LO.1 Describe the financial reporting environment and generally accepted accounting practice

Transcription

1 NOTES Module 1 LO.1 Describe the financial reporting environment and generally accepted accounting practice What is accounting? The purpose of accounting is: 1. To identify, record, and communicate the economic events of an: - Identification (relevance to business) - Records: History of financial activities systematic, chronological - Communication: Summarise information into useful form to interested users - Interpretation involves explaining the uses, meaning, and limitations of reported data. - Bookkeeping: Involves only the recording of economic events 2. To organisation: Are we talking about groups, sole traders, and partners? What does organisation mean? Interested Users Internal users: Human Resources Finance Management Marketing Internal users have greater access External users: Tax Authorities Customers Regulatory Agencies Labour Union Creditors Investors NZ Law: Financial Reporting Act ( FRA ) of 2013 (mainly external users) Which entities have to follow which law The Players: Who are the one preparing the rules International Accounting Standards Board (IASB): Prepare International Financial Reporting Standards (IFRS) - 15 members - Based in London - The number 1 player - Private entity IASB: - Researches topics/discussion Papers: Revise standards, create them etc. - After discussion papers -> DUE PROCESS (allow for comments)

2 - Then Exposure Draft (ED): Before a standard, like baby standard - Due Process - Standard Issued if 9 of 15 members approve NZ External Reporting Board (XRB): Governmental entity, auditing standards (The XRB and Financial Reporting Standards) - Create own independent standards for NZ derived from IASB standard, since different laws in NZ - IFRS adopt FIFO or AVCO, NZASB or XRB cannot change the standard in a way saying NZ wont adopt FIFO or AVCO - Edit loops: If IASB makes law regarding those, they must follow NZ Accounting Standards Board (NZASB/XRB): - Committee of XRB, have delegated authority from XRB to prepare FRS for NZ - Receive IASB standard - Submits standard to XRB for approval Under the FRA, only private sector, for profit entities that are publicly accountable or large must follow generally accepted accounting practice ( GAAP ) Publicly accountable: Debt/equity (shares/bonds) traded on exchange - 95% are not publically accountable or not large - Possible for businesses to not have public shares but still be public accountability Large (for NZ companies, not subsidiaries of international company): - X > $30 mill in revenue or X > $60 mill in assets - Lower threshold for international businesses Not publicly accountable OR large, legally required to prepare special reports, two tier GAAP regime: Tier 1: full IFRS for publicly accountable entities the Gold Standard. - If you re public ALWAYS TIER 1, even if you re small Tier 2: reduced disclosure IFRS for not publicly accountable yet large - Less rules -> lower costs - Unelected -> Tier 1 - Can t change IFRS, but can have less footnotes (reduced disclosure) NZASB decides how the disclosures work, then submit to XRB for final decision Gold Standard GAAP in NZ: - International financial reporting standards o IFRS + IAS: IAS -> IFRS (28 IAS, 15 IFRS and 3 FRS standards) o IASB interpretations of IFRS and IAS: Interpretation issued to solve problems GAAP: but what if there is no standard?

3 - Analogies: Nearest standard similar to your problem, look and apply the logic - NZ Framework for the Preparation and Presentation of Financial Statements (known as the Conceptual Framework ): A guidance for preparation for financial reporting GAAP compliance and fair presentation of financial statements (old name true and fair view) - Presumption: Follow GAAP -> Fair presentation - Not -> deviate from GAAP, MUST have footnotes. Rare - If GAAP didn t present a fair and true view, change but MUST disclose it LO.2 Discuss the Conceptual Framework s objective of financial reporting - Conceptual framework NOT standards, theoretical frameworks - Standard > Framework Objective of Financial Reporting: - General purpose financial reporting 1. Broad Summary

