WEYGANDT . KIESO . KIMMEL . TRENHOLM . KINNEAR . BARLOW . ATKINS
PRINCIPLES OF
FINANCIAL ACCOUNTING
CANADIAN EDITION
Chapter 11
Financial Reporting Concepts
Prepared by:
Debbie Musil
Kwantlen Polytechnic University
1
Financial Reporting Concepts
• The conceptual framework of accounting
• The objective of financial reporting, underlying
assumption, and constraint
–
–
–
–
The objective of financial reporting
Underlying assumption
Cost constraint
Elements of financial statements
• Qualitative characteristics of useful financial
information
– Fundamental characteristics
– Enhancing qualitative characteristics and their
application
– Differences under IFRS and ASPE
– Full disclosure
• Recognition and measurement criteria
– Revenue and expense recognition criteria
– Measurement of elements
– Errors and intentional misstatements
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Chapter 11: Financial Reporting
Concepts
Study Objectives
1. Explain the importance of having a
conceptual framework of accounting, and list
the key components.
2. Identify and apply the objective of financial
reporting, as well as the underlying
assumption and cost constraint used by
accountants.
3. Describe the fundamental and enhancing
qualitative characteristics of financial
reporting.
4. Identify and apply the basic recognition and
measurement concepts of accounting.
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Conceptual Framework of
Accounting
• A foundation for accounting:
– Ensures existing standards and practices
are clear and consistent
– Provides guidance in responding to new
issues and developing new standards
– Assists in the application of standards
– Increases users’ understanding and
confidence in financial statements
• Standards built on general principles,
not rules
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Conceptual Framework 2
• Use professional judgment and framework
to determine appropriate accounting
treatment
• Six major components to framework:
1. Objective of financial reporting
2. Underlying Assumption
3. Cost constraint
4. Elements of financial statements
5. Qualitative characteristics of accounting
information
6. Recognition and measurement criteria
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Chapter 11: Financial Reporting
Concepts
Study Objectives
1. Explain the importance of having a
conceptual framework of accounting, and list
the key components.
2. Identify and apply the objective of financial
reporting, as well as the underlying
assumption and cost constraint used by
accountants.
3. Describe the fundamental and enhancing
qualitative characteristics of financial
reporting.
4. Identify and apply the basic recognition and
measurement concepts of accounting.
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Objective of Financial
Reporting
• To provide information that is useful for making
decisions about a business
– To investors and creditors
• To give information about:
– Economic resources (assets) and claims on those
resources (liabilities, equity)
– Changes in resources and claims on them
– Economic performance
• Enables users to decide whether management
used company resources in the best way
possible
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Underlying Assumption &
Cost Constraint
• Going Concern Assumption
– Assumes that a company will continue
operating for the foreseeable future
– Important implications for how financial
information is presented
• Cost constraint
– The value of information should be
greater than the cost of providing it
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Elements of Financial
Statements
• Basic categories that are used in
financial statements
– Assets, liabilities, equity, revenues and
expenses
• Must be precisely defined and applied
in the same way by all reporting
entities
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Chapter 11: Financial Reporting
Concepts
Study Objectives
1. Explain the importance of having a
conceptual framework of accounting, and list
the key components.
2. Identify and apply the objective of financial
reporting, as well as the underlying
assumption and cost constraint used by
accountants.
3. Describe the fundamental and enhancing
qualitative characteristics of financial
reporting.
4. Identify and apply the basic recognition and
measurement concepts of accounting.
