Intermediate Financial Accounting Chapter 2 PDF

Intermediate Financial Accounting I Chapter 2 Jae-Young Kim The role of an Auditor Assumption: Assumption:Limited LimitedAmount Amount of Resources...

Intermediate Financial Accounting I Chapter 2 Jae-Young Kim The role of an Auditor Assumption: Assumption:Limited LimitedAmount Amount of Resources Resources Manufacturer Manufacturer Consumer Financial Financial Consumer (Company’s (Company’s (External Information Information (External Users) Management) Management) Users) Auditor  Intermediate Accounting IFRS Edition Kieso, Weygandt, Warfield Fourth Edition Chapter 2 Conceptual Framework for Financial Reporting Prepared by Coby Harmon University of California, Santa Barbara Westmont College This slide deck contains animations. Please disable animations if they cause issues with your device. Copyright © 2020 John Wiley & Sons, Inc. Learning Objectives After studying this chapter, you should be able to: LO 1 Describe the usefulness of a conceptual framework and the objective of financial reporting. LO 2 Identify the qualitative characteristics of accounting information and the basic elements of financial statements. LO 3 Review the basic assumptions of accounting. LO 4 Explain the application of the basic principles of accounting. Copyright © 2020 John Wiley & Sons, Inc. 4  Learning Objective 1 Describe the usefulness of a conceptual framework and the objective of financial reporting. LO 1 Copyright © 2020 John Wiley & Sons, Inc. 5 Conceptual Framework (1) Conceptual Framework establishes the concepts that underlie financial reporting. Need for a Conceptual Framework Rule-making should build on and relate to an established body of concepts. Enables I A S B to issue more useful and consistent pronouncements over time. Help professions to solve new problems quickly because they have a reference. LO 1 Copyright © 2020 John Wiley & Sons, Inc. 6 Conceptual Framework (2) Conceptual Framework is not and IFRS, yet it is part of the authoritative literature. Therefore the Conceptual Framework can provide guidance in many situations where an IFRS does not cover the issue under consideration. LO 1 Copyright © 2020 John Wiley & Sons, Inc. 7 Overview of the Conceptual Framework Three levels: First Level = Objective of Financial Reporting Second Level = Qualitative Characteristics and Elements of Financial Statements Third Level = Recognition, Measurement, and Disclosure Concepts. LO 1 Copyright © 2020 John Wiley & Sons, Inc. 8 Conceptual Framework for Financial Reporting LO 1 Copyright © 2020 John Wiley & Sons, Inc. 9 Objective of the Conceptual Framework Objective of the financial reporting is the foundation of the Conceptual Framework. To provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions about providing resources to the entity. Provided by issuing general-purpose financial statements. Assumption is that users need reasonable knowledge of business and financial accounting matters to understand the information. LO 1 Copyright © 2020 John Wiley & Sons, Inc. 10  Learning Objective 2 Identify the qualitative characteristics of accounting information and the elements of financial statements. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 11 Fundamental Concepts Qualitative Characteristics of Accounting Information IASB identified the Qualitative Characteristics of accounting information that distinguish better (more useful) information from inferior (less useful) information for decision-making purposes. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 12 Hierarchy of Accounting Qualities ILLUSTRATION 2.2 LO 2 Copyright © 2020 John Wiley & Sons, Inc. 13 Fundamental Quality—Relevance To be relevant, accounting information must be capable of making a difference in a decision. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 14 Predictive Value Financial information has predictive value if it has value as an input to predictive processes used by investors to form their own expectations about the future. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 15 Confirmatory Value Relevant information also helps users confirm or correct prior expectations. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 16 Materiality Information is material if omitting it or misstating it could influence decisions that users make on the basis of the reported financial information. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 17 Fundamental Quality—Faithful Representation Faithful representation means that the numbers and descriptions match what really existed or happened. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 18 Completeness Completeness means that all the information that is necessary for faithful representation is provided. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 19 Neutrality Neutrality means that a company cannot select information to favor one set of interested parties over another. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 20 Free From Error An information item that is free from error will be a more accurate (faithful) representation of a financial item. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 21 Enhancing Qualities Enhancing qualitative characteristics are complementary to the fundamental qualitative characteristics. