Section 1 – Conceptual Framework & IFRS - anna-n … 1 – Conceptual Framework & IFRS . FASB...

FAR Section 1 –

Conceptual Framework & IFRS

FASB Conceptual Framework (Acctg Constitution) for Financial Reporting Special Notes: The revised Framework stated that relevant financial information is capable of making a difference to the decision made by users. In order to make a difference, financial information has Predictive value, confirmatory value or both. The Boards have clarified that “materiality” is an entity specific aspect of relevance. A standard setter does not consider materiality when developing standards because it is an entity-specific consideration., i.e., it cannot be specified in general terms to encompass every situation,

Comprehensive Income=7 - 10 (DENT; P 1-5)

Equity = 4 - 6

Moment in Time =1 - 3 (Basic elements) Period of Time = 4 - 10

Information includes: B/S (stmt of financial position) I/S (stmt of earnings; accrual acctg) Stmt of Cash Flows Stmt of Investments by & Distributions to Owners (Changes not from financial performance

Financial performance from econ resources/claims

When to recognize a F/S element & how to measure the performance using the elements & Monetary Terms?

The monetary unit: an accounting principle that assumes business transactions or events can be measured and expressed in terms of monetary units (money) and the monetary units are stable and dependable.

Full disclosure: a. Notes b. Supplementary info

(Fundamental Concepts)

(Basic Objectives)

“The FASB identified the Qualitative Characteristics of accounting information that distinguish better (more useful) information from inferior (less useful) information for decision-making purposes.”

Second Level: Fundamental Concepts

Qualitative Characteristics

Second Level: Qualitative Characteristics

Illustration Hierarchy of Accounting Qualities


Fundamental Quality—Relevance

To be relevant, accounting information must be capable of making a difference in a decision.



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.



Relevant information also helps users confirm or correct (change) prior expectations. For example, when ABC corp. issues its year end financial statements, it confirms or changes past expectations based on previous evaluations.


Fundamental Quality—Faithful Representation

Faithful representation means that the numbers and descriptions match what really existed or 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.



An information item that is free from error will be a more accurate (faithful) representation of a financial item.


Enhancing Qualities

Information that is measured and reported in a similar manner for different companies is considered comparable.


Enhancing Qualities

Verifiability occurs when independent measurers, using the same methods, obtain similar results.


Enhancing Qualities

Timeliness means having information available to decision-makers before it loses its capacity to influence decisions.


Enhancing Qualities

Understandability is the quality of information that lets reasonably informed users see its significance.

Elements of Financial Statements

Elements of Financial Statements

Comprehensive Income = Revenue – Expenses + Gains – Losses (see slide 2; Elements 7-10)

Conceptual Framework is the basis for setting accounting rules/standards. The FASB has issued 7 Statements of Financial Accounting Concepts (SFAC) for business enterprises.

Development of Conceptual Framework

SFAC No.1 - Objectives of Financial Reporting (replaced by No. 8).

SFAC No.2 - Qualitative Characteristics of Accounting Information (replaced by #8).

SFAC No.3 - Elements of Financial Statements (replaced by No. 6).

SFAC No.5 - Recognition and Measurement in Financial Statements (3rd level).

SFAC No.6 - Elements of Financial Statements.

SFAC No.7 - Using Cash Flow Information and Present Value in Accounting Measurements.

SFAC No.8 - The Objective of General Purpose Financial Reporting (1st level) and Qualitative Characteristics of Useful Financial Information (2nd level). (SFAC 4: Non business organizations)

Economic Entity – company keeps its activity separate from its owners and other businesses.

Going Concern - company to last long enough to fulfill objectives and commitments.

Monetary Unit - money is the common denominator.

Periodicity - company can divide its economic activities into time periods.

Third Level: Basic Assumptions

Measurement Principle – The most commonly used measurements are based on historical cost and fair value.

Issues: Historical cost provides a reliable benchmark for

measuring historical trends.

Fair value information may be more useful.

Recently the FASB has taken the step of giving companies the option to use fair value as the basis for measurement of financial assets and financial liabilities.

Reporting of fair value information is increasing.

Third Level: Basic Principles

3rd Level: Basic Principles Revenue Recognition - generally occurs (1) when realized or realizable and (2) when earned. FASB Concepts Statement No. 5:

Revenue is not recognized until earned. Revenues are considered to have been earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues.

Revenues are realized when goods or services are exchanged for cash or claims to cash. Revenues are realizable when related assets received in exchanges are readily convertible to known amounts of cash or claims to cash.

Short and Sweet Tricks: (1). Earned = work is done. (2). (a) Realized = cash was exchanged. (b) Realizable = claim to cash. C, D, E, F: Collectability (1); Delivery (1); Evidence of an arrangement (2); Fee is fixed or determinable (2) (SOP 97-2 Software Revenue Recognition)

Review Question (true or false):

A conceptual framework underlying financial accounting is important because it can lead to consistent standards and it prescribes the nature, function, and limits of financial accounting and financial statements.

Conceptual Framework

True

Review Question (true or false):

A conceptual framework underlying financial accounting is necessary because future accounting practice problems can be solved by reference to the conceptual framework and a formal standard-setting body will not be necessary.


