Foundational Principles Flashcards
1.4: Describe the foundational principles of accounting
1
Q
What is the conceptual framework’s third level, and what does it implement?
A
Foundational principles, implement the basic objectives of the first level
2
Q
What do the concepts of foundational principles help explain?
A
Which, when, and how financial elements and events should be recognized, measured, and presented/disclosed by the accounting system
3
Q
What do the foundational principles act as a guideline for?
A
Developing rational responses to controversial financial reporting issues
4
Q
How have foundational principles changed over time?
A
Evolved over time, and the specific accounting standards issued by standard setters are based on these concepts in a fundamental way
5
Q
When is it important to decide at which level these concepts will be applied? What is this calle?
A
Recognizing and measuring rights (assets) and obligations (liabilities). This is called the unit of account
6
Q
What is the unit of account?
A
The level at which an asset such as property, plant, and equipment is recognized (that is, the extent to which separate components are measured and recorded).
7
Q
Describe how unit of account is recognized for a building in accounting.
A
Owner building has right to use, right to pledge, and right to sell. Rights grouped together and recognized as one asset: property, plant, and equipment. The building is therefore the unit of account
8
Q
What determines the unit of account?
A
The accounting standard itself
9
Q
How is the accounting standard itself determines the unit of account. Give an example with depreciation applied to an asset like an airplane.
A
When depreciating an asset like an airplane, the total cost is divided into its component parts, and each component is depreciated separately.
An airplane would have numerous components, including the engine, body, and cabin interior equipment
10
Q
What is an example of a unit of account for an airplane?
A
The airplane itself serves as a unit of account for recognition purposes, while its individual components are used for measurement purposes during depreciation.
11
Q
Do accounting standards allow for different units of account for recognition and measurement?
A
Yes, it is acceptable to use one unit of account for recognition purposes and another for measurement purposes (such as depreciation).
12
Q
How are the components of an airplane treated in terms of depreciation?
A
The components of an airplane, such as the engine, body, and cabin interior equipment, are depreciated separately from the whole aircraft.
13
Q
What rights does the owner of a building have according to the content?
A
The owner of a building has the right to use, pledge, and sell the property.
14
Q
What do the basic foundational principles underlying the financial accounting structure also include?
A
Assumptions and conventions
15
Q
Why have the basic foundational principles become grouped together?
A
Because it is often difficult to put a label onto them and accounting practices vary
16
Q
The label of the basic foundational principles isn’t important rather…?
A
It is the substance of the concept and how it provides a solid foundation for accounting standard setting that is important
17
Q
What are the 10 Foundational Principles and Assumptions?
A
- Economic entity assumption
- Control
- Revenue recognition and realization principles
- Matching principle
- Periodicity assumption
- Monetary unit assumption
- Going concern assumption
- Historical cost principle
- Fair value principle and value in use
- Full disclosure principle
18
Q
The 10 foundational principles and assumptions are under what 3 groupings?
A
- Recognition/derecognition
- Measurement
- Presentation and disclosure
19
Q
What are the 4 principles/assumptions under recognition/derecognition?
A
- Economic entity assumption
- Control
- Revenue recognition and realization principles
- Matching principle
20
Q
What are the 4 principles/assumptions under measurement?
A
- Periodicity assumption
- Monetary unit assumption
- Going concern assumption
- Historical cost principle
- Fair value principle and value in use
21
Q
What is the principle/assumption under presentation and disclosure?
A
- Full disclosure principle
22
Q
What is recognition?
A
The process of recording a transaction in a company’s statement of financial position or income statement.
23
Q
At what 2 levels do recognition decisions occur?
A
- Macro level
- Micro level
24
Q
What recognition decisions occur at a macro level?
A
Deciding whether to consolidate investments in other entities.
25
What recognition decisions occur at a micro level?
Deciding whether and when to include specific items (e.g., assets, liabilities, revenues, expenses, gains, and losses) in financial statements.
26
What are executory contracts?
Agreements between two or more parties under which neither party has yet performed their obligations.
27
Can you provide an example of an executory contract?
A contract to buy inventory from a supplier where neither the goods have been shipped nor payment has been made.
28
Are executory contracts typically recognized in financial statements? Why or why not?
Most are not recognized because neither party has performed under the contract (e.g., purchase orders for inventory).
29
What is an example of recognition.
Executory contracts
30
What does the conceptual framework provide for recognition?
General recognition and measurement criteria.
31
What may be used to justify whether something should be reflected in the financial statements or not in the absence of specific guidance under IFRS and ASPE?
Underlying principles
32
Historically, when have elements of financial statements been recognized?
When they:
- Meet the definition of an element (e.g., a liability).
- Are probable.
- Are reliably measurable.
33
How does ASPE handle recognition criteria?
ASPE maintains the historical criteria:
- An entity must assess if the element meets the definition
- Determine if it is probable that an inflow or outflow of resources will occur
- Confirm the element is reliably measurable
34
What significant change does the new IFRS conceptual framework introduce for recognition?
