Chapter 1 Notes

Financial Accounting and Reporting

Revision notes from the uploaded book and the previous questions

1) Objective of Financial Reporting / Financial Accounting

Objective: financial reporting gives information that is useful to investors, lenders, and other creditors when they
decide whether to provide resources to the reporting entity.
Financial reports include financial statements and other disclosures, so users can assess financial position,
performance, and cash flow.
Financial accounting rules matter because business transactions are complex, many items need judgment and
estimates, and standards reduce different answers for the same event.
Global capital flows and accounting scandals increased the demand for uniform, high-quality international
standards.
2) Conceptual Framework / Basic Principles / IFRS Framework
The IASB Conceptual Framework gives the ideas behind financial statements and guides standard setters,
preparers, auditors, and users.
Its central objective is to provide financial information that helps users make decisions about providing resources to
the entity.
Qualitative characteristics of financial reports

Characteristic Easy meaning

Relevance Information can affect a decision; it has predictive value,
confirmatory value, or both. Materiality is part of relevance
because important information can influence decisions.
Faithful representation Information should be complete, neutral, and free from error,
so it reflects the economic event as closely as possible.
Comparability Users can identify similarities and differences across time
and across companies.
Verifiability Different knowledgeable observers would reach similar
conclusions about the same information.
Timeliness Information is available before a decision is made.
Understandability Information is clear and concise for users with reasonable
business knowledge.
Constraints on financial reports

The main constraint is cost: the benefits from information should exceed the cost of providing and using it.
Not every useful item can be measured, so some information, such as workforce quality or customer loyalty, may
be left out of the statements.
Trade-offs are normal, because one enhancing characteristic may be given more weight than another in a specific
case.
The elements of financial statements

Element Simple meaning

Assets Present economic resources controlled by the entity because
of past events; they are what the company owns or controls.
Liabilities Present obligations to transfer economic resources because
of past events; they are what the company owes.
Equity Assets minus liabilities; it is the residual interest of owners.
Income Increases in assets or decreases in liabilities that increase
equity, except owner contributions; it includes revenue and
gains.
Expenses Decreases in assets or increases in liabilities that decrease
equity, except distributions to owners; it includes losses.
Underlying assumptions in financial statements
Accrual accounting means transactions are recorded when they happen, not only when cash moves, so related
revenues and expenses appear in the same period.
Going concern means the company is expected to continue in business for the foreseeable future, so assets are
measured on that basis unless liquidation is expected.
Recognition of financial statement elements

Recognition means an item is included in the balance sheet or income statement when it meets the definition of an
element and gives relevant, faithfully represented information.
Measurement of financial statement elements

Measurement basis Meaning

Historical cost Cash or cash equivalents paid to acquire an asset; for
liabilities, the amount received for the obligation.
Amortised cost Historical cost adjusted for amortisation, depreciation,
depletion, or impairment.
Current cost Amount needed today to buy the same or an equivalent
asset; for liabilities, the amount needed to settle today.
Realizable value / settlement value For assets, the cash that could be obtained by selling the
asset in an orderly disposal; for liabilities, the cash expected
to be paid to settle the obligation.
Present value Present value of future cash inflows for assets or future cash
outflows for liabilities, discounted at an appropriate rate.
Fair value Exit price: the price received to sell an asset or paid to
transfer a liability in an orderly market transaction at the
measurement date.
3) Accounting Standards Boards / Global Financial Markets / IFRS
Standard-setting bodies such as the IASB and FASB write the standards; regulatory authorities such as the SEC
enforce them in their jurisdictions.
The IASB works through the IFRS Foundation, which aims for one set of high-quality, transparent, comparable,
decision-useful standards and convergence of national standards with IFRS.
The FASB issues US GAAP through the Accounting Standards Codification, and the SEC officially recognizes US
GAAP while still keeping legal authority over reporting requirements.
Global financial markets need strong standards because investors compare companies across countries and need
consistent information.
IFRS and FASB in short

Body Main role Key point

IASB Sets IFRS Independent body under the IFRS
Foundation; standards become
authoritative when adopted by
regulators.
FASB Sets US GAAP Works through the Codification; SEC
recognizes it for US non-governmental
entities.
Regulators Enforce standards Can require reporting and may overrule
private standard setters in their
jurisdictions.
4) Qualitative Characteristics of Financial Reports
Relevance and faithful representation are the two fundamental qualities of useful financial information.
Comparability, verifiability, timeliness, and understandability are the four enhancing qualities that improve
usefulness.
Materiality belongs to relevance, because information is material when its omission or misstatement could influence
decisions.
Cost is the main constraint, so a good report balances usefulness against the cost of producing the information.
5) IFRS and US GAAP / Accounting Standards Comparison
 Point IFRS US GAAP
Style More principles-based More rules-based
Main board IASB FASB
Authority IFRS become authoritative when US GAAP is authoritative for non-
recognized by regulators governmental entities through the SEC
and FASB Codification
Framework role Conceptual framework is authoritative Conceptual framework is not
guidance authoritative
Global use Widely used in global markets Mainly used in the United States
Similarity: both systems aim to provide decision-useful financial information and rely on a conceptual framework.
Difference: IFRS gives more general guidance, while US GAAP gives more detailed rules.
The Elements of Financial Statements
Three elements describe financial position: assets, liabilities, and equity.
Two elements describe performance: income and expenses.
Major Financial Statements
Statement What it shows Exam meaning
Balance sheet / statement of financial Financial position at one point in time: Use the accounting equation: Assets =
position assets, liabilities, and equity. Liabilities + Equity.
Income statement / statement of Performance over a period: revenues, Revenue - Expenses = Net income.
comprehensive income expenses, profit or loss.
Statement of changes in equity Changes in each equity component Shows opening balance, additions,
during the period. deductions, and closing balance.
Cash flow statement Cash from operating, investing, and Shows liquidity, solvency, and financial
financing activities. flexibility.
A complete set of financial statements also includes notes, and public-company reports often add MD&A, auditor
reports, governance reports, and corporate responsibility reports.
The balance sheet gives a point-in-time picture, the income statement and cash flow statement show period
performance, and the statement of changes in equity explains movements in owners’ equity.
Key formulas
Item Formula or idea
Accounting equation Assets = Liabilities + Owners’ equity
Residual claim Assets - Liabilities = Owners’ equity
Income statement Revenue - Expenses = Net income
Statement of changes in equity Opening equity + comprehensive income + capital increases
- dividends = closing equity