Chapt 1 & 2 Presentation

Slide 1

MGT 220 Chapter 1 & 2

Slide 2

What is Financial Accounting for?

Accounting identifies, measures, and communicates financial information about economic entities to interested parties such as investors, creditors, unions and governmental agencies.

Slide 4

What Are the Forms of Financial Reporting?

• Major forms of financial reporting include:– the balance sheet– the income statement– the statement of cash flows– the statement of owners’ (or shareholders’) equity

• Other forms of financial reporting include:– annual report– prospectuses– government reporting– news releases– management forecasts

Slide 5

How does Information flow through the Financial Statements

Income Statement

Statement of Equity

Balance Sheet

Statement of Cash Flows

Reports Net Income

Ending balance reported

Change in cash as reported displays the change in cash position

Slide 7

Who Are the Stakeholders in Financial Reporting

• Definition: someone who prepares, relies on, reviews, audits or monitors financial information

• Includes both internal and external parties

• Key stakeholders include:– users of the financial information– both internal and external parties

Slide 8

Generally Accepted Accounting Principles (GAAP)

• The profession has developed GAAP, which present fairly, clearly and completely the financial operations of the enterprise

• GAAP consist of authoritative pronouncements issued by certain accounting bodies

• CICA Handbook is the foremost source for GAAP

Slide 9

The GAAP Hierarchy

Primary SourcePrimary SourceAccounting recommendations covered in the CICA Handbook

Secondary SourceSecondary SourcePrinciples generally accepted by a significant number of entities in Canada

Principles consistent with the CICA Handbook and are developed through professional judgement

Slide 11

What is a Conceptual Framework for Financial Reporting

• A coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function, and limits of financial accounting and financial statements

Slide 13

Conceptual Framework for Financial Reporting

Recognition and Measurement Recognition and Measurement ConceptsConcepts

3rd Level: Answers the ‘How’ Question

2nd Level: The ‘Bridge’

QualitativQualitativee

ElementsElements

ObjectivesObjectives

1st Level: Answers the ‘Why’ Question

Slide 14


Recognition and Measurement ConceptsRecognition and Measurement Concepts

QualitativeQualitative ElementsElements


AssumptionsAssumptionsEconomic EntityGoing concernMonetary unitPeriodicity

PrinciplesPrinciplesHistorical costRevenue recognitionMatchingFull disclosure

ConstraintsConstraintsUncertaintyCost-benefitMaterialityIndustry Practice

AssetsLiabilitiesEquity/Net AssetsRevenuesExpensesGains and Losses

Primary:-Relevance-ReliabilitySecondary:

-Comparability-Consistency

-useful in investment & credit decisions-useful in making resource allocation decisions-useful in assessing management stewardship

Slide 15

Conceptual Framework – Objectives (level 1)

To provide information:

• useful to investors, creditors and other users in making their resource allocation decisions

• useful in assessing management stewardship

• to individuals who reasonably understand business and economic activities.

Slide 17

Qualitative Characteristics (level 2)• Information is relevant if

it:– has predictive value– has feedback value– is timely

• Information is reliable if it:– is verifiable; independent

users can arrive at the same conclusion

– is representationally faithful; it represents (reports) what actually happened

– is neutral; is free from bias

• Information is comparable if it:– allows users to identify real

economic similarities and differences

• Information is consistent if:– similar events have the same

accounting treatment from period to period

– if the treatment changes, full disclosure is made

Slide 19

Basic Elements (level 2)

Balance SheetAssets: probable future economic benefit

Liabilities: probable future sacrifice of economic benefits

Equity/Net Assets: residual interest (Assets – Liabilities)

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Assets: Three essential characteristics

1. They embody a future benefit

2. The entity can control access to this benefit

3. The transaction or event giving the entity access to this benefit has occurred.

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Liabilities: Three essential characteristics

1. They embody a duty or responsibility

2. The entity has little or no discretion to avoid the duty

3. The transaction or event obligating the entity has occurred.

Slide 22

Basic Elements (level 2)

Income StatementRevenues: increases in economic resources

Expenses: decreases in economic resources

Gains: increases in equity

Losses: decreases in equity

Slide 23

What Is Comprehensive Income

• Is the sum of net income and all other changes in equity exclusive of owners’ investments and distributions.

• Example of other comprehensive income– Unrealized holding gains and losses on certain

securities

– Certain gains and losses related to foreign exchange instruments

– Gains and losses related to certain hedges

Slide 24

Economic Entity Assumption– The economic entity can be identified with a particular

unit of accountability– The business activity is separate and distinct from its

owners– The entity’s assets and other financial elements are not

commingled with those of the owners– The economic entity assumption is an accounting

concept, and not a legal construct– Departments or divisions of an entity may be

considered separate entities

Basic Assumptions (level 3)

Slide 25

Going Concern Assumption– The business is assumed to continue indefinitely unless

terminated by owners– Expectation of continuing long enough to meet their

objectives and commitments– The basis of recording financial elements is historical

accounting– If liquidation of the enterprise is assumed to occur, then

liquidation accounting is more appropriate– Liquidation accounting (net realizable value) is not followed

unless liquidation of the enterprise appears imminent


Slide 26

Monetary Unit– Money is the common unit of measure of economic

transactions

– Use of a monetary unit is relevant, and simple and understandable, universally available, and useful

– The dollar is assumed to remain relatively stable in value (effects of inflation/deflation are ignored