Now require:
- Meeting the definition of the element.
- Providing users with relevant information that faithfully represents the underlying transaction or event.
35
How does the new IFRS framework differ from historical recognition criteria?
No additional special recognition criteria. Principle is to recognize an element in the financial statements if the information is useful (and therefore has the fundamental qualities associated with useful information)
36
What is existence uncertainty?
Uncertainty as to whether an element exists or not (for instance, a liability).
37
What is derecognition?
The process of removing an item from a company's statement of financial position or income statement.
38
Does IFRS include probability or measurability as recognition criteria?
No, these criteria are not explicitly required under IFRS.
39
How does significant uncertainty affect recognition under IFRS?
Information may not be useful if:
- There is significant existence uncertainty (e.g., whether a liability exists).
- There is low probability of occurrence.
- Measurement of the element is uncertain.
40
What is existence uncertainty under IFRS? Give an example.
It refers to uncertainty about whether something (e.g., a liability) exists.
Example: A lawsuit where it is unclear if the company is at fault.
41
Why might a lawsuit not be recognized as a liability under IFRS initially?
If fault is unclear (existence uncertainty), information about the lawsuit may not be relevant or faithfully represent the situation. Even if fault is established, it might similarly be difficult to measure the expected damages to be paid (measurement uncertainty)
42
When might representational faithfulness not be met?
When insufficient or biased information is available, preventing users from understanding the transaction or event.
43
How can biased information be addressed?
Engaging neutral experts (e.g., lawyers for both sides) to provide more objective information.
44
When does derecognition occur for assets and liabilities?
Assets: When control is relinquished.
Liabilities: When the obligation is extinguished.
45
What is the economic entity assumption?
An assumption that a company's business activity can be kept separate and distinct from its owners and any other business units. Economic activity can therefore be identified with a particular degree of accountability.
46
Why is the economic entity assumption important for accounting?
It provides a basis for determining what to include or recognize in financial statements and what to exclude.
47
What factors often influence a company's organizational structure?
Tax considerations and legal factors.
48
What are the two additional types of organizational structures that are used by professionals in Canada?
1. Professional corporations
2. Limited liability partnerships (LLPs)
49
What are the 2 main reasons the additional types of organizational structures have evolved in Canada?
1. for tax planning, and
2. to limit liability of the partners for negligence by other partners.
50
What does LLP legislation state about a partner's liability?
A partner is not personally liable for the debts, obligations, or liabilities of the LLP resulting from another partner’s negligent acts or those under another partner’s direct supervision.
51
Does LLP legislation limit the liability of the firm as a whole?
No, the firm’s assets and insurance protection remain at risk.
52
Are partners in an LLP accountable for their own actions?
Yes, partners remain personally liable for their own actions and for those they directly supervise and control.
53
How does the liability of a partner in an LLP differ regarding the actions of other partners?
Partners are not held personally liable for the actions of other partners.
54
What are the advantages of professional corporations?
They may provide greater flexibility for tax planning.
55
How are legal entities treated for tax and legal purposes in incorporated companies?
The legal entity is the relevant unit.
Tax returns are filed, and taxes are paid based on the taxable income of each corporation.
Lawsuits are generally filed against the corporation as it is a separate legal entity.
56
How does GAAP differ from legal entity treatment when preparing financial statements?
GAAP uses a broader definition, consolidating parent companies and subsidiaries into one set of financial statements for meaningful information.
57
What is the perspective used for preparing consolidated financial statements under GAAP?
The perspective of the economic entity, grouping together assets, liabilities, and other elements under the parent company's control
58
Why are consolidated financial statements prepared?
To recognize and group assets, liabilities, and other financial elements under the control of the parent company into a single set of statements.
## Footnote
Several separate corporations may therefore be grouped together to produce the consolidated financial statements
59
Historically, how has control been defined in financial reporting?
Control has been anchored in owning more than 50% of the voting common shares of another entity.
60
How has the concept of control in financial reporting been changing?
The definition of control has evolved to reflect changes in business practices.
61
Why is control an important concept in financial reporting?
It is crucial in determining whether something meets the definition of an asset.
62
What are the three criteria for an investor to have control over an investee under IFRS 10?
1. power over the investee;
2. exposure, or rights, to variable returns from its involvement with the investee; and
3. the ability to use its power over the investee to affect the amount of the investors' returns.
63
How does IFRS 10 broaden the concept of control?
It assesses control not only through ownership of common shares but also through exposure to the risks and rewards of the entity.
64
How does IFRS 10 relate to the IFRS conceptual framework's definition of control?
IFRS 10 specifically deals with consolidation and overrides the more general definition of control in the conceptual framework.
65
How does ASPE define control?
Control is the continuing power to determine strategic decisions without the cooperation of others.
66
Are ASPE standards similar to IFRS for companies owning voting common shares in another company?
Yes, they are mostly similar in these cases.
