Framework for the Preparation and Presentation of Financial Statements Flashcards
3.3: Describe the framework for the preparation and presentation of financial statements.
What is the conceptual framework?
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.
Who determines the conceptual framework for financial reporting?
The conceptual framework for financial reporting is determined by standard-setting bodies, in consultation with the accounting profession and the business community.
Why do accounting standards differ between countries?
Accounting standards differ between countries due to variations in legal systems, standard-setting processes, government requirements, and economic environments.
How does the lack of uniformity in accounting standards affect global companies?
The lack of uniformity in accounting standards creates challenges and increases reporting costs for companies operating globally.
What is the role of the International Accounting Standards Board (IASB)?
The IASB develops International Financial Reporting Standards (IFRS) to reduce differences in accounting systems and unify global standard setting.
How many countries require the use of IFRS, and when did Canada adopt it?
More than 140 countries, or nearly 90% of worldwide jurisdictions, require the use of IFRS. Canada adopted IFRS in 2011.
Which two major economies have not adopted IFRS?
The United States and China have not adopted IFRS.
How are foreign companies using IFRS treated by U.S. securities regulators?
U.S. securities regulators accept financial statements prepared using IFRS from foreign companies registered on U.S. exchanges.
When did the IASB update its conceptual framework?
In 2018
What 5 key conceptual framework items are covered in chapter 3?
- Objective of general-purpose financial reporting
- Qualitative characteristics of useful financial information
- Going concern assumption
- Elements of financial statements
- Measurement of the elements of financial statements
What types of entities must follow the conceptual framework?
The conceptual framework applies to any reporting entity, which includes any entity required or choosing to prepare financial statements.
How does the conceptual framework differ for publicly traded and private companies in Canada?
The conceptual framework is fundamentally similar for publicly traded companies reporting under IFRS and private companies reporting under ASPE. Although there are some differences, the Accounting Standards Board does not believe they justify entirely separate frameworks.
What is the objective of financial reporting?
The provision of 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.
What is the primary objective of general-purpose financial reporting?
The objective is to provide financial information that is useful to external users (investors, creditors, etc.) in decision-making processes.
What types of decisions do external users make based on financial statements?
Buying or selling the company’s shares or lending to and collecting loans from the company. These decisions depend on the company’s profitability, cash flows, and financial position
What factors do external users consider when analyzing financial statements?
External users focus on the company’s profitability, cash flows, financial position, and management’s stewardship of assets.
What types of users are identified in the conceptual framework?
Are all external users (don’t have access to the same financial info as internal users). So it is important that the financial info that primary users receive be as useful as possible
In addition to information provided in financial statements, users of financial statements have what other data available to analyze?
Such as information about future demand and supply forecasts for products a company sells or for labour that the company will need
What kind of data do financial users compare?
Comparing the data provided in a company’s financial statements with similar data provided by competitors to better assess the company’s performance
How do data analytics help users?
Enhancing users’ assessments of information in the financial statements
Where do external users receive most of their financial info about a company?
By reading its financial statements
Why do companies prepare general purpose financial statements?
Because external users are interested in many aspects of a company’s financial position and performance
Why can’t general-purpose financial statements provide all the information external users need?
General-purpose statements focus on specific financial aspects and cannot cover every detail, such as future demand forecasts or competitor comparisons.
What do general-purpose financial statements provide information about?
The company’s economic resources (assets) and the claims against these resources (liabilities). They also provide info about the effects of transactions and other events that change a company’s economic resources and claims.
How are financial statements prepared?
Using the accrual basis of accounting
Under accrual basis of accounting, how do companies record transactions?
Record the effects of transactions in the period they occur and not when the company receives or pays cash.
If a local utility provided electricity to an Aritzia store in February but the company did not pay for that electricity until March, when should Aritzia record the expense for using this electricity?
In February, when using the electricity, and not in March, when making the payment. Likewise, the utility company will record revenue from providing the electricity in February and not in March when it receives the payment
What is the purpose of qualitative characteristics of useful financial information in financial reporting?
Identify the types of information that are likely to be most useful to existing and potential investors and creditors in making their decisions
How does the conceptual framework categorize qualitative characteristics?
It divides them into fundamental characteristics and enhancing characteristics.
What are fundamental qualitative characteristics?
They are essential for financial information to be useful.
What are enhancing qualitative characteristics?
They improve the usefulness of financial information that is already considered useful.
What are the two fundamental qualitative characteristics of useful financial information?