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10
Fundamental Characteristics of
Useful Financial Information
• To be useful, information should have two
fundamental qualitative characteristics:
– Relevance
– Faithful Representation
• Other characteristics enhance the
usefulness of accounting information:
– Comparability
– Verifiability
– Timeliness
– Understandability
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Fundamental Characteristics:
Relevance
• Accounting information has relevance if it
makes a difference in coming to a decision
• Relevant information has predictive and/or
confirmatory value:
– Predictive value: helps users forecast future
events
– Confirmatory value: confirms or corrects prior
expectations
• Materiality is an important component of
relevance
– An item is material if it will influence a decision
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Fundamental Characteristics:
Faithful Representation
• Information must be a faithful
representation of the economic reality of
reported events
• This is achieved when the information is:
– Complete: includes all necessary information
– Neutral: information is free from bias
– Free from material error: will not affect
decisions by investors and creditors
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Enhancing Qualitative Characteristics:
Comparability
• Comparability: Similar companies use the same
accounting principles
• Consistency: A company uses the same accounting
principles from year to year
• However, accounting principles can change:
– Due to new requirements that have been issued
– When management decides that a difference
principle gives more relevant information
• Accounting changes are disclosed in the financial
statements
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Enhancing Qualitative Characteristics:
Verifiability and Timeliness
• Verifiable: assures users that the accounting
information shows the economic reality of a
transaction
– Information is verifiable if two knowledgeable
and independent people agree that it faithfully
represents the economic reality
• Timely: accounting information is provided when it
is still useful for decision-making
– Available to decision makers before it loses its
ability to influence their decisions
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Enhancing Qualitative Characteristics:
Understandability
• Information must be understandable
to users for it to be useful
• Enables users to interpret and
comprehend the information provided
in the financial statements
• Users are assumed to have a
reasonable knowledge of:
– Business, economic and financial
activities
– Financial reporting
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Differences in Qualitative
Characteristics Under IFRS and ASPE
• ASPE identifies four principal characteristics:
– Understandability – higher status under ASPE
than IFRS
– Relevance – important under both ASPE and
IFRS
– Reliability – considered reliable if it is a faithful
representation
– Comparability – higher status under ASPE than
IFRS
• ASPE also identifies conservatism as a
qualitative characteristic:
– The choice of accounting treatment that is least
likely to overstate assets, revenues and gains or
understate liabilities, expenses and losses
• It is anticipated that ASPE will adopt the IFRS
conceptual framework
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Full Disclosure
• Requires disclosure of circumstances
and events that make a difference to
financial statement users
• Accomplished through:
– The data in the financial statements
– The notes that accompany the
statements
• A summary of significant accounting
policies is usually the first note to the
financial statements
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Chapter 11: Financial Reporting
Concepts
Study Objectives
1. Explain the importance of having a
conceptual framework of accounting, and list
the key components.
2. Identify and apply the objective of financial
reporting, as well as the underlying
assumption and cost constraint used by
accountants.
3. Describe the fundamental and enhancing
qualitative characteristics of financial
reporting.
4. Identify and apply the basic recognition and
measurement concepts of accounting.
Copyright John Wiley & Sons Canada, Ltd.
19
Recognition & Measurement
Criteria
• Accrual basis of accounting – transactions are
recorded in the period in which the events occur,
rather than when cash is received or paid
• Recognition criteria help determine when items
should be included in financial statements
• Measurement criteria provide guidance on what
amount should be recorded
• An item is usually included in the financial
statements if:
– It meets the definition of an asset, liability, equity,
revenue or expense
– It can be measured, and
– If a reasonable estimate of the amount can be made
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Recognition & Measurement
Criteria
Two important concepts underlying the
general recognition criteria:
1. If an asset is going to be recorded it
must be probable there will be future
economic benefit
2. If a liability is going to be recorded it
must be probable there will
economic resources given up
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Revenue Recognition Criteria
• Revenue should be recognized at the
same time that:
– An increase in an asset is recognized, or
– A decrease in a liability is recognized
for profit-generating activities
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Revenue Recognition:
Sale of Goods
• Revenue recognized when all conditions
met:
– Significant risks and rewards of ownership have
transferred from seller to buyer
– Seller no longer controls or manages goods
– Revenue can be reliably measured
– Probable increase in economic resources (cash
collected)
– Costs relating to sale can be reliably measured
• For retail sales, these conditions are met at
point of sale
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Revenue Recognition:
Service and Construction
Contracts
• Revenue is generally recognized when:
– Service is provided, and
– Seller can be reasonably sure that cash
will be collected
• Revenue may also be recognized as
chunks of services are provided
– percentage-of-completion method used
for long-term service and construction
contracts
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Revenue Recognition:
During Production
• Percentage-of-completion method recognizes revenue based
on reasonable estimates of progress to completion
• Progress to completion is determining by comparing the costs
incurred to date to estimated total cost:
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Expense Recognition Criteria
• Expenses are recognized when there is:
– A decrease in an asset
– An increase in a liability
– Excludes distributions to owners
• Not necessarily when the cash is paid
• Can be a direct association between costs
incurred and revenue earned
– When no direct relationship, another systematic
and rational allocation policy may be used
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Measurement of Elements
• Acquired assets are recorded at cost
• Cost is used because it is:
– Relevant: represents the price paid, assets sacrificed
or the commitment made at the date of acquisition
– A Faithful Representation: objectively measurable,
factual and verifiable
• For some assets, more relevant to use fair
value
– Amount of cash expected to be collected when asset
is sold
• Some other assets and liabilities use
amortized cost
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Errors and Intentional
Misstatements
• Revenues and expenses may be misstated
by:
1.
2.
3.
4.
5.
Recognizing in the incorrect accounting period
Misstatement of estimates
Misstatement of accruals
Failure to record a revenue or expense
Failure to apply the correct measurement
• Important to analyze transactions carefully
to ensure that accounting principles are
applied correctly and are faithfully
represented
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Copyright
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by the use of these programs or from the use of the
information contained herein.
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