67
How does ASPE differ from IFRS for control in certain situations, such as sales of financial instruments?
ASPE focuses on whether the other entity is "demonstrably distinct" from the company.
68
What factors are assessed under ASPE to determine if an entity is demonstrably distinct?
- Whether the entity in question can be unilaterally dissolved by the company
- Whether others have more than a 10% ownership interest
69
What is the purpose of having a high-level view of the economic entity in financial reporting?
To understand which entities are included as part of the economic entity, such as special purpose entities.
70
How does the inclusion of entities impact financial reporting under ASPE?
It influences consolidation and the accounting for derecognition of financial instruments when assets are transferred.
71
What are special purpose entities (SPEs)?
Separate legal entities, such as limited partnerships or corporations, created for specific purposes like holding leases, pension funds, investments, or creating investment opportunities for investors.
72
Are SPEs part of the economic entity for consolidated financial reporting purposes?
It depends on the specific circumstances and accounting standards. Under revised standards, SPEs that were previously excluded may now be included if they meet consolidation criteria.
73
What was the role of SPEs in the Enron scandal?
Enron created many SPEs, did not consolidate them, and sold assets to these entities, often at a profit.
Enron’s failure to consolidate the SPEs understated liabilities and overstated income in its financial statements.
74
Why should Enron have consolidated its SPEs?
Enron was exposed to the risks of ownership, meaning the liabilities and losses of the SPEs were effectively those of Enron.
75
How have accounting standards for SPEs changed?
Revised standards may require SPEs that were previously excluded to be consolidated, while others may now be excluded due to updated detailed guidance.
76
What is another name for SPEs?
Variable interest entities or structured entities.
77
What is the revenue recognition principle?
The accounting principle that sets guidelines as to when revenue should be reported.
78
What are performance obligations?
An obligation that arises when a company promises to deliver something or provide a service in the future.
79
What does being "realized (revenue)" mean?
Revenue from products (goods or services), merchandise, or other assets that is received in cash.
80
What is realizable (revenue)?
Revenue from products (goods or services), merchandise, or other assets that is received in cash.
81
What principle governs revenue recognition?
The revenue recognition principle
82
Historically what 3 conditions are met under the revenue recognition principle when a revenue has generally been recognized?
1. risks and rewards have passed and/or the earnings process is substantially complete (significant acts have been performed and there is no continuing involvement);
2. the revenue is measurable; and
3. the revenue is collectible (realized or realizable).
83
How does ASPE approach revenue recognition?
ASPE follows an income statement approach, focusing on the earnings process.
84
What significant change occurred under IFRS 15 for revenue recognition?
IFRS 15 uses a five-step, balance sheet approach to recognize revenue:
1. Identify the contract with the customer.
2. Identify the performance obligations in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to each performance obligation.
5. Recognize revenue when each performance obligation is satisfied.
85
What is the new IFRS approach and how does it recognize revenues?
Balance sheet approach, which recognizes that a transaction has occurred when the entity enters into a contract. The entity has rights and performance obligations under the contract
86
How does IFRS 15 differ from ASPE in its approach?
IFRS 15 takes a balance sheet approach, focusing on rights and obligations under the contract, while ASPE emphasizes the earnings process.
87
When are collectible revenues recognized?
When performance obligations are settled (when control over goods or services passes to the customer). There is a presumption that the contract is measurable
88
When are revenues considered realized or realizable?
Revenues are realized when goods or services are exchanged for cash.
Revenues are realizable if assets received can be readily converted into cash or claims to cash.
89
What makes an asset readily convertible into cash?
It can be sold or interchanged in an active market at readily determinable prices with no significant additional costs.
90
What is matching?
The accounting principle that dictates that efforts (expenses) be matched with accomplishments (revenues) whenever reasonable and practicable.
91
What is the matching principle in accounting?
It matches effort (expenditures) with accomplishment (revenues) to reflect the cause-and-effect relationship between the money spent to generate revenues and the revenues themselves.
92
How does accounting allocate the costs of long-lived assets?
Costs are allocated over all accounting periods during which the asset contributes to revenue generation, using a rational and systematic allocation policy.
93
Why is it often necessary to estimate asset contributions to revenues?
Because it can be difficult to establish exactly how much of a contribution is made to each period.
94
How do property, plant, and equipment differ from inventory in contributing to revenue generation?
Property, plant, and equipment are used up over time to generate revenue, while inventory is sold to generate revenue.
95
How must the cost of a long-lived asset be allocated?
Over all accounting periods during which the asset is used because the asset contributes to revenue generation throughout its useful life.
96
How does inventory contribute to a company's ability to generate revenues?
While property, plant, and equipment are normally used up in generating revenues, inventory is sold to generate revenues.
97
What 2 groups are operating expenditures incurred during the year often classified in? How are they classified?
Into two groups depending on whether they are seen to be part of the inventory production process or not:
1. product costs
2. period costs.
98
What are product costs?
