UNIT 2: ACCOUNTING CONCEPTS AND PRINCIPLES
UNIT 2: ACCOUNTING CONCEPTS AND PRINCIPLES
Qualitative characteristics of useful financial informationFundamental qualitative characteristics
The fundamental qualitative characteristics are qualities that make accounting information useful for decision making by interested users. If financial information is to be useful, it must be relevant and faithfully represent what it purports to represent.
Relevance – Relevant financial information is capable of making a difference in the decisions made by users.
Predictive value – if it can be used as an input to processes employed by users to predict future outcomes
Confirmatory value – if it provides feedback about (confirms or changes) previous evaluations
The predictive value and confirmatory value of financial information are interrelated.
For example, revenue information for the current year, which can be used as the basis for predicting revenues in future years, can also be compared with revenue predictions for the current year that were made in past years.
The results of those comparisons can help a user to correct and improve the processes that were used to make those previous predictions.
Materiality – if omitting, misstating, or obscuring an information could reasonably be expected to influence decisions that the primary users of general-purpose financial reports make on the basis of those reports
A business entity may depart from the generally accepted principles for recording some transactions when an information is not significant enough to affect financial decisions (follows convenience rather than theoretical principles).
When is a financial information considered obscured?
vague disclosure, language is unclear
information is scattered
dissimilar items are improperly aggregated
similar items are disaggregated
if material information is hidden
if there are a lot of unnecessary information
Faithfully representation – Financial reports represent economic phenomena in words and numbers. To be useful, financial information must also faithfully represent the substance of the phenomena that it purports to represent.
Completeness – includes all information necessary for a user to understand the phenomenon being depicted, including all necessary descriptions and explanations. Omitting a portion of that information can cause it to be false or misleading.
For example,
Assets should have description, nature, numerical and depiction.
Explanations of significant facts about the quality and nature of the items, factors and circumstances that might affect their quality and nature, and the process used to determine the numerical depiction.
Neutrality – without bias in the selection or presentation of financial information
Neutrality is supported by the exercise of prudence. Prudence is the exercise of caution when making judgements under conditions of uncertainty.
Free from error – no errors or omissions in the description of the phenomenon, and the process used to produce the reported information has been selected and applied with no errors in the process.
For use of estimates, it should be described clearly and accurately as being an estimate, the nature and limitations of the estimating process are explained, and no errors have been made in selecting and applying an appropriate process for developing the estimate.
Enhancing qualitative characteristics
The enhancing qualitative characteristics are attributes that enhance the fundamental qualitative characteristics of financial information.
Comparability – enables users to identify and understand similarities in items and differences among items.
Consistency – Consistency refers to the use of the same methods for the same items, either from period to period within a reporting entity or in a single period across entities.
Uniformity – Comparability of financial information is not enhanced by making unlike things look alike any more than it is enhanced by making like things look different.
Verifiability – helps assure users that different knowledgeable and independent observers could reach consensus, although not necessarily complete agreement, that a particular depiction is a faithful representation.
Timeliness – having information available to decision-makers in time to be capable of influencing their decisions.
Generally, the older the information is, the less useful it is.
