Intermediate Accounting: IFRS Edition, 3rd Edition Class Notes
Master key topics with Intermediate Accounting: IFRS Edition, 3rd Edition Class Notes, your perfect class companion.
Madison Taylor
Contributor
4.3
62
about 2 months ago
Preview (31 of 319)
Sign in to access the full document!
CHAPTER 1
Financial Reporting and Accounting
Standards
LEARNING OBJECTIVES
1. Describe the growing importance of global financial markets and its relation to
financial reporting.
2. Identify the major financial statements and other means of financial reporting.
3. Explain how accounting assists in the efficient use of scarce resources.
4. Explain the need for high-quality standards.
5. Identify the objective of financial reporting.
6. Identify the major policy-setting bodies and their role in the standard-setting
process.
7. Explain the meaning of IFRS.
8. Describe the challenges facing financial reporting.
Financial Reporting and Accounting
Standards
LEARNING OBJECTIVES
1. Describe the growing importance of global financial markets and its relation to
financial reporting.
2. Identify the major financial statements and other means of financial reporting.
3. Explain how accounting assists in the efficient use of scarce resources.
4. Explain the need for high-quality standards.
5. Identify the objective of financial reporting.
6. Identify the major policy-setting bodies and their role in the standard-setting
process.
7. Explain the meaning of IFRS.
8. Describe the challenges facing financial reporting.
CHAPTER 1
Financial Reporting and Accounting
Standards
LEARNING OBJECTIVES
1. Describe the growing importance of global financial markets and its relation to
financial reporting.
2. Identify the major financial statements and other means of financial reporting.
3. Explain how accounting assists in the efficient use of scarce resources.
4. Explain the need for high-quality standards.
5. Identify the objective of financial reporting.
6. Identify the major policy-setting bodies and their role in the standard-setting
process.
7. Explain the meaning of IFRS.
8. Describe the challenges facing financial reporting.
Financial Reporting and Accounting
Standards
LEARNING OBJECTIVES
1. Describe the growing importance of global financial markets and its relation to
financial reporting.
2. Identify the major financial statements and other means of financial reporting.
3. Explain how accounting assists in the efficient use of scarce resources.
4. Explain the need for high-quality standards.
5. Identify the objective of financial reporting.
6. Identify the major policy-setting bodies and their role in the standard-setting
process.
7. Explain the meaning of IFRS.
8. Describe the challenges facing financial reporting.
CHAPTER REVIEW
1. Chapter 1 describes the environment that has influenced both the development and use
of the financial accounting process. The chapter traces the development of financial
accounting standards, focusing on the groups that have had or currently have the
responsibility for developing such standards. Certain groups other than those with direct
responsibility for developing financial accounting standards have significantly influenced the
standard-setting process. These various pressure groups are also discussed in Chapter 1.
Global Markets
2. (L.O. 1) World markets are becoming increasingly intertwined. And, due to technological
advances and less onerous regulatory requirements, investors are able to engage in
financial transactions across national borders, and to make investment, capital allocation,
and financing decisions involving many foreign companies. As a result, an increasing
number of investors are holding securities of foreign companies, and a significant number
of foreign companies are found on national exchanges. The move toward adoption of
international financial reporting standards has and will continue to facilitate this movement.
3. (L.O. 2) Financial accounting is the process that culminates in the preparation of
financial reports on the enterprise for use by both internal and external parties.
4. Financial statements are the principal means through which a company communicates
its financial information to those outside it. The financial statements most frequently
provided are (1) the statement of financial position, (2) the income statement or statement
of comprehensive income, (3) the statement of cash flows, and (4) the statement of
changes in equity. Note disclosures are an integral part of each financial statement. Other
means of financial reporting include the president’s letter or supplementary schedules in
the corporate annual report, prospectuses, and reports filed with government agencies.
5. (L.O. 3) Accounting is important for markets, free enterprise, and competition because it
assists in providing information that leads to capital allocation. Reliable information leads
to a better, more effective process of capital allocation, which in turn is critical to a
healthier economy.
6. (L.O. 4) To facilitate efficient capital allocation, investors need relevant information and a
faithful representation of that information to enable them to make comparisons across
borders. A single, widely accepted set of high-quality accounting standards is a necessity
to ensure adequate comparability. In order to achieve this goal the following element
must be present:
a. A single set of high-quality accounting standards established by a single standard-
setting body.
b. Consistency in application and interpretation.
c. Common disclosures.
1. Chapter 1 describes the environment that has influenced both the development and use
of the financial accounting process. The chapter traces the development of financial
accounting standards, focusing on the groups that have had or currently have the
responsibility for developing such standards. Certain groups other than those with direct
responsibility for developing financial accounting standards have significantly influenced the
standard-setting process. These various pressure groups are also discussed in Chapter 1.
Global Markets
2. (L.O. 1) World markets are becoming increasingly intertwined. And, due to technological
advances and less onerous regulatory requirements, investors are able to engage in
financial transactions across national borders, and to make investment, capital allocation,
and financing decisions involving many foreign companies. As a result, an increasing
number of investors are holding securities of foreign companies, and a significant number
of foreign companies are found on national exchanges. The move toward adoption of
international financial reporting standards has and will continue to facilitate this movement.
3. (L.O. 2) Financial accounting is the process that culminates in the preparation of
financial reports on the enterprise for use by both internal and external parties.
4. Financial statements are the principal means through which a company communicates
its financial information to those outside it. The financial statements most frequently
provided are (1) the statement of financial position, (2) the income statement or statement
of comprehensive income, (3) the statement of cash flows, and (4) the statement of
changes in equity. Note disclosures are an integral part of each financial statement. Other
means of financial reporting include the president’s letter or supplementary schedules in
the corporate annual report, prospectuses, and reports filed with government agencies.
5. (L.O. 3) Accounting is important for markets, free enterprise, and competition because it
assists in providing information that leads to capital allocation. Reliable information leads
to a better, more effective process of capital allocation, which in turn is critical to a
healthier economy.
6. (L.O. 4) To facilitate efficient capital allocation, investors need relevant information and a
faithful representation of that information to enable them to make comparisons across
borders. A single, widely accepted set of high-quality accounting standards is a necessity
to ensure adequate comparability. In order to achieve this goal the following element
must be present:
a. A single set of high-quality accounting standards established by a single standard-
setting body.
b. Consistency in application and interpretation.
c. Common disclosures.
d. Common high-quality auditing standards and practices.
e. A common approach to regulatory review and enforcement.
f. Education and training of market participants.
g. Common delivery systems (e.g., eXtensible Business Reporting Language—XBRL).
h. A common approach to corporate governance and legal frameworks around the world.