Material, labour, and overhead attach to the product and are carried into future periods as inventory (if not sold)
99
Why are product costs carried into future periods?
Because they are part of the inventory production process and inventory meets the definition of an asset.
100
What are period costs?
Officers' salaries and other administrative expenses are recognized immediately—even though the benefits associated with these costs occur in the future
101
Why are period costs recognized immediately?
They are not seen as part of the production process and therefore are not inventory costs, and because the costs do not meet the definition of an asset by themselves
Seen to be a normal ongoing annual expense of running the business as opposed to part of the inventory production process.
102
How are self-constructed or internally generated assets treated in terms of cost allocation?
They follow the same analysis as inventory, with costs classified into product or period costs depending on their nature and relevance to the production process.
103
What was the main issue with Livent Inc.'s accounting treatment of pre-production costs?
Livent deferred pre-production costs until the show opened and reclassified some of these costs as fixed assets or allocated them to unrelated shows, manipulating financial statements.
104
What was the outcome of the fraudulent activities at Livent Inc.?
Senior management was convicted of fraud, and the auditors were found negligent and fined. The court ruling was upheld in 2017, though the damages were reduced.
105
What is the issue with capitalizing costs based solely on matching?
It is no longer acceptable to capitalize costs unless they meet the specific definitions of assets and liabilities under the conceptual framework.
106
What happens if a cost or expenditure does not meet the definition of an asset?
It must be expensed, regardless of the matching principle.
107
What should be ensured when including costs related to assets like inventory or property, plant, and equipment?
Only costs directly related to the creation of those assets should be included.
108
Is deferral of revenues as liabilities acceptable based solely on matching?
No, there are no grounds for deferring revenues as liabilities based only on matching.
109
What is measurement uncertainty?
What occurs when there is a variance between the recognized amount and another reasonably possible amount.
110
What is outcome uncertainty?
Uncertainty surrounding future cash inflows or outflows relating to assets and liabilities.
111
What is the next step after determining whether something meets the definition of an element?
After determining an element's definition, we decide whether to recognize it and then determine how to measure it.
112
Why is measurability an important issue in financial statements?
Because accrual accounting is used any numbers in financial statements are inexact, and accountants must estimate values, particularly when it’s difficult to measure economic events like the potential cost of selling a dangerous product.
113
How is measurability a big issue for many financial statement elements and an even greater issue in certain types of companies or industries?
For instance, in the pharmaceutical industry, it is very challenging to measure the cost of a newly developing drug.
114
When a company cannot objectively identify a value (for instance, the value of a share that is not publicly traded) and therefore it must estimate the value, the resulting imprecision is called _________?
Measurement uncertainty?
115
How do accountants deal with measurement uncertainty?
Accountants use measurement tools like option pricing and discounted cash flow models to estimate values when observable values are unavailable.
116
How does existence uncertainty affect the decision to recognize an asset or liability?
Existence uncertainty may complicate the decision as to whether to recognize an asset or liability and if so, how to measure it.
117
Can you give an example of outcome uncertainty?
An example of outcome uncertainty is predicting the future cash inflows from a hotel, where the range of possible outcomes may be large and the probabilities difficult to determine.
118
"Genco has just invested $1,000 in a small start-up company through an initial token offering. In return for paying cash to the new company, Genco receives 10 tokens. The tokens give Genco rights to a percentage of revenues from specific products that Genco will sell in future. Sometimes tokens such as these end up trading on a cryptocurrency market. That is not the case here." Is Genco’s investment an asset?
Yes, the investment is an asset. Genco controls the tokens, which represent rights to future cash flows from sales of specific products.
119
"Genco has just invested $1,000 in a small start-up company through an initial token offering. In return for paying cash to the new company, Genco receives 10 tokens. The tokens give Genco rights to a percentage of revenues from specific products that Genco will sell in future. Sometimes tokens such as these end up trading on a cryptocurrency market. That is not the case here." Why is Genco’s investment considered an asset?
The tokens give Genco rights to a percentage of future revenues, making it a resource controlled by Genco that is expected to provide future economic benefits.
120
"Genco has just invested $1,000 in a small start-up company through an initial token offering. In return for paying cash to the new company, Genco receives 10 tokens. The tokens give Genco rights to a percentage of revenues from specific products that Genco will sell in future. Sometimes tokens such as these end up trading on a cryptocurrency market. That is not the case here." What type of uncertainty exists regarding the investment?
There is outcome uncertainty due to the potential for no future sales or the possibility of significant future sales by the start-up company.
121
"Genco has just invested $1,000 in a small start-up company through an initial token offering. In return for paying cash to the new company, Genco receives 10 tokens. The tokens give Genco rights to a percentage of revenues from specific products that Genco will sell in future. Sometimes tokens such as these end up trading on a cryptocurrency market. That is not the case here." How does outcome uncertainty affect the investment’s measurement?
Outcome uncertainty contributes to measurement uncertainty, as the future cash flows are uncertain, making it difficult to estimate the value of the investment accurately.