False

Assets

Liabilities

Equity

Investment by owners

Distribution to owners

Comprehensive income

Revenue

Expenses

Gains

Losses

Second Level: Basic Elements

Exercise: Identify the element or elements associated with items below. (a) Arises from peripheral or

incidental transactions.

(b) Obligation to transfer resources arising from a past transaction.

(c) Increases ownership interest.

(d) Declares and pays cash dividends to owners.

(e) Increases in net assets in a period from nonowner sources.

(a)

Elements

(b)

(c)

(d)

(c)

(a)

(e)

LO 5

(g)


Exercise: Identify the element or elements associated with items below. (f) Items characterized by future

economic benefit.

(g) Equals increase in net assets during the year, after adding distributions to owners and subtracting investments by owners.

(h) Arises from income statement activities that constitute the entity’s ongoing major or central operations.

LO 5

Elements (f)

(h) (h)

Assets

Liabilities

Equity




Revenue

Expenses

Gains

Losses

(i) Residual interest in the net assets of the enterprise.

(j) Increases assets through sale of product.

(k) Decreases assets by purchasing the company’s own stock.

(l) Changes in equity during the period, except those from investments by owners and distributions to owners.


Exercise: Identify the element or elements associated with items below.

LO 5

(i)

(j)

(k)

(l)

Assets

Liabilities

Equity




Revenue

Expenses

Gains

Losses

Elements

Review:


According to the FASB conceptual framework, an entity’s revenue may result from

a. A decrease in an asset from primary operations.

b. An increase in an asset from incidental transactions.

c. An increase in a liability from incidental transactions.

d. A decrease in a liability from primary operations.

What are the Statements of Financial Accounting Concepts intended to establish?

a. Generally accepted accounting principles in financial reporting by business enterprises.

b. The meaning of “Present fairly in accordance with generally accepted accounting principles.”

c. The objectives and concepts for use in developing standards of financial accounting and reporting.

d. The hierarchy of sources of generally accepted accounting principles.


Review

Third Level: Assumptions

Exercise: Identify which basic assumption of accounting is best described in each item below.

(a) The economic activities of KC Corporation are divided into 12-month periods for the purpose of issuing annual reports.

(b) Solectron Corporation, Inc. does not adjust amounts in its financial statements for the effects of inflation.

(c) Walgreen Co. reports current and noncurrent classifications in its balance sheet.

(d) The economic activities of General Electric and its subsidiaries are merged for accounting and reporting purposes.

Periodicity

Going Concern

Monetary Unit

Economic Entity

Note: (c), if a co. adopts the liquidation approach, the current/noncurrent Classification of assets & liab loses its significance.

Statement of Cash Flows – Operating Activities

Preparing the Statement of Cash Flows Two Formats for Reporting Operating Activities

Reports the cash effects of each operating activity

Direct Method

Starts with accrual net income and

converts to cash basis

Indirect Method

Net Income

Cash Flows from Operating Activities

97.5% of all companies use the indirect method.

Changes in current assets and current liabilities.

+ Losses & - Gains + Noncash expenses (e.g., depreciation and amortization.

Indirect Method

Assets = Liabilities + Stockholders Equities Cash = - Accounts Receivable – Prepaid – Inventory- all other current assets +A/p + Salaries Payable + all other current liabilities +All Long-term Liabilities + Stocks + Paid-in Capital + Non-cash Expenses (e.g. depreciation, amortization) – Gains + Losses - Dividend (Note: Trade A/P – a debt owed for Inventory (goods, raw materials), & supplies, that are not evidenced by a promissory note. Accrued liabilities – a liability for an expense you have not yet paid, e.g., interest payable, salary payable, income tax payable. Other misc. current liabilities: Sales taxes payable, prop taxes payable, use taxes payable (taxes collected from the buyer on goods purchased outside of the taxing jurisdiction)).

Change in Account Balance During YearIncrease Decrease

Current Subtract from net Add to net income.Assets income.

Current Add to net income. Subtract from netLiabilities income.

Indirect Method

Indirect Method Example – B&G Company

Information Available:

Preparing a Statement of Cash Flows - Example

Additional Information for 2009: • Net income was $105,000. • Cash dividends declared and paid were $40,000. • Bonds payable of $50,000 were redeemed for

$50,000 cash. • Common stock was issued for $35,000 cash.


Cash flows from operating activitiesNet income 105,000$ Adjustments to accrual-basis net income: Depreciation expense 34,000$

Increase in accounts receivable (9,000) Decrease in inventory 19,000 Decrease in accounts payable (8,000) Total adjustments 36,000

Net cash provided by operating activities 141,000 Cash flows from investing activities

B&G CompanyStatement of Cash Flows

For the Year Ended December 31, 2009


Recognition & Measurement - GAAP • Recognition: must meet following 2 general criteria – 1. Probability 2. Reliable measurement Revenue: are increases of assets and reductions of liabilities during a period of time. Rev Recognition: Revenues & gains are recognized when: it is realized or realizable & earned. 1). Realized: when goods or services have been exchanged for cash or claims to cash. or Realizable: when goods or services have been exchanged for assets that are readily convertible into cash or claims to cash. (Readily convertible assets: 1. interchangeable units & 2. quoted prices available in an active market that can rapidly absorb the quantity held by the entity w/o a significant effect on the price. & 2). Earned: when the earning process has been substantially completed, & the entity is entitled to the resulting benefits or revenues.