7. The major standard-setters of the world, coupled with regulatory authorities, now
recognize that capital formation and investor understanding is enhanced if a single set of
high-quality accounting standards is developed.
Objective of Financial Reporting
8. (L.O. 5) The objective of general-purpose financial reporting is to provide financial
information about the reporting entity that is useful to present and potential equity
investors, lenders, and other creditors in making decisions about providing resources to
the entity.
a. General-purpose financial statements provide at the least cost the most useful
information possible to a wide variety of users.
b. Equity investors and creditors are the primary user groups and have the most
critical and immediate needs for information in the financial statements. Investors and
creditors need this information to assess a company’s ability to generate net cash
inflows and to understand management’s ability to protect and enhance the assets of
a company.
c. The entity perspective means that the company is viewed as being separate and
distinct from its investors (both shareholders and creditors). Therefore, the assets of
the company belong to the company, not a specific creditor or shareholder. Financial
reporting focused only on the needs of the shareholder—the proprietary
perspective—is not considered appropriate.
d. Decision-usefulness means that information contained in the financial statements
should help investors assess the amounts, timing, and uncertainty of prospective cash
inflows from dividends or interest, and the proceeds from the sale, redemption, or
maturity of securities or loans. In order for investors to make these assessments, the
financial statements and related explanations must provide information about the
company’s economic resources, the claims to those resources, and the changes in
them.
9. Information generated using the accrual basis of accounting provides a better indication
of a company’s present and continuing ability to generate favorable cash flows than the
cash basis.
e. A common approach to regulatory review and enforcement.
f. Education and training of market participants.
g. Common delivery systems (e.g., eXtensible Business Reporting Language—XBRL).
h. A common approach to corporate governance and legal frameworks around the world.
7. The major standard-setters of the world, coupled with regulatory authorities, now
recognize that capital formation and investor understanding is enhanced if a single set of
high-quality accounting standards is developed.
Objective of Financial Reporting
8. (L.O. 5) The objective of general-purpose financial reporting is to provide financial
information about the reporting entity that is useful to present and potential equity
investors, lenders, and other creditors in making decisions about providing resources to
the entity.
a. General-purpose financial statements provide at the least cost the most useful
information possible to a wide variety of users.
b. Equity investors and creditors are the primary user groups and have the most
critical and immediate needs for information in the financial statements. Investors and
creditors need this information to assess a company’s ability to generate net cash
inflows and to understand management’s ability to protect and enhance the assets of
a company.
c. The entity perspective means that the company is viewed as being separate and
distinct from its investors (both shareholders and creditors). Therefore, the assets of
the company belong to the company, not a specific creditor or shareholder. Financial
reporting focused only on the needs of the shareholder—the proprietary
perspective—is not considered appropriate.
d. Decision-usefulness means that information contained in the financial statements
should help investors assess the amounts, timing, and uncertainty of prospective cash
inflows from dividends or interest, and the proceeds from the sale, redemption, or
maturity of securities or loans. In order for investors to make these assessments, the
financial statements and related explanations must provide information about the
company’s economic resources, the claims to those resources, and the changes in
them.
9. Information generated using the accrual basis of accounting provides a better indication
of a company’s present and continuing ability to generate favorable cash flows than the
cash basis.
Loading page 4...
Standard-Setting Organizations
10. (L.O. 6) The main international standard setting organization is the International
Accounting Standards Board (IASB), based in London, United Kingdom. The IASB
issues International Financial Reporting Standards (IFRS) which are used by most
foreign exchanges.
11. The two organizations that have a role in international standard-setting are the
International Organization of Securities Commissions (IOSCO) and the IASB. (A
detailed discussion of the U.S system is provided at the book’s companion website)
a. The IOSCO does not set accounting standards; it is dedicated to ensuring that the
global markets can operate in an efficient and effective basis.
b. The member agencies have agreed to:
(1) Cooperate together to promote high standards of regulation in order to maintain
just, efficient, and sound markets.
(2) Exchange information on their respective experiences in order to promote the
development of domestic markets.
(3) Unite their efforts to establish standards and an effective surveillance of
international securities transactions.
(4) Provide mutual assistance to promote the integrity of the markets by a rigorous
application of the standards and by effective enforcement against offenses.
12. IOSCO recommends that its members allow multinational issuers to use IFRS in cross-
folder offerings and listings, as supplemented by reconciliation, disclosure, and
interpretation where necessary, to address outstanding substantive issues at a national or
regional level.
13. The international standard-setting structure is composed of the following four
organizations:
a. The IFRS foundation (22 trustees) provides oversight to the IASB, IFRS Advisory
Council, and IFRS Interpretations Committee. It appoints members, reviews
effectiveness, and helps in fundraising efforts for these organizations.
b. The International Accounting Standards Board (IASB) consisting of 13 members,
develops in the public interest, a single set of high-quality, enforceable, and global
international financial reporting standards for general-purpose financial statements.
c. The IFRS Advisory Council (40 or more members) provides advice and council to
the IASB on major policies and technical issues.
d. The IFRS Interpretations Committee (14 members) assists the IASB through the
timely identification, discussion, and resolution of financial reporting issues within the
framework of IFRS.
14. In addition, as part of the governance structure, a Monitoring Board was created. It
establishes a link between accounting standard-setters and those public authorities that
generally oversee them (e.g. IOSCO). It also provides political legitimacy to the overall
organization.
10. (L.O. 6) The main international standard setting organization is the International
Accounting Standards Board (IASB), based in London, United Kingdom. The IASB
issues International Financial Reporting Standards (IFRS) which are used by most
foreign exchanges.
11. The two organizations that have a role in international standard-setting are the
International Organization of Securities Commissions (IOSCO) and the IASB. (A
detailed discussion of the U.S system is provided at the book’s companion website)
a. The IOSCO does not set accounting standards; it is dedicated to ensuring that the
global markets can operate in an efficient and effective basis.
b. The member agencies have agreed to:
(1) Cooperate together to promote high standards of regulation in order to maintain
just, efficient, and sound markets.
(2) Exchange information on their respective experiences in order to promote the
development of domestic markets.
(3) Unite their efforts to establish standards and an effective surveillance of
international securities transactions.
(4) Provide mutual assistance to promote the integrity of the markets by a rigorous
application of the standards and by effective enforcement against offenses.