122
"Genco has just invested $1,000 in a small start-up company through an initial token offering. In return for paying cash to the new company, Genco receives 10 tokens. The tokens give Genco rights to a percentage of revenues from specific products that Genco will sell in future. Sometimes tokens such as these end up trading on a cryptocurrency market. That is not the case here." What challenges are involved in measuring the value of the tokens?
There is measurement uncertainty because the tokens do not have a market value, and the start-up has no established sales record. Therefore, estimating the value of the tokens requires significant judgment.
123
"Genco has just invested $1,000 in a small start-up company through an initial token offering. In return for paying cash to the new company, Genco receives 10 tokens. The tokens give Genco rights to a percentage of revenues from specific products that Genco will sell in future. Sometimes tokens such as these end up trading on a cryptocurrency market. That is not the case here." What risk exists for Genco’s investment?
There is a significant risk that Genco’s $1,000 investment may need to be written down if the start-up company does not generate the expected future sales.
124
"Genco has just invested $1,000 in a small start-up company through an initial token offering. In return for paying cash to the new company, Genco receives 10 tokens. The tokens give Genco rights to a percentage of revenues from specific products that Genco will sell in future. Sometimes tokens such as these end up trading on a cryptocurrency market. That is not the case here." Is there any existence uncertainty at the time of the investment?
Initially, there is no existing uncertainty, as the transaction clearly results in the creation of tokens, which Genco controls and are expected to generate future revenues.
125
What are the 3 different types of uncertainties?
1. Existence uncertainty
2. Outcome uncertainty
3. Measurement uncertainty
126
How do the 3 different types of uncertainties affect each other?
Existence uncertainty and outcome uncertainty may affect measurement uncertainty
127
What determines which model or tool should be used to measure financial statement elements?
The choice depends on the nature of the transaction or balance, the variability of related cash flows, sensitivity to market forces (like interest rates), and the nature of the business/industry.
128
What are the common measurement bases for financial statements?
Common measurement bases include historical cost (including amortized cost), value in use, and fair value.
129
How should accountants determine which measurement basis to use?
The choice should result in the most useful information, reflecting the transaction or event faithfully. In many cases, IFRS and ASPE specify the basis (e.g., inventory is generally recorded at cost unless impaired or obsolete).
130
What are the two categories of measurement bases according to the new IFRS conceptual framework?
The new IFRS framework identifies two categories: historical costs and current values.
131
Historic costs are often more readily available; however, what complexities can they include?
Estimating depreciation, useful life, impairment, and other things
132
Why can estimating current values be very subjective?
Current values are relevant and easy to determine where market values exist; however, this is not always the case
133
What are the three current value measurement bases identified by the IFRS framework?
1. fair value,
2. value in use for assets and fulfilment value for liabilities, and
3. current cost
134
How does uncertainty affect the measurement of financial statement elements?
High uncertainty (existence, outcome, or measurement) may make recognition inappropriate, as it undermines the usefulness of the financial statements. Estimates with high uncertainty provide less relevant information for decision making.
135
What is the trade-off with uncertainty in financial statements?
Too much uncertainty can make it inappropriate to recognize an element, but not recognizing the element at all may result in incomplete financial statements. The compromise is to recognize the element but disclose the uncertainty in the notes.
136
What are the key steps accountants should follow when dealing with uncertainty in financial statements?
1. Determine an acceptable level of uncertainty.
2. Use measurement tools that help deal with the uncertainty (such that useful information is produced).
3. Disclose enough information to signal the uncertainty.
137
What is periodicity assumption?
The accounting assumption that implies that a company's economic activities can be divided into artificial time periods.
138
What is the most accurate way to measure an enterprise's activity?
The most accurate way is to measure the results at the time of the enterprise's eventual liquidation, when all cash flows are known with complete certainty.
139
Why can't businesses wait until liquidation to measure performance?
Users, including business, government, and investors, need timely information to evaluate and compare firms, making it necessary to report information periodically (on a timely basis).
140
What does the periodicity assumption (or time period assumption) imply?
That an enterprise's economic activities can be divided into artificial time periods. These time periods vary, but the most common are one month, one quarter, and one year.
141
How does the length of the time period affect the reliability of results?
Shorter time periods make it harder to determine proper net income. A month's results are less reliable than a quarter's, and a quarter’s results are less reliable than a year's, due to the need for more estimates in accrual accounting.
142
What is the trade-off between quick information release and accuracy?
Investors demand quick information, but the quicker the release, the more likely errors are to occur due to the complexity of estimating costs and revenues within shorter periods.
143
Why is the question of an appropriate time period becoming more important?
Product cycles are shorter, and products become obsolete more quickly. There is increasing pressure to provide more timely, real-time financial information due to advances in technology.
144
What is the role of real-time financial information in today's business environment?
Given technological advances, real-time financial information is becoming essential to ensure that relevant and up-to-date information is available to users.
145
What is the monetary unit assumption?