Measuring Assets and Liabilities - Fair Value Valuation Techniques

Fair value: is the price that would be received to sell an asset or paid to transfer a liability in an orderly market participants at the measurement date. • Market approach: valuation based on market

information. • Income approach: by estimating future amounts

(earnings or cash flows) and converting those amounts to a single present value.

• Cost approach: estimating the amount that would be required to buy or construct an asset of similar quality and condition.

Fair Value Hierarchy

U.S. GAAP gives companies the option to report some or all of their financial assets and liabilities at fair value.

Example for FV in Level 2

• When there is no principal market, FVs are based on the assumption that a transaction would occur in the most advantageous market. Therefore the market that would result in the highest net sales proceeds is the most advantageous market.

• Although transition costs are considered in determining the most advantageous market, they are ignored for the purpose of the FMV and is added back to net sales proceeds.

Recognition & Measurement – GAAP (cont’d) • All 4 criteria must be met for each element of the contract before any

revenue can be recognized: 1) persuasive evidence of an arrangement exists; 2) delivery has occurred or services have been rendered; 3) the price is fixed & determinable; & 4) collection is reasonably assured • Revenue from the sale of products or the disposal of other assets is

recognized on the date of sale (exchange) of the product or other asset, i.e., the delivery date. The following 2 criteria apply:

1) delivery of goods or setting aside goods ordered, and/or 2) transfer of legal title • Revenue from allowing others the use of the entity’s assets (e.g.,

interest, royalty, & rental revenue) is recognized when the assets are used (time passage)

• Revenue from the performance of services is recognized in the period the services have been rendered & are able to be billed by the entity.

GAAP & IFRS Differences Fall into 5 Basic Categories

During recent years’ convergence project, the most significant differences between GAAP & IFRS are being eliminated when possible & otherwise minimized. GAAP & IFRS most differences fall into one of the following basic categories: • Terminology & definitions • Recognition • Measurement • Presentation • Disclosure

FASB vs. IASB (GAAP vs. IFRS: International Financial Reporting Standards)

Differences between the FASB & IASB:

GAAP: more rules-based IFRS: principle-based or concept based

10 elements of Financial Statements 5 elements of Financial Statements3 basic elements 3 elements of financial position Assets Assets Liabilities Liabilities Equity or Net Assets Equity or Net Assets

3 elements of Equity Contributions/Investments by owners Distributions to owners Comprehensive income

4 elements of comprehensive income 2 elements of performance Revenues Income* (both revenues & gains) Expenses Expenses (& losses from ordinary activities) Gains Note: Capital maintenance adjustments Losses are from revaluation or restatement

of assets & liabilities, not from income or exp

Net Income Profit

* Under GAAP, "income" is not a financial statement element; it is used to describe a calculation of some type (e.g., income from continuting operations, net income).

FASB Conceptual Framework IASB Framework

With IFRS, income is a financial statement element which includes revenues & gains. As such, IFRS uses “profit” whereas GAAP uses “net income”.

Revenue Recognition - IFRS General: revenue is measured at the FV of consideration received or receivable. • For a sale of goods, revenue is recognized when all 5 conditions are met: 1. significant risks & rewards of ownership transferred to the buyer. 2. the selling entity doesn’t retain managerial involvement associated with ownership or control over the asset/goods sold. 3. the revenue amount can be reliably measured. 4. it is probable (likely) that the economic benefits will flow to the entity. 5. transaction costs incurred & to be incurred can be reliably measured. • For the rendering of a service: 1. when the outcome can be reliably estimated, revenue is recognized based on the %-of-completion method. 2. when the outcome cannot be reliably estimated, revenue is recognized to the extent of recoverable expenses recognized (cost recovery). • Revenues from interest, royalties, & dividends are recognized when the amounts

can be reliably estimated & economic benefits will probably flow to the entity. Interest: effective interest method Royalties: accrual basis Dividends: when the shareholders’ right to receive payment is established.

ASB Codification Framework (ASC)

Which of the following statements about the IASB and FASB conceptual frameworks is not correct?

a. The IASB conceptual framework does not identify the element comprehensive income.

b. The existing IASB and FASB conceptual frameworks are organized in similar ways.

c. The FASB and IASB agree that the objective of financial reporting is to provide useful information to investors and creditors.

d. IFRS does not allow use of fair value as a measurement basis.

IFRS SELF-TEST QUESTION

Which of the following statements is false?

a. The monetary unit assumption is used under IFRS.

b. Under IFRS, companies may use fair value for property, plant, and equipment.

c. The FASB and IASB are working on a joint conceptual framework project.

d. Under IFRS, there are the same number of financial statement elements as in GAAP.

IFRS SELF-TEST QUESTION

Section 1 – Conceptual Framework & IFRS - anna-n … 1 – Conceptual Framework & IFRS . FASB...

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