1. WEYGANDT. KIESO. KIMMEL. TRENHOLM. KINNEAR. BARLOW. ATKINS PRINCIPLES OF FINANCIAL ACCOUNTING CANADIAN EDITION Chapter 11 Financial Reporting Concepts Prepared by: Debbie Musil Kwantlen Polytechnic University 1

2. Copyright John Wiley & Sons Canada, Ltd.2 The conceptual framework of accounting The objective of financial reporting, underlying assumption, and constraint – The objective of financial reporting – Underlying assumption – Cost constraint – Elements of financial statements Qualitative characteristics of useful financial information – Fundamental characteristics – Enhancing qualitative characteristics and their application – Differences under IFRS and ASPE – Full disclosure Recognition and measurement criteria – Revenue and expense recognition criteria – Measurement of elements – Errors and intentional misstatements Financial Reporting Concepts

3. Copyright John Wiley & Sons Canada, Ltd.3 Chapter 11: Financial Reporting Concepts Study Objectives 1.Explain the importance of having a conceptual framework of accounting, and list the key components. 2.Identify and apply the objective of financial reporting, as well as the underlying assumption and cost constraint used by accountants. 3.Describe the fundamental and enhancing qualitative characteristics of financial reporting. 4.Identify and apply the basic recognition and measurement concepts of accounting.

4. Copyright John Wiley & Sons Canada, Ltd.4 A foundation for accounting: – Ensures existing standards and practices are clear and consistent – Provides guidance in responding to new issues and developing new standards – Assists in the application of standards – Increases users’ understanding and confidence in financial statements Standards built on general principles, not rules Conceptual Framework of Accounting

5. Copyright John Wiley & Sons Canada, Ltd.5 Use professional judgment and framework to determine appropriate accounting treatment Six major components to framework: 1. Objective of financial reporting 2. Underlying Assumption 3. Cost constraint 4. Elements of financial statements 5. Qualitative characteristics of accounting information 6. Recognition and measurement criteria Conceptual Framework 2

6. Copyright John Wiley & Sons Canada, Ltd.6 Chapter 11: Financial Reporting Concepts Study Objectives 1.Explain the importance of having a conceptual framework of accounting, and list the key components. 2.Identify and apply the objective of financial reporting, as well as the underlying assumption and cost constraint used by accountants. 3.Describe the fundamental and enhancing qualitative characteristics of financial reporting. 4.Identify and apply the basic recognition and measurement concepts of accounting.

7. Copyright John Wiley & Sons Canada, Ltd.7 To provide information that is useful for making decisions about a business – To investors and creditors To give information about: – Economic resources (assets) and claims on those resources (liabilities, equity) – Changes in resources and claims on them – Economic performance Enables users to decide whether management used company resources in the best way possible Objective of Financial Reporting

8. Copyright John Wiley & Sons Canada, Ltd.8 Going Concern Assumption – Assumes that a company will continue operating for the foreseeable future – Important implications for how financial information is presented Cost constraint – The value of information should be greater than the cost of providing it Underlying Assumption & Cost Constraint

9. Copyright John Wiley & Sons Canada, Ltd.9 Basic categories that are used in financial statements – Assets, liabilities, equity, revenues and expenses Must be precisely defined and applied in the same way by all reporting entities Elements of Financial Statements

10. Copyright John Wiley & Sons Canada, Ltd.10 1.Explain the importance of having a conceptual framework of accounting, and list the key components. 2.Identify and apply the objective of financial reporting, as well as the underlying assumption and cost constraint used by accountants. 3.Describe the fundamental and enhancing qualitative characteristics of financial reporting. 4.Identify and apply the basic recognition and measurement concepts of accounting. Chapter 11: Financial Reporting Concepts Study Objectives

11. Copyright John Wiley & Sons Canada, Ltd.11 To be useful, information should have two fundamental qualitative characteristics: – Relevance – Faithful Representation Other characteristics enhance the usefulness of accounting information: – Comparability – Verifiability – Timeliness – Understandability Fundamental Characteristics of Useful Financial Information

12. Copyright John Wiley & Sons Canada, Ltd.12 Accounting information has relevance if it makes a difference in coming to a decision Relevant information has predictive and/or confirmatory value: – Predictive value: helps users forecast future events – Confirmatory value: confirms or corrects prior expectations Materiality is an important component of relevance – An item is material if it will influence a decision Fundamental Characteristics: Relevance

13. Copyright John Wiley & Sons Canada, Ltd.13 Fundamental Characteristics: Faithful Representation Information must be a faithful representation of the economic reality of reported events This is achieved when the information is: – Complete: includes all necessary information – Neutral: information is free from bias – Free from material error: will not affect decisions by investors and creditors

14. Copyright John Wiley & Sons Canada, Ltd.14 Comparability: Similar companies use the same accounting principles Consistency: A company uses the same accounting principles from year to year However, accounting principles can change: – Due to new requirements that have been issued – When management decides that a difference principle gives more relevant information Accounting changes are disclosed in the financial statements Enhancing Qualitative Characteristics: Comparability

