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Advanced Financial Accounting - Maastricht University - Chapters 1, 3, 4, 5, 6, 7, 15, 18, 28, 29
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Chapter 1 – Conceptual FrameworkConceptual Framework
The purpose of a conceptual framework is to provide a coherent set of principles:
To assist standard setter to develop a consistent set of accounting standards for the
preparation of financial statements
To assist prepares of financial statements in the application of accounting standards and in
dealing with topics that are not the subject of an existing applicable accounting standard.
To assists users in the interpretation of information in financials statements.
Objective financial reporting
The objective of general purpose financial reporting is to provide financial information about the
reporting entity that is useful to present and potential equity investors, lenders and other creditors
in making decisions about providing resources to the entity. Those decisions involve buying,
selling or holding equity and debt instruments, and providing or settling loans and other forms of
credit.
Arguments Objective
Financial statements should reflect the perspective of the entity rather than the perspective of
the entity’s equity investors. The focus is then on the entity’s resources and the changes in
them rather than on the shareholders as owners of the entity
The key users of financial statements are capital providers and lenders.
Fundamental Qualitative Characteristics
Relevance
o Capable of making a difference in decision making
o It has predictive value, confirmatory value or both
o Capable of making a difference whether users use it or not
Information is material if its omission or misstatement could influence the decisions that users
make about a specific reporting entity.
Faithfull representation
o Attained when the depiction of an economic phenomenon is complete, neutral and
free from material error
Apply relevance to information afterwards faithful representation is applied
Enhancing Qualitative Characteristics
Comparability
Verifiability
Timeliness
Understandability
Going Concern Assumption
It is assumed that an entity will continue to operate at least long enough to carry out its existing
commitments the use of historical cost.
Definitions and Recognitions
Definition Recognition
Asset A resource controlled by the entity as a result Probable future economic
of past events and from which future benefits will flow to the
economic benefits are expected to flow to the company
entity. Can be measured reliably
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,
3 Characteristics probable econ benefits,
control, past event
Liability A present obligation of the entity arising from Probable outflow
past events, the settlement of which is Can be measured reliably
expected to result in an outflow from the
entity of resources including economics
benefits
3 Characteristics present obligation, giving
up resources to settle obligation, result from
past transaction
Income Increases in economic benefits during the Can be measured reliably
accounting period in the form of inflows or IAS 18 requires all
enhancements of assets or decreases of revenue recognized in the
liabilities that result in increases in equity, entity’s financial
other than those relating to contributions statements to be
from equity participants measured at the fair value
of the consideration
received or receivable
Revenue Gross inflow arising from ordinary activities
Expenses Expenses are decreases in economic benefits Recognized
during the accounting period in the form of simultaneously with a
outflows or depletions of assets or decrease in an asset or
incurrences of liabilities that result in increase in liability
decreases in equity, other than those Matching process
relations to distributions to equity
participants.
Measurement of Elements
Equity, income and expenses are highly dependent on the concepts of asset and liabilities,
measurements of the former depends on measurements of the latter.
- Historical cost asset is recorded at the amount paid for it. Liabilities are recorded at the
amount needed to satisfy the obligation
- Current cost asset is recorded at amount that would be needed to acquire the asset
currently. Liability is recorded at the amount needed to settle the obligation currently.
- Realizable value asset is recorded at the amount that would be obtained by selling the
asset in an orderly disposal. Liability is recorded at the amount expected to pay to satisfy
the obligation
- Present value asset recorded at the discounted future net cash inflows. Liability
discounted future net cash outflows
The measurement basis most commonly adopted by entities is the historical cost basis, although
there is a trend towards greater use of fair values. For example, to comply with IAS 2 Inventories
inventories are measured at lower of cost and net realizable value.
Chapter 3 – Fair value measurement
IAS 39 requires financial liabilities to be measured at fair value
IAS 37 requires liabilities in general to be measured at the best estimate of expenditure
required to settle the present obligation at the end of the reporting period.
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,Fair value
IFRS 13 defines fair value:
The price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants
The exchange transaction is hypothetical and not a forced transaction.