Some information may continue to be timely long after the end of a reporting period (E.g., to identify and assess trends)
Understandability – classifying, characterising, and presenting information clearly and concisely
Underlying assumptions – assumptions made when preparing financial statements to avoid misunderstanding
Entity / Business entity / Economic entity / Separate entity
assumes that a business unit is separate and distinct from its owner/s
requires that business’s accounting records should always be kept separate from the owner’s personal accounting records
Going concern / Continuity
assumes that a business entity has an indefinite life, that it will continue to operate in the foreseeable future in the absence of any evidence to the contrary
Monetary / Money measurement / Monetary unit
assumes that only transactions that can be expressed in monetary terms are recorded
assumes that the peso
is used to record transactions and
that it is relatively free from value fluctuations
Time period / Periodicity of income / Time interval
assumes that the indefinite life of a business entity is subdivided into short periods of equal length within which financial statements are prepared to provide users of financial statements with timely information
Accrual
revenue should be recognized when earned, regardless of when cash is received, and
expenses should be recognized when incurred, regardless of when cash is paid
General principles – guidelines in preparing financial statements
Cost / Historical cost
transactions should be recorded at the cost paid by the business and that assets should be shown at their original cost (this will also support the objectivity concept since the assets can be verified with business documents)
Revenue recognition
revenue is recorded when it is earned regardless of when cash is received (Exception: goods delivered on ‘sale or return’ basis)
when a sale is made
when a service is provided
revenue is recorded only if it has been earned and realized
realization of revenue occurs at the time new assets are created in the form of
cash
accounts receivable
Matching / Expense recognition
revenues earned during an accounting period should be matched (offset) with the expenses incurred in generating this revenue in the same accounting period (cause and effect)
Full disclosure / Disclosure
the business entity should provide financial information and other facts that are necessary for the users to properly interpret the financial statements
Modifying constraints – limitations that restrict and practical considerations that modify the accounting choices that an accountant makes in preparing financial statements
Materiality
if omitting, misstating, or obscuring an information could reasonably be expected to influence decisions that the primary users of general-purpose financial reports make on the basis of those reports
Cost-Benefit Test
the cost of gathering information to fully comply with an accounting principle or rule may be much higher than the benefit received
information is cost effective only if the benefit of increased decision usefulness exceeds the costs of providing that information
For example, depreciating low-value assets such as a stapler
Conservatism / Prudence
the exercise of caution when making judgements under conditions of uncertainty
if there are two or more equally acceptable treatments to record a transaction, then the accountant should choose the conservative approach
lower income
lower valued asset
assets and income are not overstated
does not mean that assets or income should be understated
liabilities and expenses are not understated
record all possible expenses or losses
does not mean that liabilities or expenses should be overstated
a business entity should always err on the side of caution
Industry Practice
Some industries have unusual tax laws or regulatory requirements and so have developed special accounting principles and procedures for their industry. These practices may not conform completely with GAAP or IFRS Standards and so are not suitable for other industries.
Other concepts
Objectivity
the business entity should use documents as basis for recording business transactions and so avoids subjectivity when preparing financial statements
Substance over form
business transactions should be treated according to the real substance, not the legal position (legal form)
REFERENCES
IFRS Foundation (2018, March). Conceptual Framework for Financial Reporting.
Spiceland, Sepe, Thomas, Tan, Low, Low (2019), Intermediate Accounting Global Edition (2nd Edition), McGraw- Hill Education (Asia).
WEBSITE
International Financial Reporting Standards (IFRS) https://www.ifrs.org/
UNIT 2: ACCOUNTING CONCEPTS AND PRINCIPLES
UNIT 2: ACCOUNTING CONCEPTS AND PRINCIPLES
Qualitative characteristics of useful financial informationFundamental qualitative characteristics
The fundamental qualitative characteristics are qualities that make accounting information useful for decision making by interested users. If financial information is to be useful, it must be relevant and faithfully represent what it purports to represent.
Relevance – Relevant financial information is capable of making a difference in the decisions made by users.
Predictive value – if it can be used as an input to processes employed by users to predict future outcomes
Confirmatory value – if it provides feedback about (confirms or changes) previous evaluations
The predictive value and confirmatory value of financial information are interrelated.
For example, revenue information for the current year, which can be used as the basis for predicting revenues in future years, can also be compared with revenue predictions for the current year that were made in past years.
The results of those comparisons can help a user to correct and improve the processes that were used to make those previous predictions.
Materiality – if omitting, misstating, or obscuring an information could reasonably be expected to influence decisions that the primary users of general-purpose financial reports make on the basis of those reports
A business entity may depart from the generally accepted principles for recording some transactions when an information is not significant enough to affect financial decisions (follows convenience rather than theoretical principles).
When is a financial information considered obscured?
vague disclosure, language is unclear
information is scattered
dissimilar items are improperly aggregated
similar items are disaggregated
if material information is hidden
if there are a lot of unnecessary information
Faithfully representation – Financial reports represent economic phenomena in words and numbers. To be useful, financial information must also faithfully represent the substance of the phenomena that it purports to represent.
Completeness – includes all information necessary for a user to understand the phenomenon being depicted, including all necessary descriptions and explanations. Omitting a portion of that information can cause it to be false or misleading.
For example,
Assets should have description, nature, numerical and depiction.
Explanations of significant facts about the quality and nature of the items, factors and circumstances that might affect their quality and nature, and the process used to determine the numerical depiction.
Neutrality – without bias in the selection or presentation of financial information
Neutrality is supported by the exercise of prudence. Prudence is the exercise of caution when making judgements under conditions of uncertainty.
Free from error – no errors or omissions in the description of the phenomenon, and the process used to produce the reported information has been selected and applied with no errors in the process.
