Accouting Theory & Conceptual Framework

Question 1

International accounting standards board framework

Answer 1

Issued the IFRS conceptual framework which sets out the fundamental concepts for financial reporting

Question 2

Frameworks purpose (IMPORTANT)

Answer 2

1. Assist the IASB to develop IFRS standards that are based on consistent concepts
2. Assist preparers to develop consistent accounting policies when no standard applies to a particular transaction or other event, or when a standard allows a choice of accounting policy
3. Assist all parity’s to understand and interpret the standards
   -> conceptually consistent info for investors, lenders and creditors

Question 3

Adv of framework

Answer 3

Because basic principles have been set out and agreed in the framework there is no need to re debate the principles every time a new standard is realised

Question 4

Status of framework (IMPORTANT)

Answer 4

-> not accounting standard and doesn’t override accounting standards. In event of conflict IFRS prevails

Question 5

Chapters of conceptual framework (IMPORTANT)

Answer 5

1. Objective of financial reporting
2. Qualitative characteristics of useful financial information
3. Reporting entity and financial statements
4. Elements of financial statements
5. Recognition and de recognition
6. Measurement
7. Presentation & disclosure
8. Capital and capital maintenance

Question 6

Objective of financial reporting. To make these decisions user groups need info to assess and about??
(IMPORTANT)

Answer 6

-standardise accounting principles
-to make these decisions user groups need info to assess
1. An entity’s potential future cash flows
2. Managements stewardship of the entity’s economic resources
-info needed
1. Economic resources of entity (asset)
2. Economic claims against the entity (liability)
3. Changes in economic resources and claim (income + expenses)
4. How efficiently and effectively management has discharged its responsibilities to use the economic resources

Question 7

Qualitative characterises of useful financial information (IMPORTANT)

Answer 7

Fundamental characteristics
1. Relevance
-info is relevant is its capable of making a difference to the decision made by users
-if it has predictive value or confirmatory value
-info is material if omitting, misstating, or obscuring it could influence the users of financial statements
->provided in time to influence decisions
->has confirmatory value that helps users to confirm or correct past assessments
->take advantages of opportunities
->react to adverse situations
2. Faithful representation
-info must faithfully represent the sub of what it purports to represent
-complete, neutral, and free from error
->effected by level of measurement uncertainty
->substance over form

Enhancing characteristics
-> prudence = exercise or caution when making judgement
1. Comparability= info within entity, between others and between one period and another
2. Verifiability= users able to verify the info that is faithfully represented
3. Timelessness= avianke in time to influence decision of users
4. Understandability= clear and concise

Question 8

Reporting entity and financial statements

Answer 8

-financial statements
-consolidated financial statements
-unconsolidated financial statements
-combined financial statements

Going concern
-assumed financial statements is based on a going concern basis and will continue in operation in foreseeable future
-no intention to enter liquidation or cease trading

Question 9

Elements of financial statements (IMPORTANT)

Answer 9

1. Asset
   -present economic resource controlled by an entity as a result of past events
   -right that has the potential to produce economic benefits
2. Liability
   -economic claim
   -present obligation of entity to transfer an economic resource as a result of past events
   -duty or responsibility entity cannot avoid
3. Equity
   -residual interest in the net asset of an entity
4. Income
   -increases in assets or decreases in liabilities that result in an increase to equity
5. Expenses
   -decrease in assets or increases in liabilities that result in an decrease to equity (not dividends)

Question 10

Recognition and de recognition (IMPORTANT)

Answer 10

Recognition
-items only recognised if they meet the definition of one of the elements
-elements recognise if recognition provides users with useful financial information
-to be useful
1. Relevant info
2. Faithful representation

1. Uncertainty over its existence
2. Low probability of an inflow of outflow of economic benefit
3. High degree of measurement uncertainty

De recognition
-> removal of asset / liability from financial statements
-occurs when the entity
1. Loses control of the asset
2. Has no present obligation for liability
-should faithfully represent the changes in the entity’s net assets as well as any assets or liabilities retained. Achieved by
1. De recognising any transferred, expired, or consumed component
2. Recognising a gain or loss on the above
3. Recognising any retained component