12. IOSCO recommends that its members allow multinational issuers to use IFRS in cross-
folder offerings and listings, as supplemented by reconciliation, disclosure, and
interpretation where necessary, to address outstanding substantive issues at a national or
regional level.
13. The international standard-setting structure is composed of the following four
organizations:
a. The IFRS foundation (22 trustees) provides oversight to the IASB, IFRS Advisory
Council, and IFRS Interpretations Committee. It appoints members, reviews
effectiveness, and helps in fundraising efforts for these organizations.
b. The International Accounting Standards Board (IASB) consisting of 13 members,
develops in the public interest, a single set of high-quality, enforceable, and global
international financial reporting standards for general-purpose financial statements.
c. The IFRS Advisory Council (40 or more members) provides advice and council to
the IASB on major policies and technical issues.
d. The IFRS Interpretations Committee (14 members) assists the IASB through the
timely identification, discussion, and resolution of financial reporting issues within the
framework of IFRS.
14. In addition, as part of the governance structure, a Monitoring Board was created. It
establishes a link between accounting standard-setters and those public authorities that
generally oversee them (e.g. IOSCO). It also provides political legitimacy to the overall
organization.
Loading page 5...
15. The IASB has a thorough, open and transparent due process in establishing financial
accounting standards. It consists of the following elements:
a. An independent standard-setting board overseen by geographically and professionally
diverse body of trustees.
b. A thorough and systematic process for developing standards.
c. Engagement with investors, regulators, business leaders, and the global accountancy
profession at every stage of the process.
d. Collaborative efforts with the worldwide standard-setting community.
16. To implement its due process, the IASB follows specific steps to develop a typical IFRS.
a. Topics are identified and placed on the Board’s agenda.
b. Research and analysis is conducted and preliminary views of pros and cons are
issued.
c. Public hearings are held on the proposed standard.
d. The Board evaluates research and public responses and issues an exposure draft.
e. The Board evaluates the responses and changes the exposure draft, if necessary.
Then the final standard is issued.
17. The following characteristics of the IASB are meant to reinforce the importance of an
open, transparent, and independent due process.
a. Membership: The Board consists of 13 well-paid members, from different countries,
serving 5-year renewable terms.
b. Autonomy: The IASB is not part of any professional organization. It is appointed by
and answerable only to the IFRS Foundation.
c. Independence: Full-time IASB members must sever all ties with their former
employer. Members are selected for their expertise in standard-setting rather than to
represent a given country.
d. Voting: Nine of 16 votes are needed to issue a new IFRS.
18. The IASB issues three major types of pronouncements.
a. International Financial Reporting Standards: To date the IASB has issued 17
standards. In addition, the previous international standard-setting body, the
International Accounting Standards Committee (IASC) issued 41 International
Accounting Standards (IAS). Those that have not been amended or superseded are
considered under the umbrella of IFRS.
b. Conceptual Framework for Financial Reporting: The IASB issued the Framework
for the Preparation and Presentation of Financial Statements (referred to as the
Framework) with the intent to create a conceptual framework that would serve as a
tool for solving existing and emerging problems in a consistent manner. However, the
accounting standards. It consists of the following elements:
a. An independent standard-setting board overseen by geographically and professionally
diverse body of trustees.
b. A thorough and systematic process for developing standards.
c. Engagement with investors, regulators, business leaders, and the global accountancy
profession at every stage of the process.
d. Collaborative efforts with the worldwide standard-setting community.
16. To implement its due process, the IASB follows specific steps to develop a typical IFRS.
a. Topics are identified and placed on the Board’s agenda.
b. Research and analysis is conducted and preliminary views of pros and cons are
issued.
c. Public hearings are held on the proposed standard.
d. The Board evaluates research and public responses and issues an exposure draft.
e. The Board evaluates the responses and changes the exposure draft, if necessary.
Then the final standard is issued.
17. The following characteristics of the IASB are meant to reinforce the importance of an
open, transparent, and independent due process.
a. Membership: The Board consists of 13 well-paid members, from different countries,
serving 5-year renewable terms.
b. Autonomy: The IASB is not part of any professional organization. It is appointed by
and answerable only to the IFRS Foundation.
c. Independence: Full-time IASB members must sever all ties with their former
employer. Members are selected for their expertise in standard-setting rather than to
represent a given country.
d. Voting: Nine of 16 votes are needed to issue a new IFRS.
18. The IASB issues three major types of pronouncements.
a. International Financial Reporting Standards: To date the IASB has issued 17
standards. In addition, the previous international standard-setting body, the
International Accounting Standards Committee (IASC) issued 41 International
Accounting Standards (IAS). Those that have not been amended or superseded are
considered under the umbrella of IFRS.
b. Conceptual Framework for Financial Reporting: The IASB issued the Framework
for the Preparation and Presentation of Financial Statements (referred to as the
Framework) with the intent to create a conceptual framework that would serve as a
tool for solving existing and emerging problems in a consistent manner. However, the
Loading page 6...
Framework is not an IFRS and does not define standards for any particular
measurement or disclosure issue. Nothing in the Framework overrides any specific
IFRS.
c. International Financial Reporting Interpretations: Interpretations are issued by the
IFRS Interpretations Committee and are considered authoritative and must be
followed. Over twenty have been issued to date. These interpretations cover (1) newly
identified financial reporting issues not specifically dealt with in IFRS, and (2) issues
where unsatisfactory or conflicting interpretations have developed, or seem likely to
develop, in the absence of authoritative guidance.
19. (L.O. 7) The IASB has no regulatory mandate and no enforcement mechanism. It relies
on other regulators to enforce the use of its standards. For example, the European Union
requires publicly traded member country companies to use IFRS. Any company indicating
that it prepares its financial statements in conformity with IFRS must use all of the
standards and interpretations. The hierarchy of authoritative pronouncements is: IFRS, IAS,
Interpretations issued by either the IFRS Interpretation Committee or its predecessor the
IAS Interpretations Committee, the Conceptual Framework for Financial Reporting, and
pronouncements of other standard-setting bodies that use a similar conceptual framework
to develop accounting standards (e.g., U.S. GAAP).
Financial Reporting Challenges
20. (L.O. 8) Although IFRS are developed by using sound research and a conceptual
framework that has its foundation in economic reality, a certain amount of pressure and
influence is brought to bear by groups interested in or affected by IFRS. The IASB does
not exist in a vacuum, and politics and special-interest pressure remain a part of the
standard-setting process.
21 The expectations gap is the difference between what the public thinks accountants
should do and what accountants think they can do. It has been highlighted by the many
accounting scandals that have occurred. In order to meet the needs of society with highly
transparent, clean, and reliable systems, considerable costs will be incurred.
