FMGT 3110 Chapter 2 Notes

Relevant Information Facts

- Should be included in financial reporting. - Helps users make predictions about the final outcome of past, present and future events; it has predictive value. - Helps users confirm or correct their previous expectations; it has feedback/confirmatory value.

Predictive Value

A characteristic of accounting information that helps users make predictions about the ultimate outcome of past, present, and future events.

Timeliness

A characteristic of relevance that states that information should be available for decision-makers before it loses its capacity to influence their decisions.

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 and financial statements. Does not override any of the ASPE or IFRS that deal with accounting for certain transactions and events. A "constitution" of sorts.

Management Stewardship

A concept whereby management is charged with protecting and enhancing the capital of a company. Alt Definition - Management stewardship is how well management is using entity resources to create and sustain value.

Cost-Benefit Relationship

A constraint of financial reporting that the costs of obtaining and providing information should not be higher than the benefits that are gained by providing it.

Transparency

A goal of financial reporting such that the information provided reflects the underlying transactions and events and their effects on a company. It is one of the characteristics of representational faithfulness.

What is an example of a Material piece of information?

A major product defect would be of interest to a potential investor.

Exit Price

A measure of fair value that represents the amount that a company would receive on selling an asset or transferring a liability.

Comprehensive Income

A measure of income under IFRS that includes net income plus other comprehensive income.

Freedom From Error

A measure of the reliability of reported information, assuring that the relevant information is accurate and unaffected by the opinions of stakeholders.

Financial Engineering

A process whereby a business arrangement or transaction is structured legally such that it meets the company's financial reporting objective (for example, to maximize earnings, minimize a debt-to-equity ratio, or other).

Relevance

A qualitative characteristic of accounting information that indicates that it must make a difference in a decision.

Representational Faithfulness (Also, Faithful Representation)

A qualitative characteristic of accounting information that represents economic reality. Information that is representationally faithful is complete, neutral, and free from error. It is transparent, complete, neutral, and free from material error and bias. Accounting information is representational faithful to the extent that it faithfully reflects or represents the underlying economic substance of an event or transaction, not just its legal form.

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.

Reciprocal Exchange

A two-way exchange.

Constructive Obligations

A type of performance obligation that is created through a past practice or by signalling something to potential customers, such as a "100% satisfaction guaranteed" policy.

Non-Monetary, 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.

Materiality Facts

Alt Definition - Materiality refers to how important a piece of information is. It is generally thought to be material if it would make a difference to the decision-maker. Material information is RELEVANT and should be included in the financial statements. We need to consider the item's impact on other factors, such as on key financial statement ratios and management compensation; in other words, on any sensitive number on the financial statements. In addition, both quantitative and qualitative factors must be considered in determining whether an item is material. Qualitative factors might include illegal acts, failure to comply with regulations, or inadequate or inappropriate description of an accounting policy. Materiality is also a factor in a large number of internal accounting decisions.

Transparency Additional Facts

Alt Definition - The notion of representing economic reality. Think - if financial statement users read the financial statements can they see what lies beneath the numbers? This is critical since the statements are meant to tell a story about the business. Is this a risky business? Is it a mature business? Is it capital-intensive?

Historical Cost Principle

An accounting principle that provides guidance on how to measure transactions and balances on the basis of acquisition price.

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.

Income

An increase in assets or decrease in liabilities resulting from transactions or events other than those relating to shareholder -contributions.

Performance Obligations

An obligation that arises when a company promises to deliver something or provide a service in the future.

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."

Decision Usefulness

Approach to financial reporting whereby the amount and types of information to be disclosed and the format in which information should be presented are determined based on which alternative provides the most useful information for decision- making purposes.

Management Best Estimate

Assumptions made by management in light of their know-ledge and familiarity with the company, the industry, and the economy.

Diagram of a Conceptual Framework

At the first level, the objectives identify accounting's goals and purposes: these are the conceptual framework's building blocks. At the second level are the qualitative characteristics that make accounting information useful and the elements of financial statements (assets, liabilities, equity, revenues, expenses, gains, and losses). At the third/ final level are the foundational principles used in establishing and applying accounting standards.

