ACCA F3 (INT) Financial Accounting - 2010 - Study text

Подождите немного. Документ загружается.

Chapter 1: The context and purpose of financial reporting

and understand the financial statements of companies in any country, and make

comparisons.

The IASC Foundation and IASB have no power to enforce the International

Financial Reporting Standards and in this sense IFRSs are ‘voluntary’. The power to

enforce the use of international standards belongs to the governments of individual

countries. Some countries have adopted IFRSs and made them compulsory for some

types of business entity. For example, in the European Union, stock market

companies are required to use IFRSs in preparing their financial statements.

Practice multiple choice questions

1 A trade receivable is an example of:

A an asset

B a liability

C income

(1 mark)

2 A loan of $30,000 from a bank, repayable in three years’ time, is:

A a current liability

B a non-current liability

C a current asset

D a non-current asset.

(1 mark)

3 International accounting standards are written primarily with regard to the

information needs of which type of users?

A managers

B employees

C the government and government agencies

D investors.

(2 marks)

4 Some of the content of the financial statements of companies might be specified by

national company law.

Is this statement TRUE or FALSE?

(1 mark)

Which of the following items are items of capital expenditure?

(1) Computer repairs

(2) Purchase of a property

(3) Short term hire of machinery

A (1) and (2) only

B (1) and (3) only

C (2) only

Paper F3: Financial accounting (International)

36 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP

D (3) only.

Which of the following items are items of capital expenditure?

(1) The cost of re-decorating offices

(2) Purchase of additional machinery

(3) Construction of an extension to the Head Office building

A (1) and (2) only

B (1) and (3) only

C (2) and (3)

D (3) only.

Paper F3 (INT)

Financial Accounting

CHAPTER

Qualitative characteristics of

financial information and the

fundamental bases of

accounting

Contents

1 Qualities offinancialinformation

2 Accounting concepts: underlying assumptions

3 Alternativebasesofaccountingandvaluation

Paper F3: Financial accounting (International)

38 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP

Qualities of financial information

 Understandability

 Relevance

 Reliability

 Comparability

 Constraints on relevant and reliable information

 True and fair view/faithful representation

1 Qualities of financial information

The IASB Framework also sets out the qualities that the information in financial

statements should have in order to make the financial statements useful to users.

There are four main qualitative characteristics:

 understandability

 relevance

 reliability

 comparability.

1.1 Understandability

The financial information should be readily understandable by its users. This might

seem obvious: financial information is of no use unless its users can understand it.

There is a potential problem that, for an ‘ordinary user’, financial statements might

be too technical or complex.

However, the IASB Framework states that it should be assumed that users have a

reasonable knowledge of business and economic activities and accounting. Complex

items must not be excluded from the financial statements for the reason that the

users of the statements will not understand them.

1.2 Relevance

Financial information should be relevant to the economic decision-making needs of

users. Financial statements can help users to evaluate past, present or future events,

in order to:

 predict the future financial position and performance of the organisation, or

 confirm or correct the evaluations and forecasts they have made in the past.

The relevance of information is affected by its materiality.

 Information is of little or no relevance if it is insignificant (immaterial).

 However, information is relevant if it is material.

Deciding what is material and what is not material can be a matter of judgement.

Chapter 2: Qualitative characteristics of financial information and the fundamental bases of accounting

1.3 Reliability

Financial information must also be reliable. Users must be able to have trust in it, so

that they can use the information to make their economic decisions with confidence

that it is not misleading or too inaccurate.

It might seem more appropriate to state that financial information ought to be

accurate, rather than reliable. However, information can be reliable provided that it

is sufficiently reliable for its purpose, and 100% accuracy is not necessary.

Information is reliable if it is free from material error and bias. In order to be

reliable, information must have the following qualities:

 Faithful representation

 Substance over form

 Neutrality

 Prudence

 Completeness.

Faithful representation

The information must represent faithfully the transactions or other events that it is

supposed to represent. For example a statement of financial position should

faithfully represent the transactions and other events that have resulted in assets,

liabilities and equity.

There is a risk that financial information might not faithfully represent transactions

and events, but this is not due to bias but rather to the difficulties that often exist in

obtaining a reliable measurement of an item.

Substance over form

The information should represent the substance or economic reality of the financial

transactions, even if the economic reality is not consistent with the legal position. An

example of ‘substance over form’ arises when an entity effectively controls the use

of an item of equipment even though it is not the legal owner. An example is a long-

term lease in which an entity pays lease rentals for an item over most of its

economic life, controlling the use of the item without becoming the legal owner. The

concept of ‘substance over form’ is that an item should be accounted for as an asset

in such a situation, even though it is not its legal owner.