15. Copyright John Wiley & Sons Canada, Ltd.15 Verifiable: assures users that the accounting information shows the economic reality of a transaction – Information is verifiable if two knowledgeable and independent people agree that it faithfully represents the economic reality Timely: accounting information is provided when it is still useful for decision-making – Available to decision makers before it loses its ability to influence their decisions Enhancing Qualitative Characteristics: Verifiability and Timeliness

16. Copyright John Wiley & Sons Canada, Ltd.16 Information must be understandable to users for it to be useful Enables users to interpret and comprehend the information provided in the financial statements Users are assumed to have a reasonable knowledge of: – Business, economic and financial activities – Financial reporting Enhancing Qualitative Characteristics: Understandability

17. Copyright John Wiley & Sons Canada, Ltd.17 ASPE identifies four principal characteristics: – Understandability – higher status under ASPE than IFRS – Relevance – important under both ASPE and IFRS – Reliability – considered reliable if it is a faithful representation – Comparability – higher status under ASPE than IFRS ASPE also identifies conservatism as a qualitative characteristic: – The choice of accounting treatment that is least likely to overstate assets, revenues and gains or understate liabilities, expenses and losses It is anticipated that ASPE will adopt the IFRS conceptual framework Differences in Qualitative Characteristics Under IFRS and ASPE

18. Copyright John Wiley & Sons Canada, Ltd.18 Requires disclosure of circumstances and events that make a difference to financial statement users Accomplished through: – The data in the financial statements – The notes that accompany the statements A summary of significant accounting policies is usually the first note to the financial statements Full Disclosure

19. Copyright John Wiley & Sons Canada, Ltd.19 1.Explain the importance of having a conceptual framework of accounting, and list the key components. 2.Identify and apply the objective of financial reporting, as well as the underlying assumption and cost constraint used by accountants. 3.Describe the fundamental and enhancing qualitative characteristics of financial reporting. 4.Identify and apply the basic recognition and measurement concepts of accounting. Chapter 11: Financial Reporting Concepts Study Objectives

20. Copyright John Wiley & Sons Canada, Ltd.20 Accrual basis of accounting – transactions are recorded in the period in which the events occur, rather than when cash is received or paid Recognition criteria help determine when items should be included in financial statements Measurement criteria provide guidance on what amount should be recorded An item is usually included in the financial statements if: – It meets the definition of an asset, liability, equity, revenue or expense – It can be measured, and – If a reasonable estimate of the amount can be made Recognition & Measurement Criteria

21. Copyright John Wiley & Sons Canada, Ltd.21 Two important concepts underlying the general recognition criteria: 1.If an asset is going to be recorded it must be probable there will be future economic benefit 2.If a liability is going to be recorded it must be probable there will economic resources given up Recognition & Measurement Criteria

22. Copyright John Wiley & Sons Canada, Ltd.22 Revenue Recognition Criteria Revenue should be recognized at the same time that: – An increase in an asset is recognized, or – A decrease in a liability is recognized for profit-generating activities

23. Copyright John Wiley & Sons Canada, Ltd.23 Revenue recognized when all conditions met: – Significant risks and rewards of ownership have transferred from seller to buyer – Seller no longer controls or manages goods – Revenue can be reliably measured – Probable increase in economic resources (cash collected) – Costs relating to sale can be reliably measured For retail sales, these conditions are met at point of sale Revenue Recognition: Sale of Goods

24. Copyright John Wiley & Sons Canada, Ltd.24 Revenue is generally recognized when: – Service is provided, and – Seller can be reasonably sure that cash will be collected Revenue may also be recognized as chunks of services are provided – percentage-of-completion method used for long-term service and construction contracts Revenue Recognition: Service and Construction Contracts

25. Copyright John Wiley & Sons Canada, Ltd.25 Percentage-of-completion method recognizes revenue based on reasonable estimates of progress to completion Progress to completion is determining by comparing the costs incurred to date to estimated total cost: Revenue Recognition: During Production

26. Copyright John Wiley & Sons Canada, Ltd.26 Expenses are recognized when there is: – A decrease in an asset – An increase in a liability – Excludes distributions to owners Not necessarily when the cash is paid Can be a direct association between costs incurred and revenue earned – When no direct relationship, another systematic and rational allocation policy may be used Expense Recognition Criteria

27. Copyright John Wiley & Sons Canada, Ltd.27 Acquired assets are recorded at cost Cost is used because it is: – Relevant: represents the price paid, assets sacrificed or the commitment made at the date of acquisition – A Faithful Representation: objectively measurable, factual and verifiable For some assets, more relevant to use fair value – Amount of cash expected to be collected when asset is sold Some other assets and liabilities use amortized cost Measurement of Elements

28. Copyright John Wiley & Sons Canada, Ltd.28 Revenues and expenses may be misstated by: 1.Recognizing in the incorrect accounting period 2.Misstatement of estimates 3.Misstatement of accruals 4.Failure to record a revenue or expense 5.Failure to apply the correct measurement Important to analyze transactions carefully to ensure that accounting principles are applied correctly and are faithfully represented Errors and Intentional Misstatements

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