22. The significant financial reporting challenges facing the accounting profession are:
a. Non-financial measurements such as customer satisfaction indexes, backlog infor-
mation, and reject rates on goods purchased.
b. Forward-looking information.
c. Soft assets (intangibles).
d. Timeliness.
measurement or disclosure issue. Nothing in the Framework overrides any specific
IFRS.
c. International Financial Reporting Interpretations: Interpretations are issued by the
IFRS Interpretations Committee and are considered authoritative and must be
followed. Over twenty have been issued to date. These interpretations cover (1) newly
identified financial reporting issues not specifically dealt with in IFRS, and (2) issues
where unsatisfactory or conflicting interpretations have developed, or seem likely to
develop, in the absence of authoritative guidance.
19. (L.O. 7) The IASB has no regulatory mandate and no enforcement mechanism. It relies
on other regulators to enforce the use of its standards. For example, the European Union
requires publicly traded member country companies to use IFRS. Any company indicating
that it prepares its financial statements in conformity with IFRS must use all of the
standards and interpretations. The hierarchy of authoritative pronouncements is: IFRS, IAS,
Interpretations issued by either the IFRS Interpretation Committee or its predecessor the
IAS Interpretations Committee, the Conceptual Framework for Financial Reporting, and
pronouncements of other standard-setting bodies that use a similar conceptual framework
to develop accounting standards (e.g., U.S. GAAP).
Financial Reporting Challenges
20. (L.O. 8) Although IFRS are developed by using sound research and a conceptual
framework that has its foundation in economic reality, a certain amount of pressure and
influence is brought to bear by groups interested in or affected by IFRS. The IASB does
not exist in a vacuum, and politics and special-interest pressure remain a part of the
standard-setting process.
21 The expectations gap is the difference between what the public thinks accountants
should do and what accountants think they can do. It has been highlighted by the many
accounting scandals that have occurred. In order to meet the needs of society with highly
transparent, clean, and reliable systems, considerable costs will be incurred.
22. The significant financial reporting challenges facing the accounting profession are:
a. Non-financial measurements such as customer satisfaction indexes, backlog infor-
mation, and reject rates on goods purchased.
b. Forward-looking information.
c. Soft assets (intangibles).
d. Timeliness.
Loading page 7...
23. In accounting, ethical dilemmas are encountered frequently. The whole process of ethical
sensitivity and selection among alternatives can be complicated by pressures that may
take the form of time pressure, job pressures, client pressures, personal pressures, and
peer pressures. And, there is no comprehensive ethical system to provide guidelines.
24. Convergence to a single set of high-quality global financial reporting standards is a real
possibility. For example, the IASB and the FASB (of the United States) have spent the
last 16 years working to converge their standards.
25. In addition, U.S. and European regulators have agreed to recognize each other’s standards
for listing on the various world securities exchanges. As a result, costly reconciliation re-
quirements have been eliminated and hopefully will lead to greater comparability and
transparency.
sensitivity and selection among alternatives can be complicated by pressures that may
take the form of time pressure, job pressures, client pressures, personal pressures, and
peer pressures. And, there is no comprehensive ethical system to provide guidelines.
24. Convergence to a single set of high-quality global financial reporting standards is a real
possibility. For example, the IASB and the FASB (of the United States) have spent the
last 16 years working to converge their standards.
25. In addition, U.S. and European regulators have agreed to recognize each other’s standards
for listing on the various world securities exchanges. As a result, costly reconciliation re-
quirements have been eliminated and hopefully will lead to greater comparability and
transparency.
Loading page 8...
LECTURE OUTLINE
The material in this chapter usually can be covered in one on two class sessions, depending
on whether the chapter appendix is discussed.
A. (L.O. 1) Global Markets and IFRS.
1. World markets are becoming more intertwined.
2. An increasing number of investors are holding securities in foreign companies.
3. An increasing number of foreign companies are found on national exchanges.
4. Companies have expanded choices of where to raise capital through debt or equity.
5. The move toward adoption of international financial reporting standards has and will
continue to facilitate this movement.
B. (L.O. 2) What are the major financial statements and other means of financial reporting?
Identification, measurement, and communication of financial information (discuss
difference between financial statements and financial reporting).
a. Financial statements:
(1) Income statement or statement of comprehensive income.
(2) Statement of financial position.
(3) Statement of cash flows.
(4) Statement of changes in equity.
(5) Note disclosures.
b. Financial reporting:
(1) President’s letter or supplementary schedules in the annual report.
(2) Prospectuses.
(3) Reports filed with government agencies.
(4) News releases and management forecasts.
(5) Social or environmental impact statements.
The material in this chapter usually can be covered in one on two class sessions, depending
on whether the chapter appendix is discussed.
A. (L.O. 1) Global Markets and IFRS.
1. World markets are becoming more intertwined.
2. An increasing number of investors are holding securities in foreign companies.
3. An increasing number of foreign companies are found on national exchanges.
4. Companies have expanded choices of where to raise capital through debt or equity.
5. The move toward adoption of international financial reporting standards has and will
continue to facilitate this movement.
B. (L.O. 2) What are the major financial statements and other means of financial reporting?
Identification, measurement, and communication of financial information (discuss
difference between financial statements and financial reporting).
a. Financial statements:
(1) Income statement or statement of comprehensive income.
(2) Statement of financial position.
(3) Statement of cash flows.
(4) Statement of changes in equity.
(5) Note disclosures.
b. Financial reporting:
(1) President’s letter or supplementary schedules in the annual report.
(2) Prospectuses.
(3) Reports filed with government agencies.
(4) News releases and management forecasts.
(5) Social or environmental impact statements.
Loading page 9...
C. (L.O. 3) How does accounting assist in the allocation of scarce resource?
1. A world of scarce resources. Accounting helps to identify efficient and inefficient users
of resources.
2. Capital allocation. Accounting assists in the effective capital allocation process by
providing financial reports to interested users.
3. Changing user needs. Accounting will continue to be faced with challenges to providing
information needed for an efficient capital allocation process.
D. (L.O. 4) Why the need for high-quality standards?
1. To facilitate efficient capital allocation.
2. In order to ensure adequate comparability across borders, a single, widely accepted
set of high-quality accounting standards is a necessity.
