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Lectures Intermediate Financial Accounting
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Brief summary of all IFA lectures, including examples, references and rules.
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Intermediate Financial AccountingLecture week 1
Financial Accounting is how organizations report their actions in a structured way for the
outside world. All the information that the manager internally can build up.
An Annual Report is unregulated. It’s a general non-standard summary of company activities
and includes more than only financial statements (CEO letters, etc.).
Financial statements are regulated by Generally Accepted Accounting Principles (GAAP).
GAAP is mostly the national standards (US GAAP, Dutch GAAP). A financial statement usually
includes all financial statements and notes, but it’s depending on the characteristics of the
firm. If it’s a small company, they will use less statements.
Financial Statements (FS) includes:
- Statement of financial position (balance sheet)
- Income statement (P&L → statement of Profit & Loss)
- Statement of cash flows
- Statement of changes in shareholders’ equity
LO1.1 Role of financial reporting
- Scarcity of resources: we need to decide where to put these resources. It’s all the
allocating decisions. “We have this much money, so we put it over here.”
- Comparability: we can compare financial statements of the whole capital market
because we use the same standards.
Economic (theory) reasoning
There is information asymmetry between the firm and the capital providers. So, the firm
needs to reduce this asymmetry as much as it can. It can be minimized by financial reporting,
because they give information to the provider in change of money. Furthermore, capital
providers write contracts to prevent management’s moral hazard behavior.
LO1.2 Role of financial reporting standards
Developed countries have their own GAAP, but there was a need for an international set of
rules. That’s why we designed International Financial Reporting Standards (IFRS). IFRS
satisfy the following rules:
- High-quality
- Understandable
- Enforceable
- Globally accepted
- Comparable
Here by, we can insure that relevant and faithful information is disclosed.
,LO1.3 Explain IFRS scope and application
166 countries are using IFRS in their country as a financial reporting statement.
LO1.4 IASB standard-setting structure
IASB is the head
function of the IFRS
structure and it has
created the IFRS. Its
created by talking
to the accounting
community.
Creating a standard is not so simple at all. There is a
process by the IASB with a lot of steps to make a
new standard or to adjust an old standard.
There are two types of research. Many times, we use positive research.
1. Normative vs positive research
Normative: ”You should do this, like I say you need to do this”. It’s based on norms. There is
literature that define how you should do things and define assets and report things.
Positive: Look at the data and ask yourself what is going on. So, there are a lot of researches
where researchers show how they think we need to report and why.
2. Controversies surrounding IFRS
How standards allow organizations to be flexible with their financial reporting (fair-value vs
historical cost accounting).
- Unformity vs flexible debate
Fair value vs Historical cost accounting, which lead to relevance vs reliability.
- Necessity of regulation
Free market perspective vs pro-regulation perspective
- Political interference & lobbying
- Some reporting issues
e.g. nonfinancial information, accounting for innovation, and timeliness (annual reports vs
daily stock prices).
,IFRS Conceptual framework
To be useful, information needs to meet 2 fundamental qualities:
- Relevance
Information is predictive and confirmatory of firm value (users can correctly interpret cash
flows), and material (when the information is absent, investors will change their thinking and
their decision).
- Faithful representation
Information is complete, neutral, and free from error.
Example relevance
Do we really need
to report this
unusually gain?
Is 20.000/1.000.000
important? No,
because it’s only 2%.
Is 5.000/10.000
important? Yes, so
this is material
because it’s 50% of
your income. We
need to report this
in our financial
statement.
The standard of materiality is 5% of Net Income.
When the information is relevant and is represented faithfully, other information qualities
can enhance the usefulness of accounting information.
The purpose of a conceptual framework is thereby:
- Comparability: comparable within and across firms
- Verifiability: verifiable by several third parties
- Timeliness: presented on time for decision-making
- Understandability: as clearly and concisely as possible
Assets: a present economic resource controlled by the entity as a result of past events with
the potential to produce economic benefits.
Liabilities: a present obligation of the entity to transfer an economic resource as a result of
past events.
Equity: the residual interest in the assets of the entity after deducting all its liabilities.
Income: increase in assets or a decrease in liabilities, that result in an increase in equity.
- Increase in Accounts Receivable/Cash as a result of a sale
Expenses: decrease in assets or an increase in liabilities, that result in a decrease in equity.
- Increase in Accounts Payable/Decrease in cash as a result of purchasing raw material.
, Historical/Amortized cost: acquisition cost (measured at transaction date)
Current value (measured at any given date):
- Fair Value: market based estimate
- Value in use and fulfillment value (L): company based measure/estimate (PV(Future
CF) the company expects to receive or pay.
- Current cost: amount paid (received) to acquire an equivalent asses (liability)
Historical cost is not well suited for financial instruments. We can e.g. use the value in use
and fulfillment for stocks → future cashflows.
A reporting entity can be single (one company), a portion of an entity or more than one. This
will affect how you report your entity.
- Consolidated FS: Parent + subsidiaries reporting as a single entity
- Unconsolidated FS: Parent or subsidiartyalone provides FS
- Combined FS: Reporting entity comprises +2 entities not linked by parent-subsidiary
relationship.
Lecture week 2
Information that you need to include with reporting statements:
- Statement of Financial position = Balance sheet (BS)
- Statement of financial performance (P&L, Income Statement, Comprehensive
Income)
- Recognizes/Unrecognized assets/liabilities/equity/income/expenses = OCI
- Statement of Cash Flows
- Statement of Shareholder’s Equity
- Notes are the details about tangible assets and it can exist out of a lot of pages.
Other Comprehensive Income: in some circumstances the board can exclude certain income
or expenses. For example, if your building is worth 1 million, but his actual costs were 1.000.
It’s not an income that’s related to the income of the company because it’s e.g. not a gain of
selling tickets, but gains from a smart investment. Then we can put the income on the
building on the OCI.
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