MOS 1023 Chapter 2 – Financial Statements

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

Chapter 2 – Financial Statements: Framework, Presentation ad Usage Conceptual Framework of Accounting:  Guides … o decisions about what to present in financial statements, o alternative ways to document economic events and o appropriate ways of communicating this information  Why is it needed? o Ensures existing standards are clear and consistent o Makes it possible to respond quickly to new issues o Increases relevance, faithful representation, comparability and understandability of reports  Need? o To develop a coherent set of standards and principles o To solve new and emerging practical problems  Foreign currency transactions 4 main sections: Main goal = Provide information that is useful to individuals who are making the investment/credit decisions  Trueblood Committee (1970s) o All about forecasting for the future and determining future cashflows  Elements such as: amounts, timing and uncertainty of future cashflows, assets, liabilities and equity Qualitative characteristics of accounting information:  Must be preformed in order …  How we can make informed decisions about financial statements o Must have tradeoff along these characteristics Relevance:  CFA has relevance if it will make a difference in users’ decisions  Predictive value – helps users make predictions about the potential effects of past, present, future truncations or other events  Feedback value - Helps users confirm or correct their previous expectations  Timely – to bee relevant accounting information must be timely Faithful Representation:  Financial reporting must present the economic substance of transaction, not just its legal form  Reflect the true economic reality of corporation  Verifiable – two or more people reviewing info should be able to come to same or similar conclusions  Neutrality – the absence of bias o Accounting info cannot be created to favour one set of interests  Completeness – all information that is needed to faithfully represent the economic reality  Substance over form  the economic impact overrides the legal form o Leasing and Enro’s SPE’s to hide debt Comparability:  When companies with similar circumstances use the same accounting standards o ID’s similarities and differences between companies  Consistency - using same accounting treatment for similar events from year to year  Companies can change accounting standards only if change is required by Accounting Standards Board OR if change will result in more relevant decision making Understandability:  Average investor is assumed to understand the accounting information  Base level of understandability = o Average user is assumed to have a reasonable understanding of accounting concepts and o procedures as well as general business sense Recognition and measurement criteria:  Accountants need detailed criteria to help them decide when and where an item is included in the financial statements Assumptions:  Create a foundation for accounting process  Indicate how economic events should be reported  Constraints make it possible to relax the principles under certain circumstances  Monetary Unit Assumption: o Only those things that can be expressed as money can be included in financial report o Unit of measurement stays the same overtime  Effects of inflation (or deflation) are assumed to be minor and are therefore ignored  Economic Entity Assumption: o Economic activity can be IDed with a particular accounting unit (company) o that is separate from the activities of the shareholders and all other economic entities  Time Period Assumption: o Activities of company can be subdivided into months, quarters or years for meaningful financial reporting even thought operations do not cease after time period o Interim periods: reporting periods of less than one year  Going Concern Assumption o Business will remain operational for foreseeable future o Directly related to cost principle o If a going concern is not assumed ..  Assets should be stated at liquidation value, not cost  Classifying assets/liabilities as short/long-term is irrelevant  Liquidation of business is likely Accounting Principles:  Generally accepted Accounting Principles (GAAP) o these principles that have authoritative support through Canadian and provincial business corporation acts and legislations  Cost principle : o assets should be recorded at their cost at the time of acquisition o Ex: land  Cost is most relevant value b/c land is intended for business use  Reported at cost until it is either sold or going concern assumption is no longer valid o Fair value is more subjective; costs are easily verified and neutral o Issues  Historical costs provides a reliable benchmark for measuring historical trends  Fair value information may be more useful  Reporting of fair value information is increasing  Full Disclosure principle o At all circumstance and events which would make a difference to financial statements users are disclosed o Providing data in the financial statements and the accompanying notes to the financial statements Cash Basis of Accounting  Revenue is recorded when cash is received  Expenses are recorded when incurred  Only records transactions that involve cash  Not GAAP Accrual Basis of Accounting  Revenues are recorded when earned  Expenses are recorded when incurred regardless of when cash is received  Records all transactions  Records cash and noncash transations Revenue Recognition Principle  Revenues realized when …. o Risk and rewards  have passed or the earnings are transferred over o Measurability  reasonably certain o Collectability  reasonably assured (realized or realizable)  Realized with products, merchandise or assets are exchangd for cash Matching:  Expenses matched with revenues that they produce o Illustrates a “cause and effect relationship” between money spent to earn revenues themselves o If the expesnes benefits the current and future periods (and meets the definition of assets), it is deffered o Asset’s costs is then systemically and rationally matched to future revenues o QV matching slide! Full Disclosure Principle:  Circumstances and events that make a difference to financial statements users should be disclosed  Provided through o Financial statements o Notes to the financial statements o Supplementary info Cons
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