concept allow for?
costs incurred in generating income are matched against the revenue they have generated
What is the going concern concept?
continuing operations in foreseeable future
no intention or necessity to liquidate
What does the going concern concept mean?
it means that assets do not need to be valued on a break-up basis - the value which they can be sold separately by the business if the business were to liquidate
What do we need to do if the management does not think that the entity is a going concern?
needs to be disclosed
- the fact itself
- the basis on which the accounts have been prepared
- the reasons why the entity is no longer a going concern
What does it mean if we are accounting on a break up basis?
there will be no non-current assets or liabilities
may show for less than original cost
Materiality
threshold of error
What can affect materiality?
depends on size and effect of the item judged
How is materiality determined?
its subjective
