Lecture Intermediate accounting (IFRS/e) - Chapter 1: Environment and theoretical structure of financial accounting

In this chapter you explore important topics such as the FASB''s conceptual framework that serve as a foundation for a more detailed study of financial statements, the way the statement elements are measured, and the concepts underlying these measurements and related disclosures.

ENVIRONMENT AND

THEORETICAL STRUCTURE OF FINANCIAL ACCOUNTING

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Financial Accounting Environment

External User Groups Investors

Creditors Employees Labor unions Customers Suppliers Government agencies

Financial intermediaries

Relevant

Financial Information

Financial Accounting Environment

Relevant financial information is provided

primarily through financial statements

and related disclosure notes.

 Statement of Financial Position

 Statement of Comprehensive Income

 Statement of Cash Flows

 Statement of Changes in Equity

and Financial Reporting

in the tens of thousands

in large corporations

A corporation is owned

by shareholders,frequently numbering

in the tens of thousands

in large corporations

A highly-developed system of financial

reporting is necessary to communicate

financial information from a corporation

to its many shareholders

A highly-developed system of financial

reporting is necessary to communicate

financial information from a corporation

to its many shareholders

A Cash Flow Perspective

Corporate shareholders receive cash

from their investments through

• Periodic dividend distributions from the

corporation.

• The ultimate sale of the ownership shares.

Accounting information should help investors evaluate the amount , timing , and uncertainty

of the enterprise’s future cash flows.

Cash Versus Accrual Accounting

Cash Basis Accounting

Revenue is recognized when cash is received Expenses are recognized when cash is paid.

Cash Versus Accrual Accounting

Cash Basis Accounting

Carter Company has sales on account totaling

$100,000 per year for three years Carter collected

$50,000 in the first year and $125,000 in the second

and third years The company prepaid $60,000 for

three years’ rent in the first year Utilities are $10,000

per year, but in the first year only $5,000 was paid

Payments to employees are $50,000 per year

Let’s look at the cash flows

Cash Versus Accrual Accounting

Cash Basis Accounting

Cash flows in any one year may not

be a predictor of future cash flows.

Cash Versus Accrual Accounting

Accrual Accounting

◦ Revenue is recognized when earned

◦ Expenses are recognized when incurred

The Development of Financial Accounting and Reporting Standards

Concepts, principles, and procedures were developed to meet the needs of external

users.

Two major sets

of accounting standards –

•IFRS

•U.S GAAP

Historical Perspective and Standards

International Standard Setting

 Standards set by private-sector

 Standards set by governmental body

International Financial Reporting Standards

and supporting organizations

IASB members include accounting profession,

analysts, academics, regulators, and government.

IFRS Foundation selects members, oversees, and

ensures adequate funding.

IFRS Advisory Council advises on agenda and work priorities.

IFRS Interpretations Committee seeks to resolve

accounting issues and interpret existing IFRS.

International Organization of Securities Commissions (IOSCO) provides regulatory oversight of IASB.

IASB is a private and non-governmental body with no authority to enforce the use of IFRS.

Structure of IASB

Establishment of Accounting Standards

Due Process

 Understand the nuances of the economic transactions the standards address and the views of key constituents concerning how accounting would best capture that

economic reality

 Steps include open hearings, deliberations, and requests for written comments from

interested parties

Role of the Auditor

Independent intermediary to help

ensure that management has appropriately applied accounting

standards.

Financial Reporting Reform in U.S.

As a result of numerous financial scandals,

the U.S Congress passed the Public Public

Company Accounting Reform and Investor Protection Act of 2002 , commonly referred to

as the Sarbanes-Oxley Act for the two

congressmen who sponsored the bill.

Ethics in Accounting

To be useful, accounting information must be

objective and reliable

Management may be under pressure to report

desired results and ignore or bend existing

rules.

Model for Ethical Decisions

 Determine the facts of the situation.

 Identify the ethical issue and the stakeholders.

 Identify the values related to the situation.

 Specify the alternative courses of action.

 Evaluate the courses of action.

 Identify the consequences of each course of

action.

 Make your decision and take any indicated action.

IASB conceptual framework provides

structure and direction to financial

accounting and reporting

IASB and FASB are working together to

develop a common conceptual framework

through 8 phases

The Conceptual Framework

The Conceptual Framework

Underlying AssumptionsRecognition of ElementsMeasurement of ElementsCapital and Capital Maintenance

Objectives of Financial Reporting

Capital and Capital Maintenance

Continued

Financial Position

Assets Liabilities Equity

Performance Income Expenses

Underlying Assumptions Going concern Recognition of Elements Probability of future economic benefits Reliability of measurement

Measurement of Elements Basis of measurement

Capital and Capital Maintenance Concepts of capital Concepts of capital maintenance and determination of profit

Financial Statements

Statement of financial position

Income statement Statement of comprehensive income

Statement of cash flows Statement of changes in shareholder’s equity Notes and supplementary disclosures

Reporting Information

Key Constraint

Cost Effectiveness

Cost Effectiveness

Elements of Financial Statements

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Recognition and Measurement Concepts

Measurement of Elements of Financial Statements

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Measurement attributes in IFRS:

The attribute chosen to measure a particular item

should be the one that maximizes the combination of

relevance and representational faithfulness

The Move Toward Fair Value

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Fair value is the price that would be received

to sell an asset or paid to transfer a liability in

an orderly transaction between market participants at a measurement date.

Market

Approaches

Income ApproachesCost

Approaches

Fair Value Hierarchy

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the asset or liability These inputs include quoted prices for similar assets or liabilities in active or inactive

markets and inputs that are derived principally from or corroborated by observable related market data.

3

Least Desirable

Unobservable inputs that reflect the entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed on the best information available on the circumstances.

IFRS gives a company the option to value financial assets

and liabilities at fair value

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