4 2. No specific users 3. Talks about financial statement - About the reporting entity 1. Doesn t have to be a legal entity: Sole trader & partnerships are not legal entities, group accounts also not legal entities 2. Report viewed from entity perspective 3. Owner and entity separate - Decision useful to primary users Decision usefulness 1. Predict about the future of the business 2. Storage shift of management Primary users 1. Investors (owners) 2. Creditors LO.3 Discuss the Conceptual Framework s qualitative characteristics of financial information RELEVANCE 1. Focus on external users 2. Relevance -> Predictions 3. Conformation: Confirm/reject previous ideas? 4. What should be disclosed & combined 5. Judgement involved (standards help) MATERIALITY 1. Aspect of relevance, how you APPLY relevance 2. Entity specific relevance: Large entity, materiality threshold = higher & vice versa 3. Material -> disclosed, avoid immaterial disclosures

5 o Combine items (e.g. other expense) 4. Insignificant asset -> expense FAITHFUL REPRESENTATION - Faithfully represent to disclose it? 3 criteria: 1. Complete E.g. PPE -> usually on face, but can be disclosed in footnotes 2. Neutral o E.g. Assets not overstated o E.g. Enron understated liabilities o Prudence: biased towards being conservative Might put back -> BUT now = put BEST value (not lower) 3. Free from error Estimates allowed <- best data available Steps: 1. Relevance 2. Faithful representation 3. 1 & 2 satisfied = decision useful -> steps below: COMPARABILITY: 1. Comparable -> more decision useful 2. 2 B.S & I.S next to each other (same business) 3. Across entity 4. Consistency -> comparability 5. Ideal but there are choices o E.g. FIFO, AVCO o Straight-line, diminishing value 6. Different standards for faithful representation VERIFIABILITY: 1. Verify -> more decision useful 2. Direct & Indirect: o Direct: Source documents o Indirect: Verify input -> output = correct Tell cost & Depn method -> correct N.B.V

6 TIMELINESS: - shorter time interval (instead of end) UNDERSTANDABILITY: - Decent business knowledge - E.g. Financial instrument (IFRS 9), many won t understand -> disclose and let reader find an expert LO.4 Discuss the Conceptual Framework s definitions and recognition criteria for financial statement elements An asset is recognised on the BS of an entity if: 1. Because of a past event 2. The entity controls a resource o Keep others from using it 3. Provide probable (more likely than not, 51%) future economic benefit o Distinguish expense & asset: Expenses not related to future periods o MUST be benefit BEYOND B.S date 4. That can be measured reliably o 1,2,3 met 4th usually met (find a way) o Can use fair value A liability is recognised on the BS of an entity if: (Result of past event) 1. Obligating event causes present obligation o Can t get out of paying o Present obligation covers both current & non-current obligation o Future obligation: The business can get out of 2. Settlement probably will result in an outflow of resources 3. That can be measured reliably Equity: The owner's claim to (or the residual interest in) the assets of the entity after deducting all its liabilities - Defined as: o Residual interest in A AFTER deducting L - Dependent on measurement of A & L o Correct A & L -> Correct E o Right amount =/= fair representation (exclude internal goodwill)

7 Income: Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants - Income is recognised if, during the period, o Increase in economic benefits: Increase A or Decrease L o E increase (apart from owner s contribution) o ALL income will increase equity one way or another - Amount dependent on measurement of A & L o Residual framework Expenses: Decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants - Decrease in economic benefits: Decrease A or Increase L - E decrease not from profit distribution - Amount dependent on measurement of A & L o Some expenses do not decrease profit but will reduce equity LO.5 Discuss the Conceptual Framework s assumptions and measurement bases Going Concern: The assumption is that the business will carry on into the near distant future it won t go out of business - Written ONLY EXPLICIT ASSUMPTION - Don t show liquidation - Going concern not assumed -> all CF & standards not considered Periodicity: The businesses live can be cut up into distinct periods - Implicit assumption - Backs up timeliness Accrual accounting: No longer explicit and not necessary implicit NZ IAS 1, paragraphs 27 & 28: An entity shall prepare its financial statements using the accrual basis of accounting When the accrual basis of accounting is used, an entity recognizes items as A, L, E, income & expenses when they satisfy the criteria for those elements in the NZ framework - Following definition of A, L, etc., don t need it as we are applying accruals CF doesn t prefer any of the 3 following measurement bases