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Canada (158,052)
York University (12,350)
ADMS 3585 (22)
Ping Peng (3)
Chapter 2

Chapter 2 conceptual framework.docx

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York University
Administrative Studies
ADMS 3585
Ping Peng

Chapter 2: Conceptual Framework Underlying Financial Reporting Conceptual Framework Why Conceptual Framework • Practical (In real world) o Providing ground rules  To develop GAAP  To resolve real-world accounting issues o Not override current GAAP  Educational (For students) o To provide a framework to analyze accounting issues in financial reporting o Case Analysis: e.g. CA2-1 (p.85) Conceptual Framework Development  AcSB, IASB and FASB have their own individual framework  These frameworks differ in various respects, are incomplete, and are not up to date  IASB and FASB are currently working on a joint project to develop a common conceptual framework o The project finished Phase A “Objectives and Qualitative Characteristics” in Sep 2010 o The project was paused thereafter o The Framework described in the text reflects IASB and FASB’s joint efforts to date Level 1: Objectives of Financial Reporting (IASB and FASB Exposure Draft) “The objective is to communicate information that is useful to users in making their resource allocation decisions”  Provide useful information to users in decision making Level 2: Qualitative Characteristics and Elements • Qualitative characteristics o To assess quality of financial reporting (high quality vs. low quality) o Include “Fundamental” and “Enhanced”  Elements o To establish language that is common to users and preparers of financial reports. Fundamental Qualitative Characteristics 1. Relevance • Makes a difference in a decision • Has predictive and feedback/confirmatory value 2. Representational Faithfulness  Complete  Neutral  Reasonably free from error or bias Enhancing Qualitative Characteristics 1. Comparability • Information measured and reported in similar way (company to company, and year to year) • Allows users to identify real economic similarities and differences 2. Verifiability • Similar results achieved if same methods are used 3. Timeliness 4. Understandability • Allows reasonably informed users to see the significance of the information • Provides “enough” information so that it is clear Trade-offs and Constraints • Trade-offs o Trade-offs happen when one qualitative characteristics is sacrificed for another  e.g. relevance and reliability • Each situation/case must be evaluated separately based on the facts available and the needs of the users • Constraints o Cost-benefit constraint o Materiality constraint: 5% rule? o How to determine materiality? Materiality  Relates to an item’s impact on an entity’s overall financial operations  Both quantitative and qualitative factors should be considered in determining relative significance o Quantitative (General rule of thumb): if the item is 5% of income from continuing operations, it is considered material o Qualitative: An item is material if including it or leaving it out influences a decision-maker o Determination of materiality requires professional judgement and expertise Level 2: Elements  Basic elements of financial statements include the following:  Assets  Liabilities  Equity  Revenues  Expenses  Gains • Losses Elements of Financial Statements: Assets  Assets have two key characteristics: o They involve a present economic resource o Entity has a right or access to those resources where others do not Elements of Financial Statements: Liabilities  Liabilities have two key characteristics: o They represent an economic obligation or burden o Entity has a present obligation Other Elements  Revenues o Increases in economic resources resulting from ordinary activities  Expenses o Decreases in economic resources resulting from ordinary activities  Gains o Increases in equity (net assets) resulting from incidental transactions  Losses o Decreases in equity (net assets) resulting from incidental transactions Foundational Principles  Recognition / Derecognition 1. Economic entity 2. Control 3. Revenue recognition and realization 4. Matching  Measurement 5. Periodicity 6. Monetary unit 7. Going concern 8. Historical cost 9. Fair value  Presentation and Disclosure 10. Full disclosure Recognition • Process of including an item on entity’s balance sheet or income statement • Elements of financial statements have historically been recognized when: o they meet the definition of an element (e.g. asset) o they are probable, and o they are reliably measurable o Derecognition o Process of ‘removing’ something from the balance sheet or income statement Economic Entity Assumption (Also called Entity Concept)  The economic activity can be identified with a particular unit of accountability  The business activity is separate and distinct from its owners (and any other business unit)  An individual, departments or divisions of an entity, or an entire industry may be considered separate entities  Does not necessarily refer to a legal entity  For tax and legal purposes, considered a legal entity Control  Important factor in determining entities to be consolidated and included in the economic entity  Some concepts of control include: o Having power to direct entity’s activities o Not sharing this power o Power doesn’t need to be absolute, or even exercised o Access to benefits Revenue Recognition Principle  Revenue is recognized when: o Risks and rewards have passed or the earnings process is substantially complete o Measurability is reasonably certain and o Collectibility is reasonably assured (realized or realizable)  Revenue realized when products (goods or services), merchandise, or assets are exchanged for cash (or claim to cash)  Alternative contract-based view also emerging Matching
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