Qualitative Characteristics of Financial Statements

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ACCOUNTING PRINCIPLES & FINANCIAL STATEMENTS QUALITATIVE CHARACTERISTICS: 

ACCOUNTING PRINCIPLES & FINANCIAL STATEMENTS QUALITATIVE CHARACTERISTICS Prepared by Coby Harmon, University of California, Santa Barbara BACK TO MAIN SLIDE Adopted from 2007 John Wiley & Sons, Inc.

Conceptual Framework: 

Conceptual Framework Need Development First Level: Basic Objectives Second Level: Fundamental Concepts Third Level: Recognition and Measurement Basic assumptions Basic principles Constraints Qualitative characteristics Basic elements Conceptual Framework BACK TO MAIN SLIDE

Conceptual Framework: 

The Need for a Conceptual Framework To develop a coherent set of standards and rules To solve new and emerging practical problems Conceptual Framework LO 1 Describe the usefulness of a conceptual framework. BACK TO MAIN SLIDE

Development of Conceptual Framework: 

Objective 2 The FASB has issued six Statements of Financial Accounting Concepts (SFAC) for business enterprises. Development of Conceptual Framework SFAC No.1 - Objectives of Financial Reporting SFAC No.2 - Qualitative Characteristics of Accounting Information SFAC No.3 - Elements of Financial Statements (superceded by SFAC No. 6) SFAC No.4 - Nonbusiness Organizations SFAC No.5 - Recognition and Measurement in Financial Statements SFAC No.6 - Elements of Financial Statements (replaces SFAC No. 3) SFAC No.7 - Using Cash Flow Information and Present Value in Accounting Measurements LO 2 Describe the FASB’s efforts to construct a conceptual framework. BACK TO MAIN SLIDE

Conceptual Framework: 

The Framework is comprised of three levels: First Level = Basic Objectives Second Level = Qualitative Characteristics and Basic E lements Third Level = Recognition and Measurement Concepts. Conceptual Framework LO 2 Describe the FASB’s efforts to construct a conceptual framework. BACK TO MAIN SLIDE

PowerPoint Presentation: 

ASSUMPTIONS Economic entity Going concern Monetary unit Periodicity PRINCIPLES Historical cost Revenue recognition Matching Full disclosure CONSTRAINTS Cost-benefit Materiality Industry practice Conservatism OBJECTIVES 1. Useful in investment and credit decisions 2. Useful in assessing future cash flows 3. About enterprise resources, claims to resources, and changes in them ELEMENTS Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses Illustration 2-6 Conceptual Framework for Financial Reporting First level Second level Third level LO 2 Describe the FASB’s efforts to construct a conceptual framework. QUALITATIVE CHARACTERISTICS Relevance Reliability Comparability Consistency

First Level: Basic Objectives: 

Financial reporting should provide information that: (a) is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. (b) helps present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts. (c) portrays the economic resources of an enterprise, the claims to those resources, and the effects of transactions, events, and circumstances that change its resources and claims to those resources. First Level: Basic Objectives LO 3 Understand the objectives of financial reporting.

Second Level: Fundamental Concepts: 

Qualitative Characteristics “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 LO 4 Identify the qualitative characteristics of accounting information. BACK TO MAIN SLIDE

Second Level: Qualitative Characteristics: 

Second Level: Qualitative Characteristics LO 4 Identify the qualitative characteristics of accounting information. Illustration 2-2 Hierarchy of Accounting Qualities

Second Level: Fundamental Concepts: 

Understandability A company may present highly relevant and reliable information, however it was useless to those who do not understand it. Second Level: Fundamental Concepts LO 4 Identify the qualitative characteristics of accounting information. BACK TO MAIN SLIDE

PowerPoint Presentation: 

ASSUMPTIONS Economic entity Going concern Monetary unit Periodicity PRINCIPLES Historical cost Revenue recognition Matching Full disclosure CONSTRAINTS Cost-benefit Materiality Industry practice Conservatism OBJECTIVES 1. Useful in investment and credit decisions 2. Useful in assessing future cash flows 3. About enterprise resources, claims to resources, and changes in them QUALITATIVE CHARACTERISTICS Relevance Reliability Comparability Consistency ELEMENTS Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses Illustration 2-6 Conceptual Framework for Financial Reporting First level Second level Third level Relevance and Reliability LO 4 Identify the qualitative characteristics of accounting information.

Second Level: Qualitative Characteristics: 

LO 4 Identify the qualitative characteristics of accounting information. Second Level: Qualitative Characteristics Primary Qualities: Relevance – making a difference in a decision. Predictive value-”correctly predicting or forecasting outcome of events” Feedback value-”enable the users confirm or correct earlier expectations” Timeliness- ”relevant information furnished after a decision is made useless or of no value” Reliability Verifiable Representational faithfulness Neutral - free of error and bias BACK TO MAIN SLIDE

PowerPoint Presentation: 

ASSUMPTIONS Economic entity Going concern Monetary unit Periodicity PRINCIPLES Historical cost Revenue recognition Matching Full disclosure CONSTRAINTS Cost-benefit Materiality Industry practice Conservatism OBJECTIVES 1. Useful in investment and credit decisions 2. Useful in assessing future cash flows 3. About enterprise resources, claims to resources, and changes in them QUALITATIVE CHARACTERISTICS Relevance Reliability Comparability Consistency ELEMENTS Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses Illustration 2-6 Conceptual Framework for Financial Reporting First level Second level Third level LO 4 Identify the qualitative characteristics of accounting information. Comparability and Consistency

Second Level: Qualitative Characteristics: 

LO 4 Identify the qualitative characteristics of accounting information. Second Level: Qualitative Characteristics Secondary Qualities: Comparability – Information that is measured and reported in a similar manner for different companies is considered comparable. Consistency - When a company applies the same accounting treatment to similar events from period to period. BACK TO MAIN SLIDE

PowerPoint Presentation: 

ASSUMPTIONS Economic entity Going concern Monetary unit Periodicity PRINCIPLES Historical cost Revenue recognition Matching Full disclosure CONSTRAINTS Cost-benefit Materiality Industry practice Conservatism OBJECTIVES 1. Useful in investment and credit decisions 2. Useful in assessing future cash flows 3. About enterprise resources, claims to resources, and changes in them QUALITATIVE CHARACTERISTICS Relevance Reliability Comparability Consistency ELEMENTS Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses Illustration 2-6 Conceptual Framework for Financial Reporting First level Second level Third level Elements LO 5 Define the basic elements of financial statements.