General-Purpose Financial Statements

Basic GAAP financial statements provide the most useful information possible that meets the needs of key users (normally external users such as investors and creditors). Alt Definition - The statements are intended to provide the most useful information possible in a manner whereby benefits exceed costs to the different kinds of users.

Elements of Financial Statements

Basic items that are presented in the financial statements. Assets, liabilities, equity, revenues, expenses, gains, and losses.

Equitable Obligations

Commitments that arise from moral or ethical considerations.

When the IASB changed the conceptual framework in 2010 what concept did it remove?

Conservatism/Prudence It referred to it again in 2018, when it released its new framework.

Expenses

Decreases in economic resources, either by outflows or reductions of assets or incurrence of liabilities resulting from a company's ordinary revenue-generating activities.

Losses

Decreases in equity (net assets) from a company's peripheral or incidental transactions and from all other transactions and other events and circumstances affecting the company during a period, except those that result from expenses or distributions to owners.

Liabilities

Duties or responsibilities (to transfer economic resources) which result from past transactions or events.

Assets

Economic resources which are controlled by the company and result from past transactions or events.

Who developed the Conceptual Framework?

FASB - Financial Accounting Standards Board created the "Conceptual Framework for Financial Accounting and Reporting: Elements of Financial Statements and Their Measurement" to help set accounting standards and resolve financial reporting controversies. AcSB and IASB followed FASB and issued their own frameworks.

What is financial information useful in doing?

Financial information is useful in making decisions about how to allocate resources (including assessing management stewardship).

Full Disclosure Principle

Financial reporting of information significant enough to influence the judgement of an informed reader.

Basic Elements

Financial reporting terms that constitute the language of accounting and business, such as "assets," "liabilities," and "equity."

Why is a conceptual framework necessary?

First, to be useful, standard setting should build on an established body of concepts and objectives. Having a soundly developed conceptual framework as a starting point, standard setters are then able to issue additional useful and consistent standards over time. The result is a coherent set of standards and rules, because they have all been built upon the same foundation. It is important that such a framework increase financial statement users' understanding of and confidence in financial reporting, and that it enhance the comparability of different companies' financial statements. Second, by referring to an existing framework of basic theory, it should be possible to solve new and emerging practical problems more quickly. It is difficult, if not impossible, for standard setters to quickly state the proper accounting treatment for highly complex situations. Practising accountants, however, must solve such problems on a day-to-day basis. By using good judgement, and with the help of a universally accepted conceptual framework, it is hoped that accountants will be able to decide against certain alternatives quickly and to focus instead on a logical and acceptable treatment.

First Principles

Foundational principles from which decisions stem, making decisions theoretically consistent if they stem from the same foundational reasoning.

Revenue

Increases in economic resources, either by inflows or other enhancements of a company's assets or settlement of its liabilities resulting from its ordinary activities.

Gains

Increases in equity (net assets) from a company's peripheral or incidental transactions and from all other transactions and other events and circumstances affecting the company during a period, except those that result from revenues or investments by -owners.

What can a well-written conceptual framework based on sound principles held address?

Information Asymmetry concerns.

Notes to 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.

Supplementary Information

Information that may include details or amounts that pre-sent a different perspective from that adopted in the financial statements.

Other Comprehensive Income (OCI)

Items of revenues, expenses, gains, and losses that are required by IFRS to be included in comprehensive income, but excluded from net income.

If a piece of information has no impact on a decision, is it Relevant?

No! It is IRRELEVANT to that decision.

What is an example of Relevant Information having feedback/confirmatory value?

Providing information about rental income and the value of the investment in rental properties might help users assess how well management is managing the investment in rental properties.

What are the two qualitative characteristics that above all else MUST be present and are fundamental qualities that make accounting information useful for decision-making?

Relevance and Faithful Representation.

Realizable (Revenue)

Revenue from assets received or sold that can be readily converted into cash or claims to cash.

