Chapter 2 Accounting Module

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Western University
Management and Organizational Studies
Management and Organizational Studies 1023A/B
Maria Ferraro

MOS Chapter 2 CONCEPTUAL FRAMEWORK OF ACCOUNTING • “a coherent system of inter-related objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function and limits of financial accounting statements” • guides decisions about what to present in financial statements • conceptual framework does the following: ensure that existing standards and practices are clear and consistent, makes it possible to respond quickly to new issues, increases the relevance, faithful representation, comparability and understandability of financial report results ensures that we have a coherent set of standards • • canadian standards are based mostly on general principles, not specific rules • makes financial statements more relevant, objective and easier to compare • more countries are adopting a uniform, global set of standards • InternationalAccounting Standards Board (IASB) tries to reduces areas of difference in countries • Canada has standards set by theAccounting Standards Board (AcSB), created by the Canadian Institute of Chartered Accountants • Accounting Standards Oversight Council oversees the activities of theAcSB AcSB recommended that profit-oriented publicly traded companies in Canada move to • International Financial Report Standards by 2011 • AcSB has begun a convergence strategy that will ensure Canadian standards become the same as IFRS • not-for-profit companies will move to a simplified set of standards Canadian companies whose shares trade on a US stock exchange, which currently permits a • Canadian company to use US accounting standards, are also required to change to IFRS by 2011 • conceptual framework of accounting has four main sections: objective of financial reporting, qualitative characteristics of accounting information, elements of financial statements, recognition and measurement criteria (assumptions, principles, constraints) OBJECTIVE OF FINANCIAL REPORTING • to provide information that is useful to individuals who are making investment and credit decisions • financial reporting should provide information about the amounts, timing and uncertainty of future cash flows, economic resources and claims to those resources • should include management’s explanations about the company’s financial activities QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION RELEVANCE • accounting information is relevant if it will make a difference in users’decisions • helps users make predictions about the potential effects of past, present or future transactions, therefore said to have predictive value • helps users confirm or correct their previous expectations, therefore said to have feedback value • in most cases, financial statements are expected to confirm and not correct expectations • must be timely- available to decision makers before it loses its ability to influence their decisions FAITHFUL REPRESENTATION • must be a faithful representation of what really exists or happened, must represent economic reality • also means that financial information must be verifiable, neutral and complete • verifiability means two or more people reviewing the same information would reach the same results or similar conclusions • must also understand financial reporting information is often based on estimates, rather tahn on exact measures of transactions and events • neutrality- absence of bias • accounting information cannot be selected, prepared or presented to favour one set of interested users over another • completeness means that all 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 • enables users to identify the similarities and differences between companies • comparability is sometimes difficult due to different accounting methods, international accounting standards will help eliminate some of these differences • users of accounting information also compare a company’s financial results over time • consistency means that a company uses the same accounting treatment for similar events from year to year, therefore can be used for meaningful analysis of trends UNDERSTANDABILITY • all users have to be able to understand financial information • international accounting standards will help ensure information is more likely to be understood by global users • financial statements cannot always satisfy the varied needs of all users • objective of financial reporting focuses mostly on the information needs of investors and creditors • necessary to agree on a base level of understandability • base level- the average user is assumed to have a reasonable understanding of accounting concepts and procedures, as well as of general business and economic conditions • those who do not have this level of understanding should rely on professionals qualitative characteristics are complementary concepts- they work together • • must be applied in a certain order • the qualitative characteristic of relevance should be applied first • will help identify what specific information that would affect decisions of users of accounting information should be included in financial reports • faithful representation is then applied to ensure that economic information faithfully represents the information being describe • next are comparability and understandability, they add to decision-usefulness of financial reporting information • must be applied after first two characteristics because they cannot, either individually or together, make information decision-useful if it is irrelevant or not faithfully represented Element of Financial Statements • important part of the conceptual framework is a set of definitions that describe the basic terms used in account this set of definitions is the elements of financial statements, includes assets, liabilities, equity, • revenues and expenses RECOGNITION AND MEASUREMENT CRITERIA • because accountants must solve problems, they need more detailed criteria to help them decide • classify these recognition and measurement criteria as assumptions, principles and constraints • assumptions create a foundation for the accounting process, principles indicate how economic events should be reported • constraints make it possible to relax the principles under certain circumstances ASSUMPTIONS MONETARY UNITASSUMPTION requires that only those things that can be expressed in money be included in the accounting • records • because the exchange of money is fundamental to business transactions, it makes sense that we measure a business in terms of money • however, also means that some important information needed by investors is not reported in financial statements i.e. customer satisfaction • also assumes that the unit of measure remains stable over time, effects of inflation are assumed to be minor and therefore ignored ECONOMIC ENTITYASSUMPTION • states that the economic activity can be identified with a particular accounting unit which is separate and distinct from the activities of the shareholders and of all other economic entities • it has to be possible to distinguish each company’s activities from the transactions of any other company, even if the companies are related TIME PERIODASSUMPTION • states that the life of a business can be divided into artificial time period that useful reports covering those periods can be prepared for the business • operations do not cease at the end of these time periods • publicly traded companies report to shareholders every three months, prepare monthly statements • reporting periods of less than one year are interim periods • the shorter the time period, the more difficult it is to faithfully represent the financial results GOING CONCERN ASSUMPTION • states that the business will remain in operation for the foreseeable future • directly related to the cost principle • if a going concern is not assumed, assets should be stated at their liquidation value Accounting Principles • principles that describe how economic events should be recorded and reported are know as generally accepted accounting principles (GAAP) • legislation is currently being updated in Canada to allow the use of international accounting standards COST PRINCIPLE • assets be recorded at their cost at the time of acquisition • cost is most relevant value because the asset is intended for use in the business, not being used for resale FULL DISCLOSURE PRINCIPLE requires that all circumstances and events which would make a difference to financial • statement users be disclosed • providing the data contained in the financial statements and the accompanying notes to the financial statements • notes can also add new information about events or situations that cannot be quantified in the financial statements
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