3. Identify the elements involved:
a. A single set of high-quality accounting standards established by a single standard-
setting body.
b. Consistency in application and interpretation.
c. Common disclosures.
d. Common high-quality auditing standards and practices.
e. Common approach to regulatory review and enforcement.
f. Education and training of market participants.
g. Common delivery systems.
h. Common approach to corporate governance and legal frameworks around the world.
4. Major standard-setters and regulatory authorities around the world recognize that
capital formation and investor understanding will be enhanced by a single set of high-
quality accounting standards.
E. (L.O. 5) Define the objective of financial reporting.
1. To provide financial information about the reporting entity that is useful to present and
potential equity investors, lenders, and other creditors in making decisions about
providing resources to the entity.
1. A world of scarce resources. Accounting helps to identify efficient and inefficient users
of resources.
2. Capital allocation. Accounting assists in the effective capital allocation process by
providing financial reports to interested users.
3. Changing user needs. Accounting will continue to be faced with challenges to providing
information needed for an efficient capital allocation process.
D. (L.O. 4) Why the need for high-quality standards?
1. To facilitate efficient capital allocation.
2. In order to ensure adequate comparability across borders, a single, widely accepted
set of high-quality accounting standards is a necessity.
3. Identify the elements involved:
a. A single set of high-quality accounting standards established by a single standard-
setting body.
b. Consistency in application and interpretation.
c. Common disclosures.
d. Common high-quality auditing standards and practices.
e. Common approach to regulatory review and enforcement.
f. Education and training of market participants.
g. Common delivery systems.
h. Common approach to corporate governance and legal frameworks around the world.
4. Major standard-setters and regulatory authorities around the world recognize that
capital formation and investor understanding will be enhanced by a single set of high-
quality accounting standards.
E. (L.O. 5) Define the objective of financial reporting.
1. To provide financial information about the reporting entity that is useful to present and
potential equity investors, lenders, and other creditors in making decisions about
providing resources to the entity.
Loading page 10...
2. Describe the elements of the objective:
a. General-Purpose Financial Statements: provide the most useful information
possible to a wide variety of users for the least cost.
b. Equity Investors and Creditors: are the primary user group and have the most
critical and immediate need for information in financial reports, in order to:
(1) Assess an entity’s ability to generate net cash inflows, and
(2) Understand management’s ability to protect and enhance the assets of the
entity.
c. Entity Perspective: companies are viewed as separate and distinct from both
their shareholders and creditors.
(1) The assets of the entity are viewed as belonging to the entity, not any specific
creditor or shareholder.
(2) The proprietary perspective, which focuses solely on the needs of the
shareholders is not appropriate.
e. Decision-Usefulness: information contained in the financial statements should
be useful to investors in order to:
(1) Assess the amounts, timing, and uncertainty of prospective cash inflows from
dividends or interest, and
(2) The proceeds from the sale, redemption, or maturity of securities or loans.
(3) The accrual basis of accounting provides more useful information than the
cash basis.
F. (L.O. 6) Identify the major standard-setting bodies and their roles in the standard-setting
process.
1. International Organization of Securities Commissions (IOSCO):
(a) Does not set accounting standards.
(b) Dedicated to ensuring that global markets operate in an efficient and effective
basis.
(c) Regulates the world’s securities and futures markets.
(d) Supports development and use of IFRS as a set of high-quality international
standards in cross-border offerings and listings.
a. General-Purpose Financial Statements: provide the most useful information
possible to a wide variety of users for the least cost.
b. Equity Investors and Creditors: are the primary user group and have the most
critical and immediate need for information in financial reports, in order to:
(1) Assess an entity’s ability to generate net cash inflows, and
(2) Understand management’s ability to protect and enhance the assets of the
entity.
c. Entity Perspective: companies are viewed as separate and distinct from both
their shareholders and creditors.
(1) The assets of the entity are viewed as belonging to the entity, not any specific
creditor or shareholder.
(2) The proprietary perspective, which focuses solely on the needs of the
shareholders is not appropriate.
e. Decision-Usefulness: information contained in the financial statements should
be useful to investors in order to:
(1) Assess the amounts, timing, and uncertainty of prospective cash inflows from
dividends or interest, and
(2) The proceeds from the sale, redemption, or maturity of securities or loans.
(3) The accrual basis of accounting provides more useful information than the
cash basis.
F. (L.O. 6) Identify the major standard-setting bodies and their roles in the standard-setting
process.
1. International Organization of Securities Commissions (IOSCO):
(a) Does not set accounting standards.
(b) Dedicated to ensuring that global markets operate in an efficient and effective
basis.
(c) Regulates the world’s securities and futures markets.
(d) Supports development and use of IFRS as a set of high-quality international
standards in cross-border offerings and listings.
Loading page 11...
2. International standard-setting structure.
a. International Financial Reporting Standards Foundation (IFRS Foundation):
(1) Selects members of the IASB, the IFRS Advisory Council, and the IFRS
Interpretations committee.
(2) Funds their activities.
(3) Oversees their activities.
(4) 22 Trustees
b. International Accounting Standards Board (IASB): Develops a single set of
high quality enforceable, and global IFRS for general-purpose financial
statements.
d. IFRS Advisory Council: Consults with the IASB on major policies and technical
issues.
e. IFRS Interpretations Committee:
(1) Assists the IASB in the timely identification, discussion and resolution of
financial reporting issues within the framework of IFRS.
(2) 14 members.
G. Discuss the elements comprising due process:
1. An independent standard-setting board overseen by a geographically and profession-
ally diverse body of trustees.
2. A thorough and systematic process for developing standards.
3. Engagement with investors, regulators, business leaders, and the global accountancy
profession at every stage of the process.
4. Collaborative efforts with the worldwide standard-setting community.
F. Describe the specific steps the IASB takes to implement due process:
1. Topics identified and placed on the Board’s agenda.
2. Research and analysis conducted and preliminary views of pros and cons issued
(Discussion Papers).
3. Public hearings on proposed standard.
4. Board evaluates research and public response and issues exposure draft.
5. Board evaluates responses and changes exposure draft, if necessary. Final standard
issued. Requires nine of 16 members to vote in favor of the new standard before
issuance.
a. International Financial Reporting Standards Foundation (IFRS Foundation):
(1) Selects members of the IASB, the IFRS Advisory Council, and the IFRS
Interpretations committee.
(2) Funds their activities.
(3) Oversees their activities.
(4) 22 Trustees
b. International Accounting Standards Board (IASB): Develops a single set of
high quality enforceable, and global IFRS for general-purpose financial
statements.
d. IFRS Advisory Council: Consults with the IASB on major policies and technical
issues.
e. IFRS Interpretations Committee:
(1) Assists the IASB in the timely identification, discussion and resolution of
financial reporting issues within the framework of IFRS.