Exit price
IFRS 3 defines exit price:
The price that would be received to sell an asset or paid to transfer a liability
The exit price is based on expectations about the future cash flows that will be generated by the
asset subsequent to the sale of the asset or the transfer of the liability to an acquiring company.
In contrast, an entry price is one that would be paid to buy an asset or received to incur a liability.
Exit price and entry price should equal, however they will differ if:
An entity’s intended use for an acquired asset is different from its highest and best use
A liability is measured on the basis of settling it with the creditor rather than transferring it to
a third party.
Orderly transaction
IFRS 3 defines orderly transaction:
A transaction that assumes exposure to the market for a period before the measurement
date to allow for marketing activities that are usual and customary for transactions
involving such assets or liabilities; it is not a forced transactions.
Market participants
Buyers and sellers in the most advantageous market have the following characteristics:
- They are independent of each other
- They are knowledgeable
- They are able to enter into a transaction for the asset or liability
- They are willing to enter into a truncation for the asset or liability
Paragraph 22 IFRS 13:
An entity shall measure the fair value of an asset or a liability using the assumptions that
market participants would use when pricing the asset or liability, assuming that market
participants act in their economic best interest.
Paragraph 23 IFRS 13:
In developing those assumptions, an entity need not identify specific market participants.
Rather, the entity shall identify characteristics that distinguish market participants
generally, considering factors to all the following:
a) the asset or liability
b) the most advantageous market
c) market participants with whom the reporting entity would enter into a transaction in
that market
NOTE the fair value measure is not an entity specific value
Transaction and transport costs
IFRS 13 defines transaction and transport costs as:
The costs to sell an asset or transfer a liability in the most advantageous market for the
asset or liability that are directly attributable to the disposal of the asset or the transfer of
the liability and meet both of the following criteria:
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, a) They result directly from and are essential to that transaction
b) They would not have been incurred by the entity had the decision to sell the asset or
transfer the liability not been made
Both transactions costs and transport cost are used to determine the most advantageous market
Transport cost impacts measure of the fair value of an asset.
Application to non-financial assets
The IASb notes that there are four steps the entity has to determine:
a) the particular asset or liability that is the subject of the measurement
b) for a non-financial asset, the valuation premise that is appropriate (consistently with its
highest and best use)
c) the most advantageous market for the asset or liability
d) the valuation technique appropriate for the measurement, considering the availability of
data with which to develop inputs that represent the assumptions market participants
would use when pricing the asset or liability and the level of fair value hierarchy within
which the inputs are characterized.
Assets should be measured on a per unit basis. However, note paragraph 69 of IFRS 13. If there is a
quoted price in an active market, such as for a number of identical asses, an entity must use that
quoted price without adjustments when measuring the fair value.
What is the valuation premise appropriate for measurement of fair value?
Fair value is measured by considering the highest and best use of an asset.
IFRS 13 defines highest and best use as:
The use of a non-financial asset by market participants that would maximize the value of
the asset or the group of assets and liabilities within which the asset would be used.
According to paragraph 28 of IFRS 13, these uses must be:
physically possible
legally permissible
financially feasible
The highest and best use is not based on how the reporting entity is currently using the asset.
the highest and best use is based on how the market participants will use the asset
In-combination valuation premise
When a fair value is measured under this premise, the highest and best use of the asset is where
the market participants obtain maximum value principally through using the asset in combination
with other assets and liabilities as a group.
The fair value of an asset, even though used in conjunction with other assets, is not determined by
an allocation of the fair value of the group assets. It is based on the sale of an individual asset.
Value in use measures the expected cash flows an entity expects to receive from using those assets.
This is an entity specific value. In contrast, fair value measured under the in-use premise is based
on the cash flows that market participants would expect to receive from using the asset.
Stand-alone valuation premise
As noted in paragraph 31(b) of IFRS 13, under this premise, the fair value of the asset is the price
that would be received in a current transaction to sell the asset to market participants who would
use the asset on a stand-alone basis.
What is the principal market for the asset?
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