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FA3 > Week 1 - Theory > Flashcards

Week 1 - Theory Flashcards

1
Q

What is the non-theoretical approach to accounting theory?

A
  • Is concerned with developing a theory or accounting techniques and principles that will be useful to users, particularly decision makers.
  • Is a pragmatic approach, used by the accounting profession.
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2
Q

What is the regulatory approach to accounting theory development?

A
  • Standards are developed as solutions to current conflicts that emerge in the attempt to provide useful information to users.
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3
Q

What are the main purposes of the 108 IASB ftamework?

A
  1. To assist the Board in the development of individual IFRS Standards while making sure that IFRS as a body of financial reporting standards is coherent and based on a consistent logic and set of principles.
  2. To assist preparers of financial statements in applying IFRS Standards when no individual standard applies to a transaction or recordable event, or when IFRS Standards allow a choice of accounting policy.
  3. To assist all parties in understanding and interpreting IFRS Standards.
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4
Q

What is the objective of general purpose financial reporting?

A
  • The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions relating to providing resources to the entity (economic decisions)
  • Those decisions involve decisions about:(a)buying, selling or holding equity and debt instruments;(b)providing or settling loans and other forms of credit; or (c)exercising rights to vote on, or otherwise influence, management’s actions that affect the use of the entity’s resources.
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5
Q

What is Decision-usefulness theory?

A
  • Decision-Usefulness Theory holds that the aim of general purpose financial reporting must be to provide information that is useful to investors and other users. It regards assets and liabilities as net cash inflow potential.
  • It defines the qualitative characteristics of useful financial reporting information with reference to its relevance to economic decision making.
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6
Q

What is meant by going concern?

A
  • Going concern refers to the assumption that the entity will continue in operation for the foreseeable future.
  • If not, the financial statements must be prepared on a different basis
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7
Q

What are the qualitative characteristics of useful financial statement information?

A

2 fundamental characteristics:

  • Relevance
  • Faithful representation

4 enhancing characteristics:

  • Comparability
  • Verifiability
  • Timeliness
  • Understandability
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8
Q

Explain what is meant by Relevance?

A
  • Financial information has the quality of relevance when it influences the economic decisions of users by helping them to evaluate the future events (predictive value) or confirming, or correcting, their past evaluations (confirmatory value) – usually material items (i.e. assets/liabilities) influence users…
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9
Q

What makes information material?

A
  • Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.
  • Materiality depends on the size of the item (i.e. asset/liability) or error judged in the particular circumstances of its omission or misstatement.
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10
Q

What are some of the characteristics of Faithful representation?

A
  • Completeness
  • Neutrality
  • Free from error
  • Reliability*
  • Substance over form*
  • Prudence*

*Related terms not explicitly referred to in IASB Framework.

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11
Q

Explain Faithful representation.

A
  • To be reliable, information must represent faithfully the transactions and other events.
  • Implies an identification of all transactions and events which result in assets, liabilities or equity at reporting date and which meet the recognition criteria
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12
Q

What makes information reliable?

A

Information is reliable when its depiction of items (i.e. asset/liability) is free from material error and bias and can be depended on by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent

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13
Q

What is meant by substance over form?

A
  • Information about economic transactions and events should be presented in accordance with the substance and economic reality of transactions/events and not merely their legal form.
  • Substance of transactions or other events is not always consistent with that which is apparent from their legal or contrived form.
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14
Q

What is meant by neutrality?

A
  • Information is neutral when its depiction of items (i.e. assets/liabilities) is free from bias in the selection and presentation of financial information.
  • Information is not neutral when by selection or presentation of the information, it influences the economic decision making or judgement of the user of the information.
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15
Q

What is Prudence?

A

Prudence is the inclusion of a degree of caution in the exercise of the judgements needed in making estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated.

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16
Q

What is Completeness?

A
  • Information in financial statements must be complete within the bounds of materiality and cost.
  • An omission can cause financial statement information to become unreliable or even false.
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17
Q

What are the constraints on relevant and faithfully represented (reliable) information?

A
  • Timeliness
  • Balance between benefit and cost
  • Balance between qualitative characteristics
18
Q

Explain comparability.

A
  • Users must be able to compare financial statements of the same entity through time.
  • Users must be able to compare financial statements of different entities.
  • Therefore changes in accounting policies should be disclosed.
19
Q

Explain understandability?

A
  • The information should be understandable by users.
  • Users are assumed to have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence.
20
Q

Explain verifiability.

A

Different knowledgeable and independent observers reach consensus, not necessarily agreement, about the faithful representation of a depiction. Direction verification is verification through observation. Indirect verification means checking inputs to a model.

