BA606 FINANCIAL ACCOUNTING

1. BA606 FINANCIAL ACCOUNTING Professor Garry Carnegie Lectures 3 and 4

2. Lectures 3 and 4: Fundamentals of general purpose financial reporting • Introduction • Qualitative characteristics of financial information • Elements of financial statements • Profit

3. Introduction • The fourth level of the conceptual framework deals with the “fundamentals” of financial reporting and comprises two parts • Qualitative characteristics of financial information • Elements of financial statements, especially the identification and definition of the elements that comprise the financial statements

4. Qualitative characteristics of financial statements • What qualities should exist in financial information in order for that information to be useful for economic decision making? • These qualities or “qualitative characteristics” are detailed and discussed in the “Framework for the Preparation and Presentation of Financial Statements” (the Framework) – paras. 24 to 46 of the Framework

5. Qualitative characteristics of financial statements • The four principal qualitative characteristics are as follows: • Understandability • Relevance • Reliability • Comparability

6. Qualitative characteristics of financial statements • Understandability: • Information is to be readily understandable to users • Users are assumed to be financially literate • Complex or detailed information should be included in financial statements because of its relevance to economic decision making

7. Qualitative characteristics of financial statements • Relevance: • To be useful, information must be relevant to the needs of decision makers • Feedback (or confirmatory) role (otherwise known as feedback value) • Predictive role (otherwise known as predictive value) • Materiality

8. Qualitative characteristics of financial statements • Reliability: • To be useful information must also be reliable • Information should be free from material error and bias • Faithful representation • Substance over form • Neutrality • Prudence • Completeness

9. Qualitative characteristics of financial statements • Comparability: • Users should be able to compare financial statements across time • Users should be able to compare the financial statements of different entities • Consistency in accounting policies and practices is desired in order to intra-firm and inter-firm comparability • Reporting corresponding information for preceding periods

10. Qualitative characteristics of financial statements • Balance between qualitative characteristics: • A balancing or trade-off between qualitative characteristics is often necessary, such as balancing relevance and reliability • Aim is to achieve an appropriate balance among the characteristics • The trade-off is a matter of professional judgement in the specific circumstances

11. Qualitative characteristics of financial statements • True and fair view/fair presentation: • “… the application of the principal qualitative characteristics and of appropriate accounting standards normally results in financial reports that convey what is generally understood as a true and fair view of, or as presenting fairly such information” (para. 46)

12. Elements of financial statements • Financial statements portray the effects of transactions and other events by grouping them into broad categories according to their economic characteristics – paras. 47 to 80 of the Framework • Balance sheet or statement of financial position (reflecting financial position): • Assets • Liabilities • Equity

13. Elements of financial statements • Income statement or profit and loss statement (reflecting financial performance): • Income [Revenue] • Expenses

14. Elements of financial statements • Definitions of the elements: • “An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity” [para. 49(a)]

15. Elements of financial statements • Characteristics of an asset: • Future economic benefits • Control by the entity • The result of a past event (i.e. a past transaction or other past event).

16. Elements of financial statements • Definitions of the elements: • “A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits” [para. 49(b)]

17. Elements of financial statements • Characteristics of a liability: • The existence of a present obligation to another entity • A future sacrifice of economic benefits • The result of a past event

18. Elements of financial statements • Definitions of the elements: • “Equity is the residual interest in the assets of the entity after deducting all its liabilities” [para. 49(c)]

19. Elements of financial statements • Definitions of the elements: • “Income [revenue] is 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” [para. 70(a)]

20. Elements of financial statements • Characteristics of income [revenue]: • It is a flow • That takes the form of an increase in assets or a decrease in liabilities • Results in an increase in equity

21. Elements of financial statements • Definitions of the elements: • “Expenses are 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” [para. 70(b)]

22. Elements of financial statements • Characteristics of expenses: • They are flows • That take the form of a decrease in assets or increases in liabilities • Result in a decrease in equity

23. Profit • Profit is a key measure of performance, as measured by the difference between income and expenses • Profit is a basis for other performance measures, such as return on assets/investment or earnings per share • Profit is derived after maintaining capital under an appropriate concept of capital • Concepts of capital – paras. 102 and 103 and also para. 81 of the Framework