Question 11

Measurement

Answer 11

-> elements must be quantified

HISTORIC COST
-provides info deprived from price of the transaction or other event that gave rise to the item being measured
-HC of assets is reduced if they become impaired and HC of liabilities is increased if they become onerous
-measure at amortised cost

CURRENT VALUE
1. 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 at the measurement date
-reflects market participants current expectations about the amount, time, and uncertainty of future cash flows
2. Value in use (for assets) fulfilment value (for liabilities)
-reflects entity specific current expectations about the amount, time, and uncertainty of future cash flows current cost
-reflects the current amount that would be paid to acquire an equivalent asset or received to take on an equivalent liability
3. Current cost
-reflects the value in which the entity could acquire the asset or liability at current market price

Relevance is maximised if
->characteristics of the asset or liability
->how the asset or liability contributes to future cash flows

Whether a measurement basis can provide faithful representation is affected by
->measurement inconsistency
->measurement uncertainty

Question 12

Presentation & disclosure

Answer 12

Statement of profit and loss
-primary source of info about entity’s financial performance

Other comprehensive income
-income or expense presented in other comprehensive income if it results from remeasuring an item to current value and this means that
-> profit or loss provides more relevant info
-> more faithfully representation is provided of an entity’s performance

Question 13

Conceptual framework tells us (IMPORTANT)

Answer 13

1. What should be brought into accounts
2. When an item should be brought into accounts
3. How it should be brought into accounts

Question 14

Objective of financial reporting

Answer 14

To provide financial info that is useful to users in making decisions relating to providing resources to the entity

1. Users decisions involve decisions about
   -> buying selling or holding equity or debt instruments
   -> providing or selling loans and other forms of credit
   -> voting or otherwise influencing managements actions
2. To make these decisions, users assess
   -> prospects for future cash inflows to the entity
   -> managements stewardship of the entity’s economic resources
3. To make both these assessments, users need information both
   -> the entity’s economic resources (assets), claims against the entity (liability) and changed in those resources and claims
   -> how efficiently and effectively management has discharged its responsibilities to use entity’s economic resources

Question 15

Main purpose of conceptual framework

Answer 15

Harmonisation through a reduction of country by counter differences in definitions, measurements and disclosures relating to financial reporting

Question 16

How realistic is one size fits all framework (IMPORTANT)

Answer 16

-> level of investor protection is not easy to measure. It is based on shareholders legal rights to receive accounts and enforce accountability on managers
-> business culture is more cooperative in some countries
-> industries make a difference (banks and oil)

Question 17

Different stakeholders make different decisions (IMPORTANT-def)

Answer 17

1.2 the objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions relating to providing resources to the entity

These decisions involve about
-> buying selling or holding equity and debt
-> providing or selling loans and other forms of credit
-> exercise rights to vote on or influence managements actions that affect the use of the entity’s economic resources

Use financial reporting
1. Managers
2. Employers
3. Lenders
4. Auditors
5. Regulators
6. Governments

-> financial statements are not directly aimed at needs so framework limited to subsection of all users accounts
-> each one will be using info to make completely different decisions regarding an entity. How realistic it satisfies all?

Question 18

Arguments for a conceptual framework (IMPORTANT)

Answer 18

1. May seem like a theoretical document but it has highly practiced aims
2. Without a framework then standards would be developed without consistency and the same basic principles would be continually examined, maybe with differing conclusions.
3. IASB therefore becomes the architect of financial reporting with a framework as solid foundations upon which everything else relies on
4. Prevents political lobbyists from pressuring changes in standards as the principles have been agreed on
5. Alternative is rule based framework, standard setting then becomes reactive rather that proactive , on a fire fighting basis. Theoretical issues are revisited every time a new standard is required

Question 19

Arguments against a conceptual framework (IMPORTANT)

Answer 19

1. Financial statements are prepared for many different users (can one set of principles be agreed by all?)
2. Different users need different info and hence different measurement bases and principles
3. Genuine difference in countries, cultures and laws and industries the framework tends to underestimate the difficulty of harmonisation
4. Accounting standards go through a huge review and sign off process

Question 20

How do we deal with the portion of the assets and liabilities that we don’t own? (IMPORTANT)

Answer 20

-> we include the non controlling interest as a separate line on the face of the consolidated balance sheet.
-> this relief to the portion of the asset and liabilities that are not under our control and which are owned by other shareholders