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 22 Enhancing Qualities—Comparability Information that is measured and reported in a similar manner for different companies is considered comparable. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 23 Enhancing Qualities—Verifiability Verifiability means different knowledgeable and independent observes could reach consensus. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 24 Enhancing Qualities—Timeliness Timeliness means having information available to decision- makers before it loses its capacity to influence decisions. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 25 Enhancing Qualities—Understandability Understandability is the quality of information that lets reasonably informed users see its significance. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 26 Basic Elements Asset A present economic resource controlled by the entity as a result of past events. An economic resource is a right with the potential to produce economic benefits. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 27 Basic Elements Liability A present obligation of the entity to transfer an economic resource as a result of past events. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 28 Basic Elements Equity The residual interest in the assets of the entity after deducting all its liabilities. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 29 Basic Elements Income Increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity claims. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 30 Basic Elements Expenses Decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims. LO 2 Copyright © 2020 John Wiley & Sons, Inc. 31  Learning Objective 3 Review the basic assumptions of accounting. LO 3 Copyright © 2020 John Wiley & Sons, Inc. 32 Recognition, Measurement, and Disclosure Concepts These concepts explain how companies should recognize, measure, and report financial elements and events. LO 3 Copyright © 2020 John Wiley & Sons, Inc. 33 Assumptions Economic Entity – company keeps its activity separate from its owners and any other business unit. Going Concern - company to last long enough to fulfill objectives and commitments. Monetary Unit - money is the common denominator. Periodicity - company can divide its economic activities into time periods. Accrual Basis of Accounting – transactions are recorded in the periods in which the events occur. LO 3 Copyright © 2020 John Wiley & Sons, Inc. 34  Learning Objective 4 Explain the application of the basic principles of accounting. LO 4 Copyright © 2020 John Wiley & Sons, Inc. 35 Basic Principles of Accounting Measurement Principles Historical Cost is generally thought to be a faithful representation of the amount paid for a given item. Fair value is defined 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.” IASB has given companies the option to use fair value as the basis for measurement of financial assets and financial liabilities. LO 4 Copyright © 2020 John Wiley & Sons, Inc. 36 Basic Principles of Accounting Fair Value Hierarchy IASB established a fair value hierarchy that provides insight into the priority of valuation techniques to use to determine fair value. ILLUSTRATION 2.4 LO 4 Copyright © 2020 John Wiley & Sons, Inc. 37 Basic Principles of Accounting Revenue Recognition Principle When a company agrees to perform a service or sell a product to a customer, it has a performance obligation. Requires that companies recognize revenue in the accounting period in which the performance obligation is satisfied. LO 4 Copyright © 2020 John Wiley & Sons, Inc. 38 Basic Principles of Accounting The Five Steps of Revenue Recognition Illustration: Assume the Airbus (DEU) signs a contract to sell airplanes to British Airways (GRB) for €100 million. To determine when to recognize revenue, Airbus uses the five steps for revenue recognition shown at right. ILLUSTRATION 2.5 LO 4 Copyright © 2020 John Wiley & Sons, Inc. 39 Basic Principles of Accounting Expense Recognition Principle Outflows or “using up” of assets or incurring of liabilities during a period as a result of delivering or producing goods and/or rendering services. ILLUSTRATION 2.6 LO 4 Copyright © 2020 John Wiley & Sons, Inc. 40 Basic Principles of Accounting Full Disclosure Principle Providing information that is of sufficient importance to influence the judgment and decisions of an informed user. Provided through: Financial Statements Notes to the Financial Statements Supplementary information LO 4 Copyright © 2020 John Wiley & Sons, Inc. 41 Cost Constraint Companies must weigh the costs of providing the information against the benefits that can be derived from using it. Rule-making bodies and governmental agencies use cost- benefit analysis before making final their informational requirements. In order to justify requiring a particular measurement or disclosure, the benefits perceived to be derived from it must exceed the costs perceived to be associated with it. LO 4 Copyright © 2020 John Wiley & Sons, Inc. 42 Summary of the Structure ILLUSTRATION 2.7 LO 4 Copyright © 2020 John Wiley & Sons, Inc. 43 Copyright Copyright © 2020 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. Copyright © 2020 John Wiley & Sons, Inc. 44