The assumption that money is the common denominator of economic activity and provides an appropriate basis for accounting measurement and analysis.
146
What does the monetary unit assumption imply about the monetary unit?
That the monetary unit is the most effective way of expressing to interested parties changes in capital and exchanges of goods and services
147
Why is the monetary unit considered effective for accounting?
The monetary unit is relevant, simple, universally available, understandable, and useful, making it the most effective way of expressing changes in capital and exchanges of goods and services.
148
What is the underlying assumption behind the monetary unit assumption?
The monetary unit assumption relies on the basic assumption that quantitative data are useful for communicating economic information and aiding rational economic decisions.
149
How do IFRS and accounting practices in Canada and the U.S. handle price-level changes like inflation and deflation?
IFRS, and accounting practices in Canada and the U.S., chosen to ignore price-level changes and assume that the monetary unit (dollar) remains stable. This allows for straightforward financial reporting without adjustments for inflation or deflation.
150
What would trigger the consideration of inflation accounting under IFRS?
Inflation accounting would only be considered if circumstances dramatically change, such as extremely high inflation. IFRS addresses this issue in IAS 29, which deals with hyperinflation.
151
Is there a comparable standard for inflation accounting under ASPE?
No, there is no comparable standard for inflation accounting under ASPE (Accounting Standards for Private Enterprises).
152
What is the going concern assumption in accounting?
The going concern assumption is the belief that business firms will continue to operate long enough to fulfill their commitments, rather than assuming liquidation is imminent.
153
Management must assess the company's ability to continue as a going concern and take into account all available information, looking out at least _______ from the date of the statement of financial position.
12 months
154
What does the going concern assumption imply for financial statement measurements?
f liquidation were assumed, financial statement elements would be measured differently, with asset values better stated at net realizable value (sales price minus disposal costs), rather than historical cost.
155
How does the going concern assumption justify amortization?
Amortization is justifiable under the going concern assumption because it assumes the enterprise will continue, allowing for the allocation of asset costs over future periods to match against future revenues.
156
What happens to the current vs. non-current classification of assets and liabilities if liquidation is assumed?
The classification of assets and liabilities as current vs. non-current would lose significance, and labeling assets as fixed or long-term would be difficult to justify under a liquidation approach.
157
When does the going concern assumption not apply?
The assumption does not apply when there is intent to liquidate the company, cease operations, or cease trading its shares, or when the company has no realistic alternative but to liquidate or cease operations.
158
What happens to asset and liability valuations when the going concern assumption does not apply?
In such cases, a revaluation of assets and liabilities to reflect their net realizable value becomes necessary to approximate the company's liquidation value.
159
How do we measure things when we assume the entity is a going concern?
Management must continually assess the likelihood of outcomes (such as whether the company will lose a lawsuit) based on history and supporting evidence.
160
How do management and specialists assess the likelihood of future outcomes under the going concern assumption?
Management continually assesses future outcomes (e.g., the likelihood of losing a lawsuit) using historical data, supporting evidence, and often consulting specialists like lawyers or engineers for assistance.
161
What is the historical cost principle?
An accounting principle that provides guidance on how to measure transactions and balances on the basis of acquisition price.
162
How are transactions initially measured? What is this called?
At the amount of cash (or cash equivalents) paid or received or the fair value ascribed to the transactions when they took place. This is often called the historical cost principle
163
The historical cost principle has what 3 underlying assumptions that support its value and usefulness?
1. It represents a value at a point in time.
2. It results from a reciprocal exchange (in other words, a two-way exchange).
3. The exchange includes an outside arm's-length party.
164
What is a reciprocal exchange?
A two-way exchange.
165
What are laid-down costs?
Any cost incurred to get the asset in place and ready for use (whether it is for sale or to generate income through use). Also known as “out-of-pocket costs.”
166
What are nonmonetary transactions?
Transactions where few or no monetary assets are received as consideration when goods or services are purchased or sold. Also known as Barter transactions.
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What are barter transactions?
Transactions where few or no monetary assets are received as consideration when goods or services are purchased or sold. Also known as Nonmonetary transactions.
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What are nonmonetary, non-reciprocal transactions?
A type of transaction where there is no exchange (such as a donation), making it difficult to determine cost or fair value.
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What are related party transactions?
A transaction in which one of the transacting parties has the ability to significantly influence the policies of the other, or in which a nontransacting party has the ability to influence the policies of the two transacting parties.
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What does the value of a non-financial asset include?
The value of a non-financial asset includes any laid-down costs, such as costs incurred to prepare the asset for sale or for generating income through its use. For inventory, this includes material, labor, and overhead costs.
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What costs are included for self-constructed assets?
For a self-constructed asset, the cost includes all expenditures to make the asset ready for its intended use, such as transportation and installation costs.
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Sometimes it is not possible or not appropriate to determine a value using the historical cost principle. Transactions that have some or all of what characteristics present challenges?
