Characteristics of Financial Information - Chapter Summary
Characteristics of Financial Information
- Importance of understanding financial information for decision-making and reporting.
- Focus on key characteristics covered in Chapter 3.
Objective of General Purpose Financial Reporting
- Accrual Accounting:
- Transactions recorded in the period they relate to, not necessarily when cash is exchanged.
- Example: Including electricity costs in financial statements for the year even if the bill arrives late.
- Going Concern:
- Assumes the business will continue operating for the foreseeable future.
- If not, assets and liabilities should be valued at breakup value (what they would sell for if the company was dismantled).
Qualitative Characteristics of Financial Information
Fundamental Characteristics:
- Relevance:
- Information must aid decision-making for users.
- Example of materiality: Missing a small amount (e.g., £5) is less relevant compared to significant amounts (e.g., £5,000,000).
- Faithful Representation:
- Accounts must accurately depict the business at a specific time, showcasing the true financial situation.
Enhancing Characteristics:
- Comparability:
- Ensure financial information can be compared across years and companies.
- Verifiability:
- Numbers must be able to be substantiated; audits ensure this.
- Timeliness:
- Information should be available at the right time for users.
- Understandability:
- Information should be comprehensible to users with basic financial knowledge.
Cost Constraint:
- Benefits of financial reporting must justify the costs involved in its preparation.
- Example: Not worth spending excessive time/funds to trace insignificant discrepancies in financial records.
Elements of Financial Statements
- Definitions to Remember for Exam:
- Asset:
- Present economic resource controlled by the entity due to past events.
- Liability:
- Present obligation to transfer economic resources due to past events.
- Equity:
- Residual interest in assets after deducting liabilities (Equity = Net Assets).
- Income:
- Increases in assets or decreases in liabilities resulting in higher equity.
- Expenses:
- Decreases in assets or increases in liabilities leading to lower equity.
Measurement Bases in Financial Reporting
- Historic Cost:
- Most commonly used; based on original invoice price.
- Example: Reliable and easy to audit due to concrete evidence.
- Current Value:
- More relevant but less reliable than historic cost; includes:
- Fair Value: Price in an actual market transaction.
- Value in Use: Present value of future cash flows from an asset or liability.
- Current Cost: Cost to acquire the asset at today’s market prices.