BUS 385
Intermediate Financial
Accounting I
Chapter 2: Conceptual
Framework
BUS 385
Winter 2022
Conceptual Framework
Objectives
Qual. Char. / Elements
Foundational Principles
BUS 385
Winter 2022
Objective of financial reporting
• Decision usefulness (see adverse
selection)
• Other option: stewardship (see moral
hazard and agency costs)
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Winter 2022
Qualitative Characteristics
Comparability
Relevance
- Predictive and
confirmatory value
Understandability
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Winter 2022
Timeliness
Faithful
representation
- Complete
- Neutral
- Free from
material error
Verifiability
Fundamental Qualitative Characteristics:
•
Relevance: information makes a difference in
decision making
•
•
Materiality: the importance of a piece of
information in user decision-making
Faithful representation: information faithfully
reflects or represents the underlying economic
substance of an event or transaction (not just
its legal form)
•
Complete, neutral, and free from error
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Winter 2022
Trade-offs
•
Relevance and faithful representation
– Example situations??
• Cost-benefit relationship
– What are the costs of information
production?
– What are the benefits?
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Winter 2022
Elements: Assets
1. Present economic resource
2. Controlled by the entity
3. Resulting from past transaction or
event
Let’s think about cash, A/R, patents, goodwill
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Winter 2022
Elements: Liabilities
1. Present duty or responsibility
2. Obligating the entity to transfer an
economic resource
3. Obligation resultings from past
transaction or event
Let’s think about A/P, mortgage, future employee
benefits, contingent liabilities, warranties
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Winter 2022
Elements
Equity: residual interest (A-L=E)
• Revenues: increase in economic resources
( assets or liabilities)
• Expenses: decrease in economic resources
( assets or liabilities)
– Defined in terms of assets/liabilities
– Balance Sheet primacy – why is this
important?
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Winter 2022
Other comprehensive income (IFRS)
• Revaluation of PPE (BUS385)
• Unrealized holding gains (on certain
investments – BUS387)
• Remeasurement of pension
obligations/assets (BUS387)
• Foreign currency translation (BUS485)
• Gains/losses on hedging instruments in a
cash flow hedge (BUS485)
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Winter 2022
Foundational Principles
•
Concepts that help explain how events should
be recognized, measured, and
presented/disclosed by the accounting system
1. Economic entity
– Whose events are they?
– Basis for consolidation and segment
disclosure
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Winter 2022
Foundational Principles: Periodicity
2. Periodicity
– In which period should the event be
recognized?
– Profit is easily defined over the life of a
company
– This is because revenue and expenses are
defined by assets and liabilities which = zero
at inception and after dissolution
– Problem is splitting into artificial time periods
BUS 385
Winter 2022
Foundational Principles: Periodicity
3. Going concern assumption
– Entity will exist for at least 12 months
– Can classify A&L as non-current
4. Revenue recognition
– 5-step approach
– Consistent with B-S primacy (asset liability
approach)
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Winter 2022
Foundational Principles
5. Historical cost – events are initially
recorded at cost which:
1. Represents value at a point in time
2. Results from reciprocal exchange (economic
entity)
–
–
how might we value elements after initial
recognition?
when does historical cost approximate current
value?
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Winter 2022
Foundational Principles
6. Fair value & value in use
–
–
–
–
What is FV? Exit price based on market price
What is value-in-use? Present value of future
cash flows associated with the asset
Why use fair value? Think about relevance and
faithful representation
How do we determine FV for assets like
investments, real estate, PPE?
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Winter 2022
Foundational Principles
7. Full disclosure
– Content
•
•
Entity-specific information (no boilerplate!!)
No duplication of information or irrelevant info.
– Accessibility
•
•
•
Structure: Grouping of info, placement of info (i.e.
narratives or financial statements or notes)
Level of detail (comparable, all material
information included)
Language (plain English)
BUS 385
Winter 2022