– Monetary unit is relevant only as long as it is assumed that quantitative data is the driving force behind users decision making


Slide 27

Periodicity (Time Period) Assumption– Economic activity of an entity may be artificially

divided into time periods for reporting purposes– Shorter time periods are subject to errors but

may be more timely• Trade-off between relevance and reliability


Slide 28

Historical Cost Principle– Three basic presumptions of historical cost

1. Represents a value at a point in time2. Results from a reciprocal exchange3. Exchange includes an outside party

– Assets and liabilities are recorded at acquisition price

– Financial information is reliable (a primary characteristic of information)

Basic Principles of Accounting (level 3)

Slide 29

Historical Cost Principle– Recording transactions at other than historical cost

results in a net income materially affected by opinion

– Trend towards a ‘mixed attribute’ system that reports historical cost, fair value, and lower of cost or market values.


Slide 30

Revenue Recognition Principle– Revenue is recognized when:

• Performance is achieved (earned)

• Measurability is reasonably certain

• Collectibility is reasonably assured (realized/realizable)

– Basic presumptions of revenue recognition• Results from a reciprocal exchange

• Exchange includes an outside party


Slide 31

Matching Principle• Expenses in one period are matched to revenues

recognized in the same period

• There should be a logical, rational association of revenues and expenses

• If the expense benefits the current and future periods, it is recorded as an asset

• This asset cost is then systematically and rationally matched to future revenues


Slide 32

Full Disclosure Principle• Financial statements must report any information that could

reasonably be seen to affect the judgement or decision of an informed user

• Disclosure may be made:– within the main body of the financial statements– as notes to those statements– as supplementary information

• Disclosed information should:– provide sufficient detail of the occurrence; and at the same time– be sufficiently brief enough to remain understandable

• Full disclosure should not be seen as a replacement for well-founded accounting practice


Slide 33

Management Discussion and Analysis (MD&A)

• Management’s explanation of the financial information and its significance

• Publicly traded corporations are now required to include MD&A in their annual reports

Slide 34


Six general principles1. Allows readers to view company through

management eyes2. Complement and supplement financial

statements3. Be reliable, complete, fair, and balanced4. Have a forward-looking perspective5. Focus on management’s strategy for

increasing investor value6. Be written in plain language

Slide 35


Five key elements to be included1. Company’s vision, core businesses, and

strategy

2. Key performance indicators

3. Resources (capabilities) to reach targets

4. Results

5. Outline of risks

Slide 36

• Uncertainty– Recognition becomes difficult (or impossible)

when there is uncertainty– Information reported is less likely to be

uncertain if:• Events reported are likely or probably, and

• They are measurable

– Measurement Uncertainty• Difference between the recognized amount and

another reasonably possible amount

Constraints (level 3)

Slide 37

Cost-Benefit Relationship

–The cost of providing information should not outweigh the benefit derived

–Costs and benefits are not always obvious or quantifiable

–Sound judgment must be used in providing information

Constraints (Level 3)

Slide 38

Constraints (level 3)Materiality• Refers to an item’s impact on a user’s decision

– An item must make a difference to be material and be disclosed

– It is a matter of the relative significance of the element

– Both quantitative and qualitative factors are to be considered in determining relative significance

• General rule of thumb: if the item is 5% or more of net income it is considered material

• Determination of materiality requires professional judgment and expertise

Slide 39

Industry Practices• The nature of some industries may sometimes

require departures from basic accounting theory

• If application of accounting theory results in statements that are not comparable or consistent, then industry practices must examined for possible explanations

Constraints (level 3)

Slide 40


Recognition and Measurement ConceptsRecognition and Measurement Concepts

QualitativeQualitative ElementsElements


AssumptionsAssumptionsEconomic EntityGoing concernMonetary unitPeriodicity

PrinciplesPrinciplesHistorical costRevenue recognitionMatchingFull disclosure

ConstraintsConstraintsUncertaintyCost-benefitMaterialityIndustry Practice

AssetsLiabilitiesEquity/Net AssetsRevenuesExpensesGains and Losses

Primary:-Relevance-ReliabilitySecondary:

-Comparability-Consistency

-useful in investment & credit decisions-useful in making resource allocation decisions-useful in assessing management stewardship

Slide 41

Financial Reporting Issue Identification

Recognition—should the element be recorded or not in the general ledger, e.g., revenue recognition or accrual of a liability?

Measurement—if recognized, how much should the element be recorded at; e.g., what is the value?

Presentation—where on the key financial statements should the item be shown, e.g., as debt or equity?

Disclosure—how much detail should be given in the financial reports? Any transactions or balances that affect key numbers or ratios by a material amount become important and significant.

Slide 42

Ethics are a crucial aspect of accounting

1. Accounting information can influence behaviour (decision making).

2. Accounting information needs to be fair and unbiased.

3. Because estimates and judgements are required and there are significant pressures that may tempt to sway these estimates and judgements into certain directions, accountants must always act ethically in doing their job. Without an ethical focus, the integrity of financial statement information would be nonexistent.

Slide 43

Recognizing and resolving ethical dilemmas

1. Recognise an ethical situation or ethical dilemma.2. Move toward an ethical resolution by identifying

and analysing the principal elements in the situation.

3. Identify the alternatives and weigh the impact of each alternative on various stakeholders.

4. Select the best or most ethical alternative considering all the circumstances and the consequences.

Documents

Chapt 1 & 2 Presentation