MOS 1023 Chapter 2 Notes.docx

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Management and Organizational Studies
Course Code
Management and Organizational Studies 1023A/B
Maria Ferraro

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Custom Select Financial Statements: Framework, Presentations and Usage Conceptual Framework of Accounting The Conceptual Framework of Accounting: A coherent system of interrelated objectives and fundamental that can lead to consistent standards and that prescribes the nature, function, and limits of financial accounting statements. In other words, it guides decisions about what to present in financial statements, alternative ways of reporting economic events, and appropriate ways of communicating this information.  As a foundation for accounting, the conceptual framework does the following 1) Ensures that existing standards and practices are clear and consistent 2) Makes it possible to respond quickly to new issues 3) Increases the relevance, faithful representations, comparability, and understandability of financial reporting results  Ensures we have a coherent set of standards  Impossible to create rule for every situation o Canadian standards based mostly on general principles  Makes financial statements more relevant, objective, easier to compare, increases users understanding of, and confidence in financial reporting  Lack of uniformity in accounting standards from country to country arises because of differences in legal systems, in processes for developing standards, in government requirements, and in economic environments  International Accounting Standards Board (IASB): formed to try to reduce these areas of difference ad unify global standard-setting  Accounting Standards Board (AcSB): An independent standard setting body created by the Canadian Institute of Chartered Accountants o They develop Canada’s own accounting standards o The Accounting Standards Oversight Council (with representation from business, finance, government, academe, the accounting and legal professions, and regulators) oversees and contributes to the activities of the AcSB  The AcSB has begun convergence strategy to ensure Canadian standards become the same as IFRS (or close) over the next few years  International Financial Reporting Standards (IFRS)  After 2011, Canadian standards will cease to exist for profit oriented publicly traded companies o Not for profit companies and private companies will move to a simplified set of standards considered to be more suitable for their own needs o More then 100 countries have already adopted IFRS (Canada, India, Japan, Korea plan to move to IFRS by 2011. US plans to switch between 2014 and 2016) The Conceptual Framework of Accounting has four main sections: 1) The objective of financial reporting 2) The qualitative characteristics of accounting information 3) The elements of financial statements 4) Recognition and measurement criteria (assumptions, principles, and constraints) 1) The Objective of Financial Reporting  Main objective is to provide information that is useful to individuals who are making investment and credit decisions  To help users make decision whether to invest r lend, or allocate resources in some other way, financial reporting should provide information about he amounts, timing, and uncertainty of future cash flows, economic resources (assets) and claims to those resources (liabilities and equity). Should also include management’s explanations about the company’s financial activities, since management knows more about the company than external users do. 2) Qualitative Characteristics of Accounting Information  To be useful in decision making, info should have relevance, faithful representation, comparability, and understandability  Relevance o Predictive Value: Helps users make predictions about the potential affects of past, present, or future transactions or other events o Feedback Value: Helps users confirm or correct their previous expectations (in most cases, financial statements are expected to confirm, not correct, expectations) o Timely: Information must be available to decision makers before it loses its ability to influence their decisions.  Faithful Representation o Verifiable: Means that two or more people reviewing the same information and using the same methods would reach the same results or similar conclusions. Financial reporting is often based on estimates however, (future environmental cleanup costs), so verifiability is sometimes hard. o Neutral: The absence of bias. Accounting information cannot be selected, prepared or presented to favor one set of interested users over another. o Complete: All the information that is needed to faithfully represent economic reality must be included.  Comparability: There is comparability when companies with similar circumstances use the same accounting standards o Enables users to identify similarities and differences between companies. o Movements to international accounting standards will help eliminate or reduce some of these differences o Users want to be able to compare a company’s financial results over time o Consistency: When company uses the same accounting treatment for similar events from year to year. o Companies can change accounting standards, but only if the change is required by the Accounting Standards Board, or if the change will result in more relevant information for decision making.  Understandability: All users must be able to understand financial statements for it to be useful. o Financial statements cannot always satisfy the varied needs al all users, so the objective of financial reporting focuses on the needs of investors and creditors o Creditors may scrutinize all aspects of the financial information, and investors may only scan the text and not study the numbers o The average user is assumed to have reasonable understanding o accounting concepts and procedures, as well as of general business and economic conditions o Understandability is greater when the information in classified, characterized, and presented clearly and concisely  These 4 concepts are complementary (they work together), but should be applied in a certain order o Relevance first because I will help identify what specific information that would affect the decision of investors, creditors, and other users of accounting information should be included in the financial reports o Faithful representation second, to ensure that the economic information faithfully represents the information being described. Together, relevance and faithful representation make financial reporting information decision-useful. o Comparability and understandability come next. They add to the decision usefulness of financial reporting information that is relevant and representationally faithful. They must be applied after because they cannot make information decision useful if it is irrelevant or not faithfully represented. 3) Elements of Financial Statements:  A set of definitions that describe the basic terms used in accounting o Assets, liabilities, equity, revenues, expenses 4) Recognition and Measurement Criteria  The objective of financial reporting, the qualitative characteristics of accounting information, and the elements of financial statements are very broad. Because accountants need to solve problems, they need more detailed criteria to help decide when items should be included in the financial statements and how they should be measured. We classify these criteria as assumptions, principles, and constraints.  Assumptions: Create a foundation for the accounting process. Four assumptions guide when to recognize (include) and how to measure economic events: o Monetary Unit Assumption: Requires only those things that can be expressed in money be included in the accounting records  Example: Customer satisfaction is important to business but is not easily quantified in dollars so is not reported in financial statements.  Monetary unit assumption assumes that the unit of measure remains stable over time (effects of inflation or deflation assumed to be minor and are ignored)  In some countries inflation is so high that a general price level index is used to adjust for the effects of inflations so information is comparable from year to year (Zimbabwe annual inflation rate is 1,000%) o Economic Entity Assumption: States that the economic activity can be identified with a particular accounting unit (a company), which is separate and distinct from the activities of the shareholders and of all other economic entities  Example: if you are a shareholder, the amount of cash you have in personal bank account and balance you owe on car loan are not included in balance sheet because you and your company are separate accounting entities  Shoppers Drug Mart: many independent drug stores operated by associates. Although financial results are consolidated (combined), individual accounting records are also produced for each specific company to accurately assess the performance and financial position of each company, even if the companies are related o Time Period Assumption: The life of a business can be divided into artificial time periods and that useful reports covering those periods can be prepared for the business. In other words, it is assumed that the activities of a company can be subdivided into months, quarters or years for meaningful financial reporting even though the company’s operations do not cease at the end of these time periods  All companies report at least annually (end of fiscal year)  Publicly traded companies also report to shareholders every three months (quarterly) and prepare monthly statements for internal purposes  Quarterly Periods: Every three months  Interim Periods: Reporting periods of less than one year. These are essential for timely and relevant decision making  The shorter the time period, the harder it is to faithfully represent the financial results  Month results harder to verify than quarter results because economic activities not complete in a month, or a quarter, and often not within a year  Waiting until an economic activity is complete to record is is not okay because not would not result in timely financial information  Time period assumption recognizes that estimates are essential for producing information that is still relevant for decision making o Going Concern Assumption: States that the business will remain in operation for the foreseeable future (if a company has a history of profitable operations and access to financial resources)  Closely related to cost principle: if going concern is not assumed, assets should be stated at their liquidation value, not at their cost. Classifying asse
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