- Relevance
- Faithful representation
To be useful for decision-making, what must information be?
Relevant and faithfully represent the transactions represented by that information
What is relevance?
A fundamental qualitative characteristic describing information that makes a difference in a user’s decision. It should have predictive value, confirmatory value, or both, and be material.
When is accounting information considered relevant?
When its knowledge influences a user’s decision.
What are the two key components (types of value) of relevance?
- Predictive value
- Confirmatory value
Can have both
What is predictive value in financial information?
It helps users make predictions about future events.
What is confirmatory value in financial information?
It helps users confirm or correct previous predictions or expectations.
How can current sales data demonstrate relevance?
Confirm if its sales strategy this year was successful and help us predict sales in future years. Financial information also helps us to confirm or correct the processes we used to make these previous predictions.
What is materiality in financial reporting?
Information is material if omitting or misstating it could influence user decisions.
The framework defines both materiality and relevance in terms of….
What influences or makes a difference to a decision maker
What factors determine materiality?
Magnitude (dollar value) and nature (the significance of the information).
Why may decisions be made to not disclose certain information?
Because users have no need for that kind of information (it is not relevant) or because the amounts involved are too small to make a difference (they are not material)
Is magnitude by itself a sufficient basis for a materiality judgement?
No, there needs to be regard to its nature
Why is nature important in materiality judgments?
Some events, like fraud or bribery, are material due to their ethical and legal implications, even if the dollar amount is small.
What is faithful representation?
A fundamental qualitative characteristic describing information that represents economic reality. It must be complete, neutral, and free from material error
Besides relevance, what other characteristic must accounting information have to be useful?
It must provide a faithful representation of economic reality.
Why might accountants report the economic substance rather than the legal form of a transaction?
To ensure financial statements reflect the true nature of events rather than just their legal structure.
What is an example of economic substance over legal form?
If a company sells a product to a customer but agrees to buy it back at a later date, there is no sale (the company lent the product). To represent this faithfully, the company shouldn’t record a sale even though it executed a sales contract
What are the three characteristics of faithful representation?
- Completeness
- Neutrality
- Freedom from material error
What does completeness mean in financial reporting?
All necessary information is included, and nothing important is omitted.
What does neutrality mean in financial reporting?
The information is unbiased and not presented to favor one outcome over another.
What does freedom from material error mean?
The information is accurate, and no errors were made in the process of determining it.
How is neutrality achieved in financial reporting?
By exercising prudence, meaning cautious judgment without excessive conservatism2.
Why is perfect financial information rarely achievable?
Because financial reporting often involves estimates, which are not exact.
Does faithful representation require absolute accuracy?
No, it requires that information reflects economic reality, even if it includes estimates.
How can an estimate still be a faithful representation?
By clearly stating that it is an estimate and explaining its nature and limitations.
How can fraud impact representational faithfulness?
Fraud can distort financial statements, making them unreliable and misleading.
What is comparability?
An enhancing qualitative characteristic of useful information that enables users to identify and understand similarities in, and differences among, items
What is verifiability?
An enhancing qualitative characteristic of useful information that means that different knowledgeable and independent users could reach a consensus that the information is faithfully represented.
What is timeliness?
An enhancing qualitative characteristic of useful information that means that information is available to decision makers in time to be capable of influencing their decisions.
What is understandability?
An enhancing qualitative characteristic of useful information that means that information is clearly and concisely classified, characterized, and presented.
What are the 4 enhancing qualitative characteristics of financial information?
- Comparability
- Verifiability
- Timeliness
- Understandability.
Why is comparability important in accounting?
It helps users identify similarities and differences in financial data across periods or between companies.
How does comparability enhance decision-making?
It allows investors and creditors to analyze trends and compare financial performance between companies.
How can verifiability be determined?
Directly by counting cash or indirectly by checking inputs and recalculating outputs.
What role do public accountants play in verifiability?
They audit financial statements to verify that they faithfully represent a company’s financial position.
Why is timeliness important in financial reporting?
Information must be available before it loses its ability to influence decisions.
What are the financial reporting deadlines for public companies on major stock exchanges?
45 days after the quarter end and 90 days after the year end.
What makes financial information understandable?
It is clearly classified, characterized, and presented concisely for users with reasonable business knowledge.
How can enhancing qualitative characteristics sometimes conflict?
Process that does not have to follow a prescribed order. We sometimes give less emphasis to one enhancing qualitative characteristic in order to maximize another qualitative characteristic.