(2) 14 members.
G. Discuss the elements comprising due process:
1. An independent standard-setting board overseen by a geographically and profession-
ally diverse body of trustees.
2. A thorough and systematic process for developing standards.
3. Engagement with investors, regulators, business leaders, and the global accountancy
profession at every stage of the process.
4. Collaborative efforts with the worldwide standard-setting community.
F. Describe the specific steps the IASB takes to implement due process:
1. Topics identified and placed on the Board’s agenda.
2. Research and analysis conducted and preliminary views of pros and cons issued
(Discussion Papers).
3. Public hearings on proposed standard.
4. Board evaluates research and public response and issues exposure draft.
5. Board evaluates responses and changes exposure draft, if necessary. Final standard
issued. Requires nine of 16 members to vote in favor of the new standard before
issuance.
Loading page 12...
G. Discuss the characteristics of the IASB.
1. Membership
2. Autonomy
3. Independence
4. Voting
H. The IFRS issues 3 major types of pronouncements.
1. International Financial Reporting Standards (IFRS) (includes remaining Interna-
tional Accounting Standards (IAS))
2. Conceptual Framework for Financial Reporting
3. International Financial Reporting Standards Interpretations
I. (L.O. 7) IFRS hierarchy.
1. Hierarchy of pronouncements in the following order:
a. IFRS, International Accounting Standards (IAs) that have not been amended a
superseded by the IASB, IFRS Interpretations, and IAS Interpretations.
b. Conceptual Framework for Financial Reporting.
c. Pronouncements of other standard-setting bodies that use a similar conceptual
framework (e.g. U.S. GAAP).
J. (L.O. 8) Describe the challenges facing financial reporting.
1. IFRS in a Political Environment.
a. Describe pressure groups, their composition, and their interests.
b. Discuss the impact of accounting on the interests of each group.
2. The expectations gap: What people think accountants should be doing versus what
accountants think they can do.
3. Describe significant financial reporting issues:
a. Non-financial measurements
b. Forward-looking information
c. Soft assets
d. Timeliness
1. Membership
2. Autonomy
3. Independence
4. Voting
H. The IFRS issues 3 major types of pronouncements.
1. International Financial Reporting Standards (IFRS) (includes remaining Interna-
tional Accounting Standards (IAS))
2. Conceptual Framework for Financial Reporting
3. International Financial Reporting Standards Interpretations
I. (L.O. 7) IFRS hierarchy.
1. Hierarchy of pronouncements in the following order:
a. IFRS, International Accounting Standards (IAs) that have not been amended a
superseded by the IASB, IFRS Interpretations, and IAS Interpretations.
b. Conceptual Framework for Financial Reporting.
c. Pronouncements of other standard-setting bodies that use a similar conceptual
framework (e.g. U.S. GAAP).
J. (L.O. 8) Describe the challenges facing financial reporting.
1. IFRS in a Political Environment.
a. Describe pressure groups, their composition, and their interests.
b. Discuss the impact of accounting on the interests of each group.
2. The expectations gap: What people think accountants should be doing versus what
accountants think they can do.
3. Describe significant financial reporting issues:
a. Non-financial measurements
b. Forward-looking information
c. Soft assets
d. Timeliness
Loading page 13...
4. Discuss the steps to take in solving an ethical dilemma.
a. Recognize an ethical dilemma exists.
b. Identify and analyze the elements of the dilemma.
c. Identify and analyze the alternatives available.
d. Select the best or most ethical alternative.
5. Discuss some of the steps taken to date that demonstrate how international
convergence is occurring.
K. Global Accounting Insights
1. Why a single set of international accounting standards is needed.
a. Multinational corporations
b. Mergers and acquisitions
c. Information technology
d. Financial markets
2. U. S. GAAP versus IFRS
a. Similarities
b. Differences
a. Recognize an ethical dilemma exists.
b. Identify and analyze the elements of the dilemma.
c. Identify and analyze the alternatives available.
d. Select the best or most ethical alternative.
5. Discuss some of the steps taken to date that demonstrate how international
convergence is occurring.
K. Global Accounting Insights
1. Why a single set of international accounting standards is needed.
a. Multinational corporations
b. Mergers and acquisitions
c. Information technology
d. Financial markets
2. U. S. GAAP versus IFRS
a. Similarities
b. Differences
Loading page 14...
CHAPTER 2
Conceptual Framework for Financial
Reporting
LEARNING OBJECTIVES
1. Describe the usefulness of a conceptual framework.
2. Describe efforts to construct a conceptual framework.
3. Understand the objective of financial reporting.
4. Identify the qualitative characteristics of accounting information.
5. Define the basic elements of financial statements.
6. Describe the basic assumptions of accounting.
7. Explain the application of the basic principles of accounting.
8. Describe the impact that the cost constraint has on reporting accounting
information.
Conceptual Framework for Financial
Reporting
LEARNING OBJECTIVES
1. Describe the usefulness of a conceptual framework.
2. Describe efforts to construct a conceptual framework.
3. Understand the objective of financial reporting.
4. Identify the qualitative characteristics of accounting information.
5. Define the basic elements of financial statements.
6. Describe the basic assumptions of accounting.
7. Explain the application of the basic principles of accounting.
8. Describe the impact that the cost constraint has on reporting accounting
information.
Loading page 15...
CHAPTER REVIEW
1. Chapter 2 outlines the development of a conceptual framework for financial accounting and
reporting by the IASB. The entire conceptual framework is affected by the environmental
aspects discussed in Chapter 1. It is composed of the basic objective, fundamental concepts,
and operational guidelines. These notions are discussed in Chapter 2 and should enhance
your understanding of the topics covered in intermediate accounting.
Conceptual Framework
2. (L.O. 1) A conceptual framework is important as a coherent system of concepts that
flow from an objective and the objective identifies the purpose of financial reporting. By
building upon an established body of concepts, a soundly developed conceptual
framework leads to more useful and consistent pronouncements over time and allows the
accounting profession to solve new and emerging practical problems more quickly.
3. (L.O. 2) Although the IASB issued the Conceptual Framework for Financial Reporting in
2010, it remains a work in process. The framework consists of three levels. The first level
identifies the objective of financial reporting. The second level provides the qualitative
characteristics that make accounting information useful and the elements of financial
statements. The third level identifies the assumptions, principles and constraints that
describe the reporting environment. Working together the IASB and the FASB developed
the converged concept statements on the objective of financial reporting and qualitative
characteristics of accounting information. Both Boards are now working on their own
individual schedules to address the remaining elements of the framework.