Realized (Revenue)

Revenue from products (goods or services), merchandise, or other assets that is received in cash.

What is an example of Relevant Information having predictive value?

Separating income from continuing operations from that of operations that have been discontinued may help users predict future income.

Fair Value Principle

The GAAP principle that provides guidance regarding how to measure financial statement elements using best estimates of market values.

Periodicity Assumption (or Time Period Assumption)

The accounting assumption that implies that a company's economic activities can be divided into artificial time periods.

Matching

The accounting principle that dictates that efforts (expenses) be matched with accomplishments (revenues) whenever reasonable and practicable.

Revenue Recognition Principle

The accounting principle that sets guidelines as to when revenue should be reported.

Monetary Unit Assumption

The assumption that money is the common denominator of economic activity and provides an appropriate basis for accounting measurement and analysis.

Going Concern Assumption

The assumption that the company will continue to operate for at least 12 more months.

Qualitative Characteristics

The characteristics defined by the conceptual framework (in it's second level) that distinguish more useful information from less useful information for decision-making purposes.

Materiality

The concept that relates to an item's impact on a company's overall financial operations. An item is material if its inclusion or omission would influence or change the judgement of a reasonable person.

Prudence

The exercise of caution in making judgments/decisions where uncertainty exists. See also Conservatism.

Conservatism

The exercise of caution where making decisions under conditions that are uncertain. Also known as prudence. Conservatism is the principle that net assets and net income should not be ovestated.

Objective of Financial Reporting

The goal "to communicate information that is useful to investors, members, contributors, creditors, and other users in making their resource allocation decisions and/or assessing management stewardship," per the CPA Canada Handbook. For example, a bank may need information in order to decide whether to lend a company money or call a loan. Similarly, an investor may need information about a company's profitability in order to decide whether to invest in it or divest.

Unit of Measure/Account

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).

Feedback/Confirmatory Value

The notion that relevant information helps users confirm or correct prior expectations.

Fair Value Option (FVO)

The option given to companies allowing them to use fair value for most financial instruments. Under IFRS, certain conditions must be met.

Information Overload

The phenomenon that too much information may result in a situation where the user is unable to digest or process the information.

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.

Recognition

The process of recording a transaction in a company's statement of financial position or income statement.

Derecognition

The process of removing an item from a company's statement of financial position or income statement.

Neutrality

The quality of accounting information that ensures faithful representation by being factual, truthful, and unbiased.

Completeness

The quality of accounting information that makes it reliable by including all information necessary to provide an accurate portrayal of events and transactions.

Verifiability

The quality of information that demonstrates that independent measurers, using the same measurement methods, obtain similar results.

Understandability

The quality of information that permits reasonably informed users to perceive its significance.

Equity

The residual interest in the assets of a company that remains after deducting its liabilities.

Economic Substance

The underlying economic reality reported on a representationally faithful document.

Non-Monetary Transactions (Barter 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.

Existence Uncertainty

Uncertainty as to whether an element exists or not (for instance, a liability).

Outcome Uncertainty

Uncertainty surrounding future cash inflows or outflows relating to assets and liabilities.

Control

Under ASPE, the continuing power to determine the strategic operating, financing, and investing policies of another entity without the co-operation of others. Under IFRS, the power to direct the activities of another entity to generate returns, either positive or negative, for the investor.

Consistency

What occurs when a company applies the same accounting treatment to similar events from period to period.

Comparability

What occurs when information that has been measured and reported in a similar manner for different companies is considered comparable.

Measurement Uncertainty

What occurs when there is a variance between the recognized amount and another reasonably possible amount.

What is an example of a highly uncertain estimate affecting representational faithfulness?

Where the only information about an amount (such as the estimated potential loss on a lawsuit) is highly uncertain, perhaps additional disclosure may be necessary to explain this.

What do you need to determine when choosing an acceptable accounting method, the amount and types of information to be disclosed, and the format in which information should be presented?

You should determine which alternative gives the most useful information for decision making purposes (Decision-usefulness).