Neutrality

The information must be free from bias.

Prudence

Financial statements must sometimes recognise the uncertainty in business

transactions. For example, if a business is owed $1,000,000 by a number of its

customers, there will be some uncertainty as to whether all the money will actually

be collected. Prudence involves allowing for some caution in preparing financial

statements, by making reasonable and sensible allowances in order to avoid

Paper F3: Financial accounting (International)

40 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP

overstating assets or income and to avoid understating expenses or liabilities. In the

example of the $1,000,000 of receivables, it might be prudent to recognise that some

of the receivables, say, $50,000, will not be collected and will become ‘bad debts’

(‘irrecoverable debts’).

However, the concept of prudence does not allow an entity to create ‘hidden

reserves’, by undervaluing an asset or over-stating an expense or a provision. For

example, suppose that a company knows from experience that about 2% of its

receivables will become bad debts. It would be prudent to make an allowance for

bad debts equal to 2% of receivables, but it would be inappropriate to make an

excessive allowance, say 10% of receivables.

Completeness

To be reliable, information should be complete, subject to materiality and cost.

(There is no need to include information if it is not material, and greater accuracy is

not required if the cost of obtaining the extra information is more than the benefits

that the information will provide to its users.)

1.4 Comparability

Financial information should enable the users of financial statements to make

comparisons:

 with the financial statements of other business entities, and

 with the entity’s own financial statements for previous years.

Proper comparisons are only possible if the information that is being compared has

been prepared on the same basis, in a consistent way.

An important implication of the need for comparability is that an entity should

disclose the accounting policies that it has used to prepare the financial information.

The IASB Framework comments that compliance with International Financial

Reporting Standards helps to achieve comparability.

Since users of financial statements often want to compare the financial performance

and position of an entity over time, it is important that financial statements should

show corresponding figures for the previous financial year as well as for the current

year (the year just ended).

1.5 Constraints on relevant and reliable information

Some of the desirable characteristics of financial information are inconsistent with

each other. For example, it is not possible for information to be completely neutral if

there is some element of prudence in the figures (such as an allowance for bad

debts, which is an assessment based on judgement).

Chapter 2: Qualitative characteristics of financial information and the fundamental bases of accounting

Inconsistencies also exist between the requirements for relevance and reliability. The

IASB Framework makes the following additional points about the quality of

information in financial statements:

 Timeliness. Sometimes it is necessary to sacrifice some reliability in order to

avoid undue delay in providing the information, by producing the financial

statements within a reasonable time after the end of the financial period to

which the statements relate. If information is made available too late, it loses its

relevance. A balance must therefore be made between timeliness and relevance.

 Cost and benefit. The benefits obtained from providing accounting information

should not exceed the cost of providing it. Sometimes, extra reliability is not

worth the cost of obtaining it. A balance must therefore be made between the

cost and the benefit of the information.

1.6 True and fair view/faithful representation

Financial statements should give a ‘true and fair view’ of the financial position,

financial performance and changes in financial position of an entity. Another way of

saying this is that financial statements should provide a ‘faithful presentation’ of the

financial position, financial performance and changes in financial position of an

entity.

The IASB Framework states that although it does not deal directly with the concept

of true and fair view or faithful representation, financial statements will normally

result in a true and fair view (faithful representation) if:

 the financial information has the main qualitative characteristics identified by

the Framework, and

 the financial statements are prepared in accordance with the international

accounting standards.

Paper F3: Financial accounting (International)

42 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP

Accounting concepts: underlying assumptions

 The business entity concept

 The money measurement concept

 The realisation concept

 Underlying assumptions

 Accruals basis (matching concept)

 Going concern assumption

2 Accounting concepts: underlying assumptions

Financial statements are prepared using a number of underlying assumptions and

concepts.

2.1 The business entity concept

A concept used in financial reporting is that a business entity is an entity that is

separate from its owners. In other words, the business entity and its owners are

different.

For example, suppose that John Smith sets up a sole trader business as a builder,

and he calls the business ‘J Smith, Builder’. For the purpose of financial reporting,

the business (J Smith, Builder) and John Smith, the owner of the business, are

different and separate from each other.

The owner of the business is someone who has contributed capital to the business,

and who owns the profits that have been made and retained and re-invested in the

business. The equity capital of a business can be thought of as an amount that the

business entity owes to its owners.

 Financial statements must not mix the assets and liabilities of the business with

the personal assets and liabilities of the individual owners. For example, the

money in a bank account for a business is an asset of the business, but money in

the personal bank account of the business owner is money belonging to the

owner.

