Kế toán, kiểm toán - Chapter 2: Conceptual framework underlying financial reporting

CHAPTER 2Wiley2After studying this chapter, you should be able to:Indicate the usefulness and describe the main components of a conceptual framework for financial reporting.Identify the qualitative characteristics of accounting information.Define the basic elements of financial statements.Describe the foundational principles of accounting.Explain the factors that contribute to choices and/or bias in financial reporting decisions. Discuss current trends in standard setting for the conceptual framework.3Chapter 2: Conceptual Framework Underlying Financial ReportingConceptual Framework Underlying Financial Reporting4Usefulness of a Conceptual FrameworkThe framework is like a constitution; it is a “coherent system of interrelated objectives”Aids in creation of standards for the accounting professionIncreases financial statement users’ understanding of and confidence in financial reportingEnhances comparability of financial statements of different companies5Objectives of the Conceptual FrameworkThe framework is the foundation for building a set of accounting concepts and objectivesThe framework is a reference of basic accounting theory for solving new and emerging practical problems of reporting6Conceptual Framework for Financial Reporting7Objective of Financial ReportingThe overall objective of financial reporting is to provide information that is:useful to users (e.g. investors, creditors, etc.), anddecision relevant (resource allocation)Resource allocation decisions are assumed to include assessment of management stewardship (i.e. management role in maximizing shareholder value)Conceptual building blocks (second level) include: qualitative characteristics, and elements of financial statements8Fundamental Qualitative CharacteristicsThe Fundamental Qualitative Characteristics are:RelevanceMakes a difference in a decisionHas predictive and feedback/confirmatory valueIncludes all material information (i.e. information that makes a difference to the decision-maker)Representational FaithfulnessCompleteNeutralFree from material error9Enhancing Qualitative CharacteristicsEnhancing Qualitative Characteristics are:ComparabilityInformation measured and reported in similar way (company to company, and year to year)Allows users to identify real economic similarities and differencesVerifiabilitySimilar results achieved if same methods are usedTimelinessUnderstandabilityAllows reasonably informed users to see the significance of the informationProvides “enough” information so that it is clear10Trade-offs and Cost/BenefitTrade-OffsIt is not always possible to have all fundamental and enhancing qualitative characteristicsTrade-offs happen when one qualitative characteristics is sacrificed for anotherCost versus BenefitsBenefits of using the information should outweigh the costs of providing that information11Elements of Financial StatementsBasic elements of financial statements include the following: AssetsLiabilitiesEquityRevenuesExpensesGainsLosses12Elements of Financial Statements: AssetsAssets have three key characteristics: They involve some economic benefit to the entityEntity has a control over that benefitBenefit results from a past transaction or event13Elements of Financial Statements: LiabilitiesLiabilities have three key characteristics: They represent a present duty or responsibility Entity is obligated and has little or no discretion to avoid the duty or responsibilityObligation results from a past transaction or event14Elements of Financial Statements: EquityEquity (net assets) represents residual interest in assets, after all liabilities are deducted15Elements of Financial StatementsRevenuesIncreases in economic resources resulting from ordinary activitiesExpensesDecreases in economic resources resulting from ordinary revenue-generating activitiesGainsIncreases in equity (net assets) resulting from incidental transactionsLosses and OCIDecreases in equity (net assets) resulting from incidental transactionsOther comprehensive incomeRevenues, expenses, gains, and losses that are recognized in comprehensive income, but are not included in net income (e.g. unrealized holding gains and losses on certain securities)16Foundational PrinciplesFoundational concepts and constraints help explain which, when, and how financial elements and events should be recognized/derecognized, measured, and presented/disclosedThey act as guidelines for developing rational responses to controversial financial reporting issues17Foundational PrinciplesRecognition / Derecognition1. Economic entity assumption2. Control3. Revenue recognition and realization principle4. Matching principleMeasurement5. Periodicity assumption 6. Monetary unit assumption 7. Going concern assumption 8. Historical cost principle9. Fair value principle Presentation and Disclosure10. Full disclosure principle18Recognition/DerecognitionRecognitionProcess of including an item on entity’s balance sheet or income statementElements of financial statements have historically been recognized when: they meet the definition of an element (e.g. asset)they are probable, and they are reliably measurableDerecognitionProcess of ‘removing’ something from the balance sheet or income statement19Recognition/DerecognitionEconomic Entity Assumption (Also called Entity Concept)The economic activity can be identified with a particular unit of accountabilityThe business activity is separate and distinct from its owners (and any other business unit)An individual, departments or divisions of an entity, or an entire industry may be considered separate entitiesDoes not necessarily refer to a legal entityLegal entity concept is used for tax and legal purposes20Recognition/DerecognitionEconomic Entity Assumption 21Recognition/DerecognitionControlImportant factor in determining entities to be consolidated and included in the economic entitySome concepts of control include: Under IFRSHaving power over investeeExposure, or rights, to variable returns from involvement with investee; andAbility to use power over investee to affect amount