1. Nonmonetary or barter transactions
2. Nonmonetary, non-reciprocal
3. Related party transactions
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Why do nonmonetary or barter transactions present challenges?
Where no cash or monetary consideration is exchanged. Here it may be more difficult to determine the value of the assets exchanged.
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Why do nonmonetary, non reciprocal transactions present challenges?
Non-reciprocal transactions where there is no exchange, such as donations.
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Why do related party transactions present challenges?
Where the parties to the transaction are not acting at arm's length (in other words, there is no outside party). In these cases, the exchange price may not reflect the true value of the assets exchanged.
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At default when its not possible or not appropriate to determine a value using the historical cost principle what attempt may be made for an estimate?
To estimate the fair value if possible, and this may become the cost basis going forward.
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Does the historical cost principle apply to financial instruments?
Bonds, notes, and accounts payable and receivable are issued by a business enterprise in exchange for assets or perhaps services. This price, established by the exchange transaction, is the “cost” gives the figure at which the instrument should be recognized in the financial statements as long as it is equal to the fair value of the financial instrument issued
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How is the cost of financial instruments determined when issued for goods or services?
When financial instruments are issued for goods or services, the cost may be more difficult to determine. In such cases, measurement techniques like discounting are used to determine the transaction’s value.
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How is the cost of financial instruments determined when issued for cash?
When financial instruments are issued for cash, the cost is straightforward, as it is equal to the amount of cash exchanged.
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What is the advantage of using historical cost for valuation?
Historical cost has the advantage of representing a fair, bargained value from an arm's-length transaction at a specific point in time. It generally reflects the fair value when first recognized.
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Why can historical cost become irrelevant over time?
Over time, historical cost often becomes irrelevant of predictive value
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What are the limitations of later remeasurement?
Subsequent remeasurements can provide more relevant information by using values like fair value. However, they often involve measurement uncertainty and may be subjective, especially when there is no external exchange.
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How is the valuation model evolving in accounting?
The trend is shifting toward a mixed valuation model, moving from a primarily historical cost-based approach (modified by conservatism) to one that incorporates market valuation models, such as fair value.
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What is the fair value principle?
The GAAP principle that provides guidance regarding how to measure financial statement elements using best estimates of market values.
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What is an exit price?
A measure of fair value that represents the amount that a company would receive on selling an asset or transferring a liability.
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What is a value in use?
The present value of the future cash flows expected to be derived from an asset's use and subsequent disposal. It is an entity-specific measure.
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What is the fair value principle in IFRS?
The fair value principle calls for the use of standardized fair value measurements in financial statements, as it provides more useful information than historical cost in certain cases.
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What is an example of certain industries preferring to use fair value?
Companies report many financial instruments, including derivatives, at fair value. Brokerage houses and mutual funds prepare their financial statements using fair value.
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How does IFRS define fair value?
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
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Is fair value an exit price?
Yes!
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What is the difference between an exit price and an entry price?
Exit price refers to the selling price of an asset or liability, while entry price reflects the purchase price paid by the entity.
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How does fair value differ from entity-specific value?
Fair value is a market-based measure, reflecting how market participants would value the item, while entity-specific value (value in use) reflects the present value of future cash flows the entity expects to receive from the asset's use.
## Footnote
Meant to be more objective
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What is an entity-specific value?
Represents how the company might value the item in question. This is often called value in use and reflects the present value of the future cash flows the entity expects to receive from the use of the asset. It is not necessarily the same as a market-based value.
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Why is fair value considered more objective than entity-specific value?
Fair value focuses on market-based valuation, which excludes company-specific factors or synergies, making it less subjective and more standardized
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What are the various ways to define "value" or price?
Entry price = purchase price (market value)
Value in use/Fulfilment value = value to the entity (entity-specific value)
Exit price = selling price (market value also what fair value is based on)
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Assume that a restaurant has a fully integrated industrial kitchen, and the grills are built-in but are now broken. How should it value the kitchen?
May attribute a higher value to the grills bc they are an integrated part of the kitchen = entity-specific value (value in use). Market participants might view the value of broken, used equipment as being lower—perhaps at scrap value—especially if the grills are too costly to fix. This latter value is the fair value under IFRS. Where a liquid market does not exist, the entity may use a model such as a discounted cash flow model to estimate fair value.
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What is the fair value option?
The option given to companies allowing them to use fair value for most financial instruments. Under IFRS, certain conditions must be met.
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Which value is better for use in the financial statements?
There is a trade-off. Entity-specific value may be more relevant for operating assets where the entity plans to hold on to them and use them to produce revenues, but it may be more subjective. The market-based view is more objective and verifiable and thus, where fair value is called for under IFRS, the market-based view must be applied.
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Which value is more relevant for operating assets and why?
Entity-specific value is more relevant for operating assets since it reflects the entity's plans to hold and use them to produce revenues. However, it is often more subjective.
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Why is the market-based view considered more objective?
The market-based view focuses on fair value derived from external markets, making it more verifiable and less subjective than entity-specific valuations.
