Intermediate 1, Chapter 2
Intermediate 1, Chapter 2 4410
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This 5 page Class Notes was uploaded by Emily Sears on Saturday January 9, 2016. The Class Notes belongs to 4410 at Auburn University taught by Kerry K. Inger in Spring 2016. Since its upload, it has received 23 views. For similar materials see Income Tax I in Accounting at Auburn University.
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Date Created: 01/09/16
1 CHAPTER 2: Financial Reporting- Its Conceptual Framework Recent Focus onObjectives Oriented Principles “Numerous and complex rules foster search for loopholes” How Do Principles, Concepts, Standards and Rules Differ? The SEC has recommended that future accounting standards should not follow a rules-based or principles based only approach, but should be objectives-oriented This approach should be built on an improved and consistently applied conceptual framework New standards should clearly state the accounting objective, provide sufficient detail and structure so that the standard can be applied consistently, and minimize expectations to the standards. Standards should also avoid bright-line tests. Thus…the SEC has charged FASB with (1) developing a conceptual framework for financial accounting and (2) establishing standards (GAAP) for financial accounting practice Accounting Principles Fundamental theories and truths that provide the foundation for financial accounting and financial reporting. Broad and definitions Concept Statements (SFAC) Establish principles of accounting Objectives of financial reporting Qualities of useful information Definition of basic elements Types, measurements and presentation/classification of events Accounting Standards Principles and concepts from the basis for GAAP FASB’s Accounting Standards Codification & Accounting Standards Updates Rules Specific implementation guidelines for applying standards to measure and report a company’s financial statements FASB Conceptual Framework Conceptual Framework originally was comprised of seven Statements of Financial Accounting Concepts (SFACS) SFAC #1- Objectives of Financial Reporting by Business Enterprises SFAC #2- Qualitative Characteristics of Accounting Information SFAC #3- Elements of Financial Statements of Business Enterprises SFAC #4- Objectives of Financial Reporting by Nonbusiness Organizations SFAC #5- Recognition and Measurement in Financial Statements of Business Enterprises 2 SFAC #6- Elements of Financial Statements, a replacement of SFAC #3 SFAC # 7- Using Cash Flow Information and Present Value in Accounting Measurements st th After 1 phase of IASB-FASB joint project the 8 SFAC was released SFAC #8- Conceptual Framework for Financial Reporting (replaced SFAC’s #1 & #2). It is comprised of 2 Chapters SFAC #8—Conceptual Framework for Financial Reporting- Chapter 1 1. Primary Objective: Provide information that is useful to existing and prospective investors, lenders, and other creditors in making decisions about providing resources to the entity (Decision useful) Expected Returns- primarily interested in amounts, timing, and uncertainty of cash flows they will receive (investors, lenders and creditors) Assessing company cash flows- determines ability to pay dividends and interest and impacts market price for the company’s securities 2. Specific Objectives: The firm’s economic resources and claims to those resources o Assets= claims on assets= liabilities + stockholders’ equity Changes in firm’s economic resources and claims o Financial performance- net income comprehensive income & components, and cash flows Financial reporting should provide information about how the management of a company has discharged its stewardship responsibility to owners (stockholders) for using the company resources Additional information important to these users: 1. Return on investment- provides a measure of overall company performance 2. Risk- the uncertainty or unpredictability surrounding a company’s future results 3. Financial flexibility- the ability of a company to use its financial resources to adapt to change 4. Liquidity- refers to how quickly a company can convert its assets into cash to pay its bills 5. Operating capability- the ability of a company to maintain a given physical level of operations SFAC #8—Conceptual Framework for Financial Reporting- Chapter 3 Chapter 3 Objectives: Specify the qualitative characteristics or “ingredients” that are likely to make information most useful to existing and potential investors, lenders, and other creditors Decision-useful information- Decision Usefulness is identified and defined in terms of fundamental (necessary) qualitative characteristics and enhancing qualitative characteristic. For the information to be decision useful, the information should be: (1) relevant & (2) faithfully represented 3 Relevant: Information is relevant if t has the potential to make a difference in a decision. There are three components (also referred to as “ingredients”) to relevance 1. Predictive Value- if it can be used to correctly forecast the outcome of some event(s) of a firm 2. Confirmatory Value- if it can confirm or correct prior expectations 3. Materiality- the nature and magnitude of an omission or misstatement of accounting information that would influence the judgment of a reasonable person relying on the information Quantitative and qualitative factors should be considered when assessing materiality SAB 99 qualitative materiality considerations- Does the misstatement… 1. Have an effect on trends (particularly trends in profitability) 2. Mask a change in earnings? 3. Change a loss into a profit? 4. Misrepresent compliance with loan agreements? 5. Increase management’s compensation? Faithful Representation- the transaction reflects the economic substance rather than legal form 1. Complete Representation- the information provides a user with full disclosure of all the information necessary to understand the information being reported, with all necessary facts, descriptions, and explanations 2. Neutral Representation- the information is not biased, slanted, emphasized, or otherwise manipulated to achieve a predetermined result or to influence users’ behavior in a particular direction 3. Free from Error- the information is measured and described as accurately as possible, using a process that reflects the best available inputs 4 Enhancing Characteristics improve the decision usefulness of info that is relevant and faithfully represented: 1. Comparability- information enables users to identify and explain similarities/differences between two or more sets of economic facts. This includes consistency over time. 2. Verifiability- the information can be substantiated by accountants who can agree that the measurement method is without material error or bias. Note, verification is a primary concern of the independent auditor. 3. Timeliness- information is available to decision makers in time to influence their decisions 4. Understandability- the information should be comprehensible to users who have a reasonable knowledge of business and economic activities and who are willing to study the information carefully All subject to “Cost Constraint”- benefits of the information must exceed the costs Accounting Assumptions and Principles Reporting Entity- The entity assumption assumes that a proprietorship, partnership, or corporation’s financial activities are distinguished from other financial organizations in keeping its own financial records and reports Going Concern- This assumption assumes that the company will continue to operate in the near future, unless substantial evidence to the contrary exists. Period of Time- In accordance with this assumption, a company prepares financial statements at the end of meaningful and consistent time frames. This assumption is the basis for the adjusting entry process at period-end Monetary Unit- There must be some basis for measuring the exchange of goods or services. The reporting country’s currency is the unit of exchange. In US, the dollar is unadjusted for inflation (stable unit of measure) Mixed Attribute Measurement- Measures assets, liabilities, revenues, expenses, and other elements of the financial statements with the most relevant and faithful measurement available. Historical Cost- Usually, the exchange price is retained in the accounting records as the value of an item until it is removed from the records. Recognition- The process of formally recording and reporting an item in the financial statements of a company. To be recognized, an item must: Meet the definition of an element Be measureable Be relevant Be representationally faithful Conservatism- The conservatism convention states that when alternative accounting valuations are equally possible, the accountant should select the one that is least likely to overstate assets and income in the current period Accrual Accounting- The process of measuring and reporting the economic effects of transactions, events, and arrangements in the period when those effects occur, even though the cash flows may occur in a different period Revenue Recognition- Revenue is recognized when (a) realized or realizable and (2) earned- usually at the point of sale. Realization is the process of converting noncash resources and rights into cash or rights to cash Expense Recognition- Expenses are recognized… 5 a) Due to cause and effect (direct relationship to revenue) Ex: sales commissions and product costs [material, labor, and overhead] b) Due to systematic and rational allocation Ex: depreciation, amortization, rent, insurance, or c) Immediately (neither a nor b) Ex: period costs [officer salaries and admin expenses] Matching Principle- match expenses to the period in which economic benefits are consumed by generating revenues
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