of investor’s returnsUnder ASPEContinuing power to determine strategic decisions without the co-operation of others22Recognition/DerecognitionRevenue Recognition PrincipleRevenue is recognized when:Risks and rewards have passed or the earnings process is substantially completeRevenue is measurable andRevenue is collectible (realized or realizable)Revenues are realized when products (goods or services), merchandise, or assets are exchanged for cash (or claims to cash)IFRS 15 contract based approach uses five-step approach to revenue recognition (See Chapter 6)23Recognition/Derecognition Matching PrincipleExpenses are matched with revenues that they produceIllustrates a “cause and effect relationship” between money spent to earn revenues and the revenues themselvesIf the expense benefits the future periods and meets the definition of asset, it is recorded as an assetThis asset’s cost is then systematically and rationally matched to future revenues 24MeasurementAll elements must be measurable to be recognizedBecause of accrual accounting, many elements of financial statements require the use of estimates (and include uncertainty)Therefore, we mustdetermine the level of uncertainty that is acceptable for recognitionuse appropriate measurement tools, and disclose sufficient information to indicate/describe the uncertainty25MeasurementPeriodicity Assumption Economic activity of an entity can be divided into artificial time periods for reporting purposesMost common: one month, one quarter, and one yearFor shorter time periods, more difficult to determine proper net income (i.e. the more likely errors become due to more estimates)With technology, investors want more on-line, real-time financial information to ensure relevant information26MeasurementMonetary Unit AssumptionMoney is the common unit of measure of economic transactionsUse of a monetary unit is relevant, simple and understandable, universally available, and usefulIn Canada and the United States, the dollar is assumed to remain relatively stable in value (effects of inflation/deflation are ignored i.e. price-level change is ignored)Monetary unit is relevant only as long as it is assumed that quantitative data are useful in communicating economic information27MeasurementGoing Concern AssumptionAssumption that a business enterprise will continue to operate in the foreseeable futureThere is an expectation of continuing long enough to meet their objectives and commitmentsManagement must look out at least 12 months from balance sheet dateIf liquidation of the company is assumed to be likely, use liquidation accounting (at net realizable value)Full disclosure is required of any material uncertainties of continuing as a going concern28MeasurementHistorical Cost PrincipleThree basic assumptions of historical costRepresents a value at a point in timeResults from a reciprocal exchange (i.e. a two-way exchange)Exchange includes an outside arm’s-length partyInitial recognition: for non-financial assets, record all costs incurred to get the asset “ready” for sale or for use (e.g. includes transportation and installation costs)29MeasurementHistorical Cost Principle (continued)Measurement is especially challenging for : 1. Non-monetary transactions (as no cash/monetary consideration exchanged) 2. Non-monetary, non-reciprocal transactions (e.g. donations) 3. Related party transactions – not acting at “arm’s length” (use exchange value or cost)Applies also to financial instruments (e.g. bonds, notes, accounts payable, and receivable)30MeasurementFair Value PrincipleFair value has been defined (under IFRS) 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”Subsequent to initial recognition, historical cost and fair value often differFair value is often considered more relevant for certain assets/liabilities (e.g. financial instruments)IFRS allows the use of fair value measurement in more situations than ASPE31MeasurementFair Value Principle (continued)Fair value (under IFRS) is a market-based measure32Presentation and DisclosureFull Disclosure PrincipleThe practice of providing information that is important enough to influence an informed user’s judgement and decisionsDisclosure may be made:Within the main body of the financial statementsAs notes to the financial statements As supplementary information, including Management Discussion and Analysis (MD&A)33Presentation and DisclosureFull Disclosure Principle (continued)Disclosed information should:Provide sufficient detail of the occurrenceBe sufficiently condensed to remain understandable, and appropriate in terms of costs of preparing/using itFull disclosure is not a substitute for proper accounting practice Notes to financial statements are essential to understanding the enterprise’s performance and position34Management Discussion and Analysis (MD&A)Management’s explanation of the financial information and the significance of the informationFive key elements that should be included:Company’s vision, core businesses, and strategyKey performance driversCapital and other resourcesHistorical and prospective resultsRisks35Expanded Conceptual Framework36Financial Reporting IssuesIFRS and ASPE are principles-basedTherefore, selecting and interpreting accounting principles and rules relies on application of professional judgmentLegally structuring transactions so that they meet the company’s financial reporting objectives (while complying with GAAP) is known as financial engineeringWhen pressures for reaching specific financial reporting objectives are high, risk of fraudulent financial reporting increases37Choice in Accounting Decision-Making38Looking AheadIASB issued an Exposure Draft relating to the conceptual framework in 2015. Some items included were:MeasurementPresentationElementsRecognitionReporting EntityObjectives and qualitative characteristics39Looking AheadIt is hoped that the revised conceptual framework will be released in 2016The IASB is currently working on two research projects:Identifying and developing a set of disclosure principlesClarification of the concept of materiality by adding key characteristics for materiality40