Chapter#2 financial statements: a window on an entity
I. The IFRS conceptual framework
A. The objective of General purpose financial reporting
The objective of general purpose financial reporting is to provide useful information about an
entity to existing and potential equity investors, lenders, and other creditors in making
decisions about providing resources to the entity.
The framework’s focus is probably narrow by necessity. Emphasizing a wider range of
stakeholders or purposes for financial statements would make it too difficult to provide useful
or coherent information.
B. Qualitative characteristics of useful financial information
Fundamental qualitative characteristics relevance and faithful representation
1. The fundamental qualitative characteristics are required if information is to be useful.
2. Relevance: Information is relevant if it helps stakeholders make predictions or if it
confirms or corrects evaluations they make in the past. For example, lenders want to
estimate future cash flows to determine whether an entity will be able to repay a loan.
3. Faithful representation: refers to the association between underlying information being
represented (the actual locations of boundaries and communities) and the representation
of that information (the map). If the statements are to be representationally faithful, all
the assets, liabilities, revenues, and expenses must be reflected in the statements.
Complete: all information required to reflect the underlying economic activity
should be provided.
Neutral: information is neutral or free from bias if it isn’t presented in a way that
is designed to bias or manipulate stakeholders’ decisions.
Free from error: information should be free of significant errors and omissions.
This doesn’t mean the information has to be perfectly accurate.
Enhancing qualitative characteristics: improve the usefulness of information that is relevant
and faithfully represented.
1. Comparability: it is easier for stakeholders to make decisions if they can readily compare
information about an entity from year to year or compare information about different
entities. It is achieved if similar transactions are accounted for the same way.
2. Verifiability: information is verifiable if independent and knowledgeable observers can
come up with similar results for measuring an attribute.
3. Timeliness: for information to be useful for decision making it must be available to
stakeholders in time to influence their decisions.
4. Understandability: to be useful, accounting information must be understood by
II. Basic accounting assumptions
A. Unit of measure
The unitofmeasure assumption states that the economic activity of an entity can be
effectively reported in terms of a single unit of measure, namely money.
It allows diverse information to be aggregated and summarized.
Information about the individual items being measured is lost. E.g. types
Characteristics not easily measured in terms of dollars are not accounted for.
Inflation is ignored.
B. Entity concept The entity concept assume that an entity of interest (corporation, partnership, proprietorship, a
division of a corporation, etc.) can provide information that is separate from the information
of owners or other entities.
C. Going concern
A going concern is an entity that will be continuing its operations for the foreseeable future. It
is expected to complete its current plans, use its existing assets in the ordinary course of
business, and meet its obligations as they come due.
D. Periodic reporting
The periodicreporting assumption states that meaningful financial information about an
entity can be provided for periods of time that are shorter than the entity’s life, such as
annually or quarterly. At a minimum, financial statements are prepared annually.
III. General purpose financial statements
A. General purpose financial statements are prepared for use by all stakeholders and aren’t
necessarily tailored to meet the information needs of any particular stakeholder or purpose.
B. Every business prepares a set of general purpose financial statements at least once a year, if for no
other reason than the statements must be included with its tax return.
IV. Leon’s financial statements: an overview
A. Leon’s financial statements are consolidated they aggregate the financial information of more
than one corporation into a single set of statements. It is prepared when a corporation controls
(own more than 50%) of other corporations and are intended to give stakeholders information on
all the companies in the group.
B. Financial statements cover a fiscal year the 12month period about which an entity provides
C. Dollar amounts in the statements are rounded to the nearest thousand dollars.
* Materiality: is the significance of financial information to stakeholders. Information is material if its
omission or misstatement affects the judgment of the information’s users. Financial statement should be
free of material misstatements or errors.
V. The balance sheet
A. Accounting equation: Assets= liability + owner’s equity
Assets are economic resources that provide future benefits to an entity.
Liabilities are an entity’s obligations
Owner’s equity is the investment owners have made in the entity.
Provide a future benefit (it will help generate cash) to the entity. If there is too much
uncertainty about whether the entity will enjoy the benefit, there is no asset.
The entity has the right to use the asset to make money
Be the result of a transaction or event that has already occurred
Types of assets
Types of asset What is it? Why is it an asset?
Cash Money Future benefit: cash can be spent to buy goods and services,
pay debts, and pay dividends
Control: Leon’s can use the cash however it wishes
Past transaction: events in the past, such as sales of
furniture, gave rise to the cash
Trade receivables Money owed to Future benefit: right to receive cash in the future
(account Leon’s by customers Control: the right to collect the cash belongs to Leon’s
receivable) who received goods Past transaction: trade receivables arise when goods are sold
but haven’t paid forto customers on credit. them yet. Measurable: the exact amount that will be collected isn’t
known because some customers may not pay.
Inventories Merchandise that Future benefit: Leon’s can sell the inventory to customers
Leon’s has available and receive cash.
for sale to customersControl: Leon’s owns the inventory and can determine how,
when, where, and what price to sell it.
Past transaction: the inventory was purchased in a
transaction with the manufacturer.
Measurable: the cost of the inventory can be determined
Property, plant, and Includes land, Future benefit: a building provides a place to operate a
equipment buildings, equipment, furniture store.
vehicles, and so on Control: Leon’s can use the building in any way it deems
that allow Leon’s to appropriate, limited only by relevant law or contract.
operate its Past transaction: a building would have been purchased
businesses. from a previous owner or built to Leon’s specifications.
Measurable: the cost of the building can be determined from
purchase documents or from construction cost details.
Missing assets: the future benefit associated with customers of some assets is difficult to measure
and companies don’t control their employees, therefore they may not be found on the balance
Balance sheet measurement: when an asset is acquired, it is recorded at the transaction value the
amount paid. E.g. inventory is reported at its cost, capital assets (property, plant, and equipment,
and intangible assets) can be reported at cost or fair value.
Current assets: are used up, sold, or converted to cash within one year or one operating cycle. (An
operating cycle is the time it takes from the initial investment made in goods and services until
cash is received from customers)
Noncurrent assets: assets that won’t be used up, sold, or converted to cash within one year or one
Criteria (according to IFRS):
Must be the result of a past transaction or economic event
A liability must require some kind of economic sacrifice to settle
Current liabilities and noncurrent liabilities
Current liabilities will be paid or satisfied within one year or one operating cycle.
Noncurrent liabilities will be paid or satisfied in more than one year or one operating cycle.
Types of liabilities
Type of liability What is it? Why is it a liability?
Trade and other Amounts owed to suppliers for Obligation: pay for goods and
payable goods and services purchased on services provided by suppliers
credit. Includes amounts owed to Past transaction or economic event:
inventory suppliers, utilities, the suppliers have provided the
property owners, and employees, tgoods and services
name a few. Economic sacrifice: in most cases,
money must be paid to settle the
Customers’ deposits Customers pay in advance for Obligation: provide goods and
goods to be provided in future services that have been paid for by
customers but not yet delivered
Past transaction: payment has been
received from customers for goods or services