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MGAB01H3 (126)
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Chapter 2


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Financial Accounting
G.Quan Fun

Tuesday, September 15, 2009 TN: Chapter 2 [MGTB05] Conceptual Framework of Accounting Conceptual Framework ofAccounting: The elements that guides the development & application of accounting principles that maintain consistent standards. “Consistent set of standards” 1. Ensures that existing standards are clear & consistent 2. Makes it possible to respond quickly to new issues 3. Increases the relevance, faithful representation, comparability, and understandability of financial reporting results • New standards can easily be build on the same foundations 1. The Objective of Financial Reporting • Used to provide information that is useful to those who are making investment and credit decisions • F.R. should provide financial information and managers explanations about financial activities 2. Qualitative Characteristics ofAccounting Information: Characteristics for useful information I. Relevance: The ability to make a difference in users’decisions a) Relevant information allows to make predictions (predictive value), confirm/correct their previous expectations (feedback value), and influence decisions on time (timely) II. Faithful Representation: The quality of describing information that shows economic reality A. Verifiable: people reviewing the information should reach similar conclusions B. Neutral: information cannot be presented to favour one set of users over another C. Complete: information needed to represent economic reality must be included III. Comparability: Describing accounting information to allow comparison between other companies A. Comparability: allows to see differences and similarities between companies B. Consistency: the act of using the same accounting treatment for similar events year to year IV. Understandability: providing information that is understandable to users (some accounting needed) 3. Elements of Financial Statements • Definitions of basic terms in accounting 4. Recognition and Measurement Criteria: Assumptions, Principles and Constrains I. Assumptions: guide when to include and how to measure economic activities A. Monetary UnitAssumption: only items that can be expressed in money be included in accounting records and that units of measure remain stable over time a) Inflation/deflation are ignored, or in some countries adjusted (if too high) B. Economic EntityAssumption: economic activity of a company are separate from shareholders C. Time PeriodAssumption: life of a business can be divided into artificial time periods a) Interim periods: reporting periods less than a one year b) The shorter the periods the more difficult to create a faithful accounting report D. Going ConcernAssumption: business will remain in operation for the foreseeable future. a) If business has history of profitable operations & access to financial resources, it’s assumed that it will operating to carry out it’s existing obligations & commitments b) If going concern is not assumed , assets are stated in liquidation value c) Assumption should not be used when liquidation of business is likely II. Accounting Principles: how economic events should be reported A. Cost Principal: assets be recorded at their cost at the time of acquisition (but some revalued) a) Value of land will remain the same because its more relevant, since the land is intended for business not for resale, until either it is sold/the going concern assumption is not valid b) Argue that over time fair value is different from original cost value, but others say that for faithful representation the principal should be used because it can be verified & is neutral B. Full Disclosure Principal: events that make a difference to F.S. users be disclosed (in notes) III. Constraints InAccounting: allow to
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