For use of estimates, it should be described clearly and accurately as being an estimate, the nature and limitations of the estimating process are explained, and no errors have been made in selecting and applying an appropriate process for developing the estimate.
Enhancing qualitative characteristics
The enhancing qualitative characteristics are attributes that enhance the fundamental qualitative characteristics of financial information.
Comparability – enables users to identify and understand similarities in items and differences among items.
Consistency – Consistency refers to the use of the same methods for the same items, either from period to period within a reporting entity or in a single period across entities.
Uniformity – Comparability of financial information is not enhanced by making unlike things look alike any more than it is enhanced by making like things look different.
Verifiability – helps assure users that different knowledgeable and independent observers could reach consensus, although not necessarily complete agreement, that a particular depiction is a faithful representation.
Timeliness – having information available to decision-makers in time to be capable of influencing their decisions.
Generally, the older the information is, the less useful it is.
Some information may continue to be timely long after the end of a reporting period (E.g., to identify and assess trends)
Understandability – classifying, characterising, and presenting information clearly and concisely
Underlying assumptions – assumptions made when preparing financial statements to avoid misunderstanding
Entity / Business entity / Economic entity / Separate entity
assumes that a business unit is separate and distinct from its owner/s
requires that business’s accounting records should always be kept separate from the owner’s personal accounting records
Going concern / Continuity
assumes that a business entity has an indefinite life, that it will continue to operate in the foreseeable future in the absence of any evidence to the contrary
Monetary / Money measurement / Monetary unit
assumes that only transactions that can be expressed in monetary terms are recorded
assumes that the peso
is used to record transactions and
that it is relatively free from value fluctuations
Time period / Periodicity of income / Time interval
assumes that the indefinite life of a business entity is subdivided into short periods of equal length within which financial statements are prepared to provide users of financial statements with timely information
Accrual
revenue should be recognized when earned, regardless of when cash is received, and
expenses should be recognized when incurred, regardless of when cash is paid
General principles – guidelines in preparing financial statements
Cost / Historical cost
transactions should be recorded at the cost paid by the business and that assets should be shown at their original cost (this will also support the objectivity concept since the assets can be verified with business documents)
Revenue recognition
revenue is recorded when it is earned regardless of when cash is received (Exception: goods delivered on ‘sale or return’ basis)
when a sale is made
when a service is provided
revenue is recorded only if it has been earned and realized
realization of revenue occurs at the time new assets are created in the form of
cash
accounts receivable
Matching / Expense recognition
revenues earned during an accounting period should be matched (offset) with the expenses incurred in generating this revenue in the same accounting period (cause and effect)
Full disclosure / Disclosure
the business entity should provide financial information and other facts that are necessary for the users to properly interpret the financial statements
Modifying constraints – limitations that restrict and practical considerations that modify the accounting choices that an accountant makes in preparing financial statements
Materiality
if omitting, misstating, or obscuring an information could reasonably be expected to influence decisions that the primary users of general-purpose financial reports make on the basis of those reports
Cost-Benefit Test
the cost of gathering information to fully comply with an accounting principle or rule may be much higher than the benefit received
information is cost effective only if the benefit of increased decision usefulness exceeds the costs of providing that information
For example, depreciating low-value assets such as a stapler
Conservatism / Prudence
the exercise of caution when making judgements under conditions of uncertainty
if there are two or more equally acceptable treatments to record a transaction, then the accountant should choose the conservative approach
lower income
lower valued asset
assets and income are not overstated
does not mean that assets or income should be understated
liabilities and expenses are not understated
record all possible expenses or losses
does not mean that liabilities or expenses should be overstated
a business entity should always err on the side of caution
Industry Practice
Some industries have unusual tax laws or regulatory requirements and so have developed special accounting principles and procedures for their industry. These practices may not conform completely with GAAP or IFRS Standards and so are not suitable for other industries.
Other concepts
Objectivity
the business entity should use documents as basis for recording business transactions and so avoids subjectivity when preparing financial statements
Substance over form
business transactions should be treated according to the real substance, not the legal position (legal form)
REFERENCES
IFRS Foundation (2018, March). Conceptual Framework for Financial Reporting.
Spiceland, Sepe, Thomas, Tan, Low, Low (2019), Intermediate Accounting Global Edition (2nd Edition), McGraw- Hill Education (Asia).
WEBSITE
International Financial Reporting Standards (IFRS) https://www.ifrs.org/