Second Level: Elements: 

Investment by owners Distribution to owners Comprehensive income Revenue Expenses Gains Losses Second Level: Elements Concepts Statement No. 6 defines ten interrelated elements that relate to measuring the performance and financial status of a business enterprise. Assets Liabilities Equity “Moment in Time” “Period of Time” LO 5 Define the basic elements of financial statements. BACK TO MAIN SLIDE

Second Level: Elements: 

Second Level: Elements Exercise 2-3 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. LO 5 Define the basic elements of financial statements. (a) Elements (b) (c) (d) (c) (a) (e) Assets Liabilities Equity Investment by owners Distribution to owners Comprehensive income Revenue Expenses Gains Losses

Second Level: Elements: 

(g) Second Level: Elements Exercise 2-3 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 Define the basic elements of financial statements. (a) Elements (b) (d) (c) (a) (f) (e) (h) (c) (h) Assets Liabilities Equity Investment by owners Distribution to owners Comprehensive income Revenue Expenses Gains Losses

Second Level: Elements: 

(g) Assets Liabilities Equity Investment by owners Distribution to owners Comprehensive income Revenue Expenses Gains Losses Second Level: Elements Exercise 2-3 Identify the element or elements associated with items below. (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. LO 5 Define the basic elements of financial statements. (a) Elements (b) (d) (c) (a) (f) (e) (h) (c) (h) (i) (j) (k) (l)

Third Level: Recognition and Measurement: 

Third Level: Recognition and Measurement The FASB sets forth most of these concepts in its Statement of Financial Accounting Concepts No. 5 , “Recognition and Measurement in Financial Statements of Business Enterprises.” ASSUMPTIONS Economic entity Going concern Monetary unit Periodicity PRINCIPLES Historical cost Revenue recognition Matching Full disclosure CONSTRAINTS Cost-benefit Materiality Industry practice Conservatism LO 6 Describe the basic assumptions of accounting.

Third Level: Principles: 

Historical Cost – the price, established by the exchange transaction, is the “cost”. Issues: Historical cost provides a reliable benchmark for measuring historical trends. Fair value information may be more useful. FASB issued SFAS 15X, “Fair Value Measurements (2005).” Reporting of fair value information is increasing. Third Level: Principles LO 7 Explain the application of the basic principles of accounting. BACK TO MAIN SLIDE

Third Level: Principles: 

Revenue Recognition - generally occurs (1) when realized or realizable and (2) when earned. Exceptions: During Production. At End of Production Upon Receipt of Cash Third Level: Principles LO 7 Explain the application of the basic principles of accounting. BACK TO MAIN SLIDE

Third Level: Principles: 

Matching - efforts (expenses) should be matched with accomplishment (revenues) whenever it is reasonable and practicable to do so. “Let the expense follow the revenues.” Third Level: Principles LO 7 Explain the application of the basic principles of accounting. Illustration 2-4 Expense Recognition

Third Level: Principles: 

Full Disclosure – providing information that is of sufficient importance to influence the judgment and decisions of an informed user. Provided through: Financial Statements Notes to the Financial Statements Supplementary information Third Level: Principles LO 7 Explain the application of the basic principles of accounting. BACK TO MAIN SLIDE

Third Level: Principles: 

Third Level: Principles LO 7 Explain the application of the basic principles of accounting. Brief Exercise 2-5 Identify which basic principle of accounting is best described in each item below. (a) Norfolk Southern Corporation reports revenue in its income statement when it is earned instead of when the cash is collected. (b) Yahoo, Inc. recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue. (c) Oracle Corporation reports information about pending lawsuits in the notes to its financial statements. (d) Eastman Kodak Company reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair market value is greater. Revenue Recognition Matching Full Disclosure Historical Cost

Third Level: Constraints: 

Cost Benefit – the cost of providing the information must be weighed against the benefits that can be derived from using it. Materiality - an item is material if its inclusion or omission would influence or change the judgment of a reasonable person. Industry Practice - the peculiar nature of some industries and business concerns sometimes requires departure from basic accounting theory. Conservatism – when in doubt, choose the solution that will be least likely to overstate assets and income. Third Level: Constraints LO 8 Describe the impact that constraints have on reporting accounting information.

Third Level: Constraints: 

Brief Exercise 2-6 What accounting constraints are illustrated by the items below? (a) Zip’s Farms, Inc. reports agricultural crops on its balance sheet at market value. (b) Crimson Tide Corporation does not accrue a contingent lawsuit gain of $650,000. (c) Wildcat Company does not disclose any information in the notes to the financial statements unless the value of the information to users exceeds the expense of gathering it. (d) Sun Devil Corporation expenses the cost of wastebaskets in the year they are acquired. Industry Practice Conservatism Third Level: Constraints Cost-Benefit Materiality LO 8 Describe the impact that constraints have on reporting accounting information.

Copyright: 

Copyright © 2007 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. Copyright BACK TO MAIN SLIDE