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How do historical cost and fair value compare at initial acquisition?
At initial acquisition, historical cost generally equals fair value.
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Why do historical cost, value in use, and fair value diverge over time?
They diverge as market and economic conditions change, with current value measures often providing more relevant information about expected cash flows.
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When a long-lived asset declines in value, what may be used to help determine a potential impairment loss?
Value in use and/or fair value measures
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Why have standard setters given companies the option to use fair value for most financial instruments (such as non-strategic investments) as an accounting policy choice?
In order to encourage increased use of fair value and to simplify accounting
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Why do standard setters feel that fair value is more relevant for most financial instruments?
Because it reflects the current cash equivalent value. In addition, markets exist for many financial instruments, thereby providing independent, objective evidence of value
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Under the fair value option, how are financial instruments measured?
At fair value with gains and losses being booked to income
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How does IFRS differ from ASPE in the use of fair value for non-financial assets?
IFRS: explicitly allow the use of fair value for some non-financial assets (investment properties and property, plant, and equipment) or require it for others (certain biological assets). ASPE doesn't refer to the use of fair value for these items, although it does acknowledge that fair value measures might be used in certain industries (agriculture and mining)
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What has ASPE defined fair value as?
Amount of consideration that would be agreed upon in an arm's length transaction between knowledgeable, willing parties who are under no compulsion to act
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What is the key difference between the IFRS and ASPE definitions of fair value?
The ASPE definition does not mention an orderly market or specify that fair value represents an exit price, unlike the IFRS definition.
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What is the full disclosure principle?
Financial reporting of information significant enough to influence the judgement of an informed reader.
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What is information overload?
The phenomenon that too much information may result in a situation where the user is unable to digest or process the information.
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What are notes to the financial statements?
Information that is linked to the financial statements that generally amplifies or explains the items presented in the main body of the statements in order to complete the picture of a company's performance and position.
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What does the full disclosure principle recognize?
That the nature and amount of information in financial reports reflects a series of judgemental trade-offs
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What are the trade-offs recognized by the full disclosure principle?
- detailed enough to disclose matters that make a difference to users
- condensed enough to make the information understandable, and also appropriate in terms of the costs of preparing and using it.
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Why is more information not always better?
Too much information may result in the user being unable to digest or process it. This is called information overload.
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Where are the 3 places where information about a company's financial position, financial performance, cash flows, and investments can be found?
1. The main body of financial statements
2. The notes to the financial statements
3. Supplementary information, including the Management Discussion and Analysis (MD&A
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What is the purpose of financial statements?
To communicate financial information in a formalized and structured manner.
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Why is disclosure not a substitute for proper accounting?
Disclosure alone may not adequately represent key financial figures, and improper accounting can lead to misleading signals, such as overstating earnings.
## Footnote
Market watches and listens for signals about earnings in particular and does not usually react well to negative earnings surprises.
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What is the purpose of notes to financial statements?
They amplify or explain items presented in the main body of the financial statements to provide a more complete picture of the enterprise's performance and position.
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Is the information in the notes required to be quantifiable?
No, it does not need to be quantifiable or qualify as an element. Notes can include narrative explanations.
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What are examples of notes to financial statements?
- Descriptions of accounting policies and methods used.
- Explanations of uncertainties and contingencies.
- Details too voluminous to include in the main statements
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Why are notes to financial statements essential?
They are crucial for fully understanding an enterprise's performance and financial position.
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What general guidance does the IFRS conceptual framework provide for effective communication in financial statements?
- Entity-specific information is more useful than general information.
- Avoid duplication of information, as it inhibits usefulness.
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What is supplementary information?
Information that may include details or amounts that pre-sent a different perspective from that adopted in the financial statements.
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What does supplementary information in financial statements include?
Details or amounts presenting a different perspective from the financial statements, including quantifiable information high in relevance but low in reliability, or helpful but not essential information.
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What is an example of supplementary information?
Data and schedules from oil and gas companies, such as proven reserves and related discounted cash flows.
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What is the purpose of the MD&A (Management Discussion and Analysis)?
To provide management's explanation of financial information and its significance, offering a broader business reporting model with forward-looking insights.
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What are the six general disclosure principles for the MD&A?
1. Enable readers to view the entity through management's eyes.
2. Supplement and complement the financial statements.
3. Provide fair, complete, and balanced material information.
4. Highlight trends, risks, uncertainties, and the quality of earnings and cash flows.
5. Explain management's short- and long-term plans.
6. `Be understandable, relevant, comparable, verifiable, and timely.
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What are the five key elements that should be included in the MD&A?
1. Core businesses.
2. Objectives and strategy.
3. Capability to deliver results.
4. Results and outlook.
5. Key performance measures and indicators.
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Why is the MD&A important for users of financial information?
It provides greater insight into a company's business, including forward-looking and strategic information.
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Under the IFRS what is the trend when it comes to disclosure?
General trend toward increased disclosures in a bid for greater transparency