What is an example of prioritizing one enhancing qualitative characteristic over another?
For example, prioritizing timeliness may reduce verifiability, such as when estimates are used instead of waiting for exact data
What is cost constraint?
The pervasive constraint that ensures that the value of the information provided in financial reporting is greater than the cost of providing it.
Why is the cost constraint important?
The benefits of financial information should justify the costs of providing and using it.
Where do costs of preparing financial statements come from?
There is a cost associated with ensuring that financial statements have an appropriate degree of qualitative characteristics
What does it mean for a cost constraint to arise?
When the cost of preparing financial information outweighs the value of that information to users
What is an example of cost constraint in action?
Accountants may avoid reporting every single minor uncertainty because the cost of disclosure outweighs the benefits.
What is the going concern assumption?
The assumption that the business will remain in operation for the foreseeable future.
Why is the going concern assumption important in accounting?
It forms the foundation for financial reporting and affects how assets and liabilities are classified.
What factors support the going concern assumption?
A history of profitable operations and access to financial resources to carry out its existing objectives and commitments.
How does the going concern assumption affect asset classification?
Non-current assets (e.g., equipment) are recorded as long-term if the company is expected to continue operations.
What happens if a company is no longer considered a going concern?
Its assets are reclassified as current assets since they are expected to be sold quickly.
What are elements of financial statements?
A set of broad categories or classes used to group financial information for presentation in the financial statements, such as assets, liabilities, equity, income, and expenses.
What are the 5 elements of financial statements?
- Assets
- Liabilities
- Equity
- Income (including gains)
- Expenses (including losses)
Why do accounting standards define the elements of financial statements with the intent of having them universally measured and applied?
Because these elements are so important and are often interrelated
What guides the recognition and measurement of financial statement elements?
The objective of financial reporting, qualitative characteristics, and the going concern assumption.
What are generally accepted accounting principles (GAAP)?
Accounting principles widely recognized and authoritatively supported through the Canadian and provincial business corporations acts and securities legislation
What are the two main bases of measurement in financial reporting?
Historical cost and fair value.
More commonly referred to as “measurement bases” rather than “principles,” although both terms can be, and are, used interchangeably
What alternative terms are used for accounting principles?
Principles, standards, policies, models, and bases are often used interchangeably.
What is the historical cost basis of accounting?
Measurement basis that states that assets and liabilities should be recorded at their cost at the time of acquisition
How long is an asset or liability recorded at historical cost?
As long as the company holds the asset or liability, unless its fair value drops below cost.
What term can be used interchangeably for “historical cost” in accounting?
The term cost
If land purchased for $3 million increases in value to $4 million, how is it reported using historical cost?
It remains recorded at $3 million (price at purchased) because historical cost is considered more reliable.
When would an asset be reported at fair value instead of historical cost?
If the fair value drops below historical cost, it is adjusted to avoid misleading financial reporting.
What is the fair value basis of accounting?
A method of accounting under which assets are recognized on the statement of financial position at their fair values.
What is fair value?
(Also known as current value or current cost) An estimate of the price a company would pay to purchase an asset or settle a liability today with arms’-length parties under normal business conditions.
How do fair value and historical cost compare at the time of acquisition?
They are generally the same at acquisition but may diverge over time.
Why might a company prefer fair value over historical cost?
Fair value may provide more relevant and useful information, especially for assets like publicly traded shares.
What is an example of cost and fair value diverging from each other over time?
If a company buys land for $100,000, at that time, the cost and fair value are equal but one year later the land may have a fair value of $120,000 while the cost remains at $100,000
Certain investments in the shares of large publicly traded companies are assets that some companies will report on their statement of financial position at fair value for what 2 reasons?
- the fair value of these shares is reliable because they trade on a stock exchange
- Readers of the financial statements will prefer fair value information to cost because they believe fair value provides relevant information.
What are some alternative terms for fair value?
Current value and current cost
In choosing between cost and fair value, companies must consider what 2 fundamental qualitative characteristics that make financial information useful for decision-making?
Relevance and faithful representation
In determining which basis of measurement to use, companies weigh the ________ of cost amounts against the ________ of the fair values
Reliability, relevance
Why do standard setters generally prefer historical cost over fair value?
Historical cost is more reliable because it is verifiable and neutral. Fair values are not always reliable
When are the only situations fair value accounting can applied?
Only in situations where similar or identical assets held by a company frequently trade in an active stock market, ex: investments in shares and bonds of publicly traded companies, is the fair value basis of accounting applied.