 If an owner takes money from the business, for example by taking out some of

the profits in cash, the capital of the business is reduced. The business pays out

its cash to the owner. (The owner is not taking his personal cash, but the cash of

the business.)

 When an owner invests new money in a business, there is an increase in the

equity capital.

The separate entity concept has legal ‘reality’ in the case of companies. A company

by law is a legal person, separate from its owners (the shareholders). However, the

separate entity concept also applies to other businesses, such as sole trader

businesses and partnerships.

Chapter 2: Qualitative characteristics of financial information and the fundamental bases of accounting

A statement of financial position presents the assets of the business entity and also

its equity and liabilities. Equity represents the amount he entity ‘owes’ to its owners

and liabilities are the amounts it owes to others. The total assets that the entity

‘owns’ are equal to the total amount of equity plus liabilities that it ‘owes’.

2.2 The money measurement concept

The money measurement concept in financial reporting is that an item should not be

‘recognised’ and included in the financial statements unless it has a money value

that can be measured reliably and objectively.

For example land can be included in the financial statements because its value can

be measured objectively, either at its original cost or at its current market value

(which can be determined objectively from a professional valuation).

On the other hand, the value of a skilled and experienced employee is not included

in a statement of financial position, partly because the cost or value of an employee

to the business cannot be measured objectively.

2.3 The realisation concept

The realisation concept is that a transaction should not be ‘recognised’ ad included

in the financial statements until it has actually happened and has ‘been realised’. For

example, it is inappropriate to include the profit on a transaction in the financial

statements if the transaction has not happened yet, even if it will happen in the

future.

As a general rule, revenue from sales is not ‘recognised’ until the sale transaction

has been realised by the delivery of the goods or service to the customer. (The rules

on revenue recognition are a bit more complex, but this explanation is sufficient for

the purpose of the F3 examination.)

2.4 Underlying assumptions

The IASB Framework identifies two underlying assumptions that are used in the

preparation of the statement of financial position and the income statement or

statement of comprehensive income. These are:

 the accruals basis, and

 the going concern assumption.

2.5 Accruals basis (matching concept)

The accruals basis of preparing financial statements, which is also called the

‘matching concept’, is based on the following assumptions.

 The cost of sales in the income statement (or within profit and loss in the

statement of comprehensive income) must be matched with the sales. Sales

income and ‘matching’ expenses must be reported in the same financial period.

 Other expenses should be charged in the period to which they relate, not the

period in which they are paid for.

Paper F3: Financial accounting (International)

 Income, such as sales, should be reported in the period when the income arises.

This might not be the same as the period when the cash is received.

With the accruals basis, financial transactions and other events are recognised in the

financial statements when they occur, and not when the cash relating to the

transaction is received or paid.

Accruals basis and the income statement:

Sales income = income arising in the financial period X

Cost of sales = costs matched with sales arising in the period (X)

Gross profit X

Other costs = charged in the period (financial year) to which they relate (X)

Net profit X

Example 1: accruals basis

A company prepares its financial statements to the 30 June each year.

It sells goods for $50,000 to a customer on 6 June Year 2, but does not receive cash

payment from the customer until 15 August Year 2.

Applying the accruals concept, the sale is recognised as income in the year to 30 June

Year 2, even though the cash is not received until after the end of this financial year.

Example 2: accruals basis

A company starts in business on 1 September Year 1. It acquires an office for which

it pays one year’s rent in advance, to 30 August Year 2. The cost of the annual rental

is $120,000. The company prepares its financial statements for a financial period

ending on 31 December each year.

Applying the accruals concept, the expense for office rental cost in the period to 31

December Year 1 is the cost of just four months’ rent. The expense is therefore

$40,000 ($120,000 × 4/12) in Year 1, and there has been a prepayment for $80,000 that

relates to the next financial period, the year to 31 December Year 2.

Definitions

Prepayment. A prepayment is an amount of money paid in advance for which the

benefits have not yet been received. A prepayment in Year 1 of some expenses

relating to Year 2 should not be charged as an expense in Year 1, but should be

treated as an expense in Year 2.

Accrued expense or accrual. An accrual or accrued expense is an amount of money

that an entity owes but that has not yet been paid for. For example, a company

might rent office space at a cost of $600,000 per year from 1 July Year 1, with the

rental payable in 12 months in arrears on 30 June. If the company prepares its

financial statements to 31 December each year, it will not have made any payment

ACCA F3 (INT) Financial Accounting - 2010 - Study text - Emile Woolf Publishing

Подождите немного. Документ загружается.