Chapter 1
Financial accounting: process that culminates in the preparation of financial reports on the
enterprise for use by both internal and external parties.
Managerial accounting: the process of identifying, measuring, analyzing and communicating
financial information needed by management to plan, control and evaluate a company’s
operations.
Financial statements: 1) statement of financial position, 2) income statement, 3) statement
of cashflows, 4) statement of changes in equity.
International Accounting Standards Board (IASB) makes International Financial Reporting
Standards (IFRS).
International Organization of Securities Commissions (IOSCO): an association of
organizations that regulate the worlds securities and future markets.
IFRS Foundation: provides oversight to the IASB, IFRS Advisory Council and IFRS
Interpretations Committee.
International Accounting Standards Board (IASB): develops, in the public interest, a single
set of high-quality, enforceable, and global international financial reporting standards for
general-purpose financial statements.
IFRS Advisory Council: provides advice and counsel to the IASB on major policies and
technical issues.
IFRS Interpretations Committee: assists IASB through the timely identification, discussion,
and resolution of financial reporting issues within the framework of IFRS.
Monitoring Board: establish a link between accounting standard-setters and those public
authorities that generally oversee them.
Conceptual framework for financial reporting: sets forth the fundamental objective and
concepts that the Board uses in developing future standards of financial reporting.
Conceptual framework (CF): can provide guidance in many situations where an IFRS does
not cover the issue under consideration.
Objective of financial reporting: the purpose of financial reporting (why)
Qualitative characteristics: make the accounting information useful
Elements of financial statements: assets, liabilities, equity, and so on.
,Management stewardship: how well management uses a company’s resources to create
and sustain value. To evaluate stewardship, companies should provide information about
their financial position, changes in their financial position and performance.
Decision-useful information: information that is useful to capital providers may also be
helpful to users of financial reporting who are not capital providers.
General-purpose financial reporting: helps users who lack the ability to demand all the
financial information they need from a company and who must therefore rely, at least
partly, on the information provided in financial reports.
Fundamental quality Relevance
Relevance: predictive value – confirmatory value – materiality
Relevant: accounting information must be capable of making a difference in a decision.
Information with no bearing on a decision is irrelevant. Financial information is capable of
making difference when it has predictive value, confirmatory value, or both.
- Predictive value: Financial information has predictive value if it has value as an input
to predictive processes used by investors to form their own expectations about the
future.
- Confirmatory value: relevant information also helps users confirm or correct prior
expectations.
- Materiality: is a company-specific aspect of relevance. Information is material if
omitting it or misstating it could influence decisions that users make on the basis of
the reported financial information it must make a difference, or a company need
not disclose it.
Fundamental quality faithful representation
Faithful representation: Completeness – neutrality – free from error
Faithful representation: means that the numbers and descriptions match what really existed
of happened.
- Completeness: means that all the information that is necessary for faithful
representation is provided.
- Neutrality: means that a company cannot select information to favor one set of
interested parties over another. Providing neutral or unbiased information must be
the overriding consideration.
- Free from error: an information item that is free from error will be a more accurate
(faithful) representation of a financial item.
Prudence: exercise of caution when making judgments under conditions of uncertainty. That
is, the exercise of prudence means that assets and income are not overstated, and liabilities
and expenses are not understated.
Enhancing qualities: are complementary to the fundamental qualitative characteristics.
These characteristics distinguish more useful information from less useful information.
Enhancing qualities: Comparability – verifiability – timeliness – understandability
- Comparability: information that is measured and reported in a similar manner for
different companies is considered comparable. Comparability enables users to
identify the real similarities and differences in economic events between companies.
, o Consistency: when a company applies the same accounting treatment to
similar events, from period to period.
- Verifiability: different knowledgeable and independent observers could reach
consensus, although not necessarily complete agreement, that a practical depiction is
a faithful representation.
- Timeliness: having information available to decision-makers before it loses its
capacity to influence decisions. Having relevant information available sooner can
enhance its capacity to influence decisions, and a lack of timeliness can rob
information of its usefulness.
- Understandability: decision-makers may vary widely in the types of decisions they
make, how the make decisions, the information they already possess or can obtain
from other sources, and their ability to process information. For information to be
useful, there must be a connection (linkage) between these users and the decisions
they make. The link understandability is the quality of information that lets
reasonably informed users see its significance. Understandability is enhanced when
information is classified, characterized, and presented clearly and concisely.
Elements of financial statements
Asset: a present economic resource controlled by the entity as a result of past events. (An
economic resource is a right that has the potential to produce economic benefits).
Liability: 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 deducing all its liabilities.
Income: increases in assets or decreases in liabilities, that result in increases in equity other
than those relating to contributions from holders of equity claims.
Expenses: decreases in assets, or increases in liabilities, that result in decreases in equity
other than those relating to distributions to holders of equity claims.
Five basic assumptions
1. Economic entity assumption: means that economic activity can be identified with a
practical unit of accountability a company keeps its activity separate and distinct
form its owners an any other business unit.
2. Going concern assumption: the company will have a long life.
3. Monetary unit assumption: money is the common denominator of eco nomic activity
and provides an appropriate basis for accounting measurement and analysis.
4. Periodicity assumption: implies that a company can divide its economic activities
into artificial time periods. These periods vary, but the most common are monthly,
quarterly and yearly.
5. Accrual basis accounting: transactions that change a company’s financial statements
are recorded in the periods in which the events occur.
Basic principles of accounting
Measurement – revenue recognition – expense recognition – full disclosure
Historical costs: report (many) assets and liabilities on the basis of acquisition price.