21
Q

Explain timeliness.

A

Financial information should be in time and be capable of influencing decisions.

22
Q

Explain what is meant by fair presentation of financial information.

A
  • This concept is not defined in the framework.
  • The solution of the framework: the application of the qualitative characteristics of useful information (referred to in previous slides) and of appropriate financial reporting standards (IFRSs/IASs) normally results in financial statements that convey what is generally understood as a true and fair view or as presenting fairly such information
23
Q

Define an asset.

A
  • An asset is a present economic resource controlled by the entity as a result of past events.
  • An economic resource is a right that has the potential to produce economic benefits.
24
Q

What is a liability?

A

A liability is a present obligation of the entity, arising out of past events, to transfer an economic resource as a result of past events.

25
Q

What is equity?

A

Equity is the residual interest in the assets of the entity after deducting all its liabilities.

26
Q

Define income.

A

Income is increases in assets or decreases in liabilities, other than those relating to contributions from holders of equity claims.

27
Q

Define expenses.

A

Expenses are decreases in assets or increases in liabilities, other than those relating to distributions to holders of equity claims.

28
Q

What is meant by recognition?

A
  • An entity recognises an item i.e. asset or a liability (and any related income, expenses or changes in equity) if recognition:
  • provides users of financial statements with relevant information about the items concerned.
  • provides a faithful representation of the items concerned and
  • the benefits of providing this information exceed its cost
29
Q

When may recognition not provide relevant information?

A
  • Recognition may not provide relevant information if:
  • It is uncertain whether or not an asset or liability actually exists, or if the asset is separable from the business as a whole.
  • An asset or liability exists but it is not sufficiently probable that an inflow or outflow of economic benefits will result.
  • The level of measurement uncertainty is too high to result in relevant information.
30
Q

What is a measurement basis?

A
  • A measurement basis is an identified feature – for example, historical cost, fair value or fulfilment value – of an item being measured.
  • Applying a measurement basis to an asset or liability creates a measure for that asset or liability and for related income and expenses.
31
Q

What different measure bases can be employed?

A
  • Historical cost
  • Current cost
  • Fair value
  • Value-in-use
32
Q

IAS 1 Presentation of financial statements prescribes what?

A
  • Prescribes the basis for presentation of general purpose financial statements.
33
Q

What are general purpose financial statements?

A
  • General purpose financial statements are those intended to meet the needs of users who are not in a position to demand reports tailored to meet specific information needs.
  • General purpose financial statements provide information about the financial position, the performance and the cash flow of an entity.
  • Provide information for decision making purposes.
  • Show the results of management’s stewardship of the resources entrusted to it.
34
Q

What is historical cost?

A

Assets: Historical cost of the asset to the extent that it is unconsumed, uncollected and recoverable.

Liabilities: Historical cost of the liability to the extent that it is unfulfilled plus the excess of estimated cash outflows over the consideration received.

35
Q

What is current value - current cost?

A

Assets: Current cost of the asset to the extent unconsumed or uncollected, and recoverable.

Liabilities: The consideration received for taking on the unfulfilled part of the liability plus the estimated cash outflows over that consideration.

For assets, current cost includes transaction costs of the purchase or replacement.

36
Q

What is current value - Value-in-use?

A

Assets: Present value of the future cash flows from the use of the asset and its disposal at the end.

Liabilities: Present value of the future cash flows that will arise when paying off the unfulfilled part of the liability.

37
Q

What is current value - fair value?

A
  • IASB : “Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable willing parties in an arm’s length transaction”.
  • Fair value may not necessarily be defined or operationalized identically in all situations.
  • Carrying value may differ from fair value (and for different reasons) under particular standards.
38
Q

Where is fair value used?

A

Valuation of Some Assets:

  • Financial Assets
    • Including Financial Instruments
  • Intangible Assets
  • Impairment of non-current assets generally
  • Recognition of some expenses
  • Share-based payment
  • Valuation of assets and liabilities acquired in acquisition accounting.
39
Q

What is the general view on fair values by the IASB?

A
  • Fair value is normally given by current prices on an active market for similar property in the same location and condition and subject to similar lease and other contracts.
  • In the absence of current prices on active market, an entity considers information from a variety of sources.
40
Q

What is the hierarchy of measurement on initial recognition?

A
  • Observable market prices
  • Accepted valuation methods/techniques
  • Current cost
  • Models and techniques that use entity-specific inputs only
  • 1 & 2 are fair value
  • 3&4 are sufficiently reliable to be used but are not fair value
  • If none of the available, do not recognise.

FA3 (7 decks)

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