First Level: Basic Objective
4. (L.O. 3) The objective of financial reporting is the foundation of the Conceptual
Framework. The objective of general-purpose financial reporting is to provide financial
information about the reporting entity that is useful to present and potential equity
investors, lenders, and other creditors in making decisions about providing resources to
the entity.
5. An implicit assumption is that users need reasonable knowledge of business and financial
accounting matters to understand the information contained in financial statements. This
means that financial statement preparers assume a level of competence on the part of
users, which impacts the way and the extent to which companies report information.
Second Level: Fundamental Concepts
6. (L.O. 4) The second level bridges the “why” or objective of accounting with the “how of
accounting that addresses recognition, measurement and financial presentation. The
fundamental qualities that make accounting information useful for decision making are
relevance and faithful representation.
a. Relevance: Accounting information is relevant if it is capable of making a difference
in a decision. Financial information is capable of making a difference when it has
1. Chapter 2 outlines the development of a conceptual framework for financial accounting and
reporting by the IASB. The entire conceptual framework is affected by the environmental
aspects discussed in Chapter 1. It is composed of the basic objective, fundamental concepts,
and operational guidelines. These notions are discussed in Chapter 2 and should enhance
your understanding of the topics covered in intermediate accounting.
Conceptual Framework
2. (L.O. 1) A conceptual framework is important as a coherent system of concepts that
flow from an objective and the objective identifies the purpose of financial reporting. By
building upon an established body of concepts, a soundly developed conceptual
framework leads to more useful and consistent pronouncements over time and allows the
accounting profession to solve new and emerging practical problems more quickly.
3. (L.O. 2) Although the IASB issued the Conceptual Framework for Financial Reporting in
2010, it remains a work in process. The framework consists of three levels. The first level
identifies the objective of financial reporting. The second level provides the qualitative
characteristics that make accounting information useful and the elements of financial
statements. The third level identifies the assumptions, principles and constraints that
describe the reporting environment. Working together the IASB and the FASB developed
the converged concept statements on the objective of financial reporting and qualitative
characteristics of accounting information. Both Boards are now working on their own
individual schedules to address the remaining elements of the framework.
First Level: Basic Objective
4. (L.O. 3) The objective of financial reporting is the foundation of the Conceptual
Framework. The objective of general-purpose financial reporting is to provide financial
information about the reporting entity that is useful to present and potential equity
investors, lenders, and other creditors in making decisions about providing resources to
the entity.
5. An implicit assumption is that users need reasonable knowledge of business and financial
accounting matters to understand the information contained in financial statements. This
means that financial statement preparers assume a level of competence on the part of
users, which impacts the way and the extent to which companies report information.
Second Level: Fundamental Concepts
6. (L.O. 4) The second level bridges the “why” or objective of accounting with the “how of
accounting that addresses recognition, measurement and financial presentation. The
fundamental qualities that make accounting information useful for decision making are
relevance and faithful representation.
a. Relevance: Accounting information is relevant if it is capable of making a difference
in a decision. Financial information is capable of making a difference when it has
Loading page 16...
predictive value, confirmatory value, or both. If the monetary size of an item could
influence a user’s discussion, then the item is material and must be disclosed.
(1) Predictive Value: Financial information has value as an input to predictive
processes used by potential investors in forming their expectations of a
company’s future.
(2) Confirmatory Value: Financial information that helps users confirm or correct
prior expectations.
(3) Materiality: Materiality is a company-specific aspect of relevance. Information is
material if omitting or misstating would make a difference in users’ decisions. It
requires evaluating both the relative size and importance of an item. While
companies and auditors adopt a general rule of thumb is that anything under 5
percent of net income is considered immaterial, this depends upon specific rules;
companies must consider both quantitative and qualitative factors when
determining materiality thresholds.
b. Faithful Representation: Means that the numbers and descriptions contained in the
financial statements match what really existed or happened. To be a faithful
representation, information must be complete, neutral, and free from error.
(1) Completeness: The financial statements include all the information that is
necessary for faithful representation of the economic phenomena that it purports
to represent.
(2) Neutrality: Information is neutral if it is unbiased, i.e., it is not presented in a
manner that favors one set of interested parties over another.
(3) Free from error: Does not mean total freedom from error. It means that the
information presented is as accurate as possible, given that any estimates are
based on the best information available at the time.
7. The enhancing qualities are complementary to the fundamental qualitative characteristics.
They include comparability, verifiability, timeliness, and understandability.
a. Comparability: Information that is measured and reported in a similar manner for
different companies is considered comparable. It enables users to identify the real
similarities and differences in economic events between companies. Another type of
comparability is consistency, which is present when a company applies the same
accounting treatment to similar events, from period to period.
b. Verifiability: Occurs when independent measurers, using the same methods, obtain
similar results.
c. Timeliness: Means having information available to decision-makers before it loses its
capacity to influence decisions.
d. Understandability: Is the quality of information that lets reasonably informed users
see the connection between their decisions and the information contained in the
influence a user’s discussion, then the item is material and must be disclosed.
(1) Predictive Value: Financial information has value as an input to predictive
processes used by potential investors in forming their expectations of a
company’s future.
(2) Confirmatory Value: Financial information that helps users confirm or correct
prior expectations.
(3) Materiality: Materiality is a company-specific aspect of relevance. Information is
material if omitting or misstating would make a difference in users’ decisions. It
requires evaluating both the relative size and importance of an item. While
companies and auditors adopt a general rule of thumb is that anything under 5
percent of net income is considered immaterial, this depends upon specific rules;
companies must consider both quantitative and qualitative factors when
determining materiality thresholds.
b. Faithful Representation: Means that the numbers and descriptions contained in the
financial statements match what really existed or happened. To be a faithful
representation, information must be complete, neutral, and free from error.
(1) Completeness: The financial statements include all the information that is
necessary for faithful representation of the economic phenomena that it purports
to represent.
(2) Neutrality: Information is neutral if it is unbiased, i.e., it is not presented in a
manner that favors one set of interested parties over another.
(3) Free from error: Does not mean total freedom from error. It means that the
information presented is as accurate as possible, given that any estimates are
based on the best information available at the time.
7. The enhancing qualities are complementary to the fundamental qualitative characteristics.
They include comparability, verifiability, timeliness, and understandability.
a. Comparability: Information that is measured and reported in a similar manner for
different companies is considered comparable. It enables users to identify the real
similarities and differences in economic events between companies. Another type of
comparability is consistency, which is present when a company applies the same
accounting treatment to similar events, from period to period.
b. Verifiability: Occurs when independent measurers, using the same methods, obtain
similar results.
c. Timeliness: Means having information available to decision-makers before it loses its
capacity to influence decisions.
d. Understandability: Is the quality of information that lets reasonably informed users
see the connection between their decisions and the information contained in the
Loading page 17...
financial statements. Understandability is enhanced when information is classified,
characterized, and presented clearly and concisely.
8. (L.O. 5) The IASB classifies the elements of the financial statements into two groups.
The first group describes amounts of resources and claims to resources at a moment in
time. The second group describes transactions, events and circumstances that affect a
company during a period time.
a. Resources and claims to resources at a moment in time.
(1) Asset: 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.
(2) Liability: 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.
(3) Equity: The residual interest in the assets of the entity after deducting all its
liabilities.
b. Transactions, events, and circumstances that affect a company during a period of time.
(1) 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.
(2) 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.
Third Level: Recognition, Measurement, and Disclosure Concepts
9. (L.O. 6) In the practice of financial accounting, certain basic assumptions are important to
an understanding of the manner in which information is presented. The following five
basic assumptions underlie the financial accounting structure.
a. Economic Entity Assumption: Means that economic activity can be identified with a
particular unit of accountability. In other words, a company keeps its activity separate
and distinct from its owners and any other business unit.
b. Going Concern Assumption: In the absence of information to the contrary, a
company is assumed to have a long life. The legitimacy of the cost principle is
dependent upon the going concern assumption, whereby depreciation and
amortization policies are justified and appropriate only if there is some permanence to
the company’s continuance.
c. Monetary Unit Assumption: Money is the common denominator of economic
activity and provides an appropriate basis for accounting measurement and analysis.
The monetary unit is assumed to remain relatively stable over the years in terms of
characterized, and presented clearly and concisely.
8. (L.O. 5) The IASB classifies the elements of the financial statements into two groups.
The first group describes amounts of resources and claims to resources at a moment in
time. The second group describes transactions, events and circumstances that affect a
company during a period time.
a. Resources and claims to resources at a moment in time.
(1) Asset: 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.
(2) Liability: 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.
(3) Equity: The residual interest in the assets of the entity after deducting all its
liabilities.
b. Transactions, events, and circumstances that affect a company during a period of time.
(1) 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.
(2) 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.
Third Level: Recognition, Measurement, and Disclosure Concepts
9. (L.O. 6) In the practice of financial accounting, certain basic assumptions are important to
an understanding of the manner in which information is presented. The following five
basic assumptions underlie the financial accounting structure.
a. Economic Entity Assumption: Means that economic activity can be identified with a
particular unit of accountability. In other words, a company keeps its activity separate
and distinct from its owners and any other business unit.
b. Going Concern Assumption: In the absence of information to the contrary, a
company is assumed to have a long life. The legitimacy of the cost principle is
dependent upon the going concern assumption, whereby depreciation and
amortization policies are justified and appropriate only if there is some permanence to
the company’s continuance.
c. Monetary Unit Assumption: Money is the common denominator of economic
activity and provides an appropriate basis for accounting measurement and analysis.
The monetary unit is assumed to remain relatively stable over the years in terms of
Loading page 18...
purchasing power. Therefore, this assumption disregards any inflation or deflation in
the economy in which the company operates.
d. Periodicity Assumption: The life of a company can be divided into artificial time
periods for the purpose of providing periodic reports on the economic activities of the
company.
e. Accrual Basis of Accounting: Transactions that change a company’s financial
statements are recorded in the periods in which the events occur. The cash basis of
accounting is prohibited under IFRS because it violates both the revenue recognition
principle and the expense recognition principle.
10. (L.O. 7) The basic principles of accounting are used to record and report transaction. The
four basic principles of accounting are:
a. Measurement Principles: We currently have two acceptable measurement
principles: historical cost and fair value. Choosing which principle to follow generally
reflects the trade off between relevance and faithful representation.
(1) Historical Cost: IFRS requires many assets and liabilities be reported at their
acquisition price, or cost, sometimes referred to as historical cost. Using cost has
an important advantage: It is thought to be a faithful representation of the amount
paid for a given item. Many users favor historical cost because it provides a
verifiable benchmark for measuring historical trends.
(2) Fair Value: Is a market-based measure. At acquisition, historical cost and fair
value are identical. In subsequent periods, as market and economic conditions
change, the two values may diverge. It is felt that where fair value information is
available, it provides more relevant information about the expected future cash
flows related to an asset or liability. The IASB allows companies the option to use
fair value, known as the fair value option, for the measurement basis of financial
assets and financial liabilities.
b. Revenue Recognition Principle: When a company agrees to perform a service or
sell a product it has a performance obligation. Therefore, revenue is recognized in
the period in which the performance obligation is satisfied.
c. Expense Recognition Principle: Recognition of expenses is related to the
consumption of assets or incurring of liabilities. The expense recognition principle is
implemented in accordance with the definition of expense by matching efforts
(expenses) with accomplishments (revenues). Some costs are difficult to associate
with revenues and must be allocated to expense based on a “rational and systematic”
allocation policy. Product costs, like materials, labor, and overhead, are expensed
when the units they are attached to are sold. Period costs, like officers’ salaries or
other administrative expenses, are expensed as incurred.
d. Full Disclosure Principle: Financial statements should include sufficient information
to permit a knowledgeable user to make an informed decision about the financial
condition of the company in question. Users can find financial information (1) within
the economy in which the company operates.
d. Periodicity Assumption: The life of a company can be divided into artificial time
periods for the purpose of providing periodic reports on the economic activities of the
company.
e. Accrual Basis of Accounting: Transactions that change a company’s financial
statements are recorded in the periods in which the events occur. The cash basis of
accounting is prohibited under IFRS because it violates both the revenue recognition
principle and the expense recognition principle.
10. (L.O. 7) The basic principles of accounting are used to record and report transaction. The
four basic principles of accounting are:
a. Measurement Principles: We currently have two acceptable measurement
principles: historical cost and fair value. Choosing which principle to follow generally
reflects the trade off between relevance and faithful representation.
(1) Historical Cost: IFRS requires many assets and liabilities be reported at their
acquisition price, or cost, sometimes referred to as historical cost. Using cost has
an important advantage: It is thought to be a faithful representation of the amount
paid for a given item. Many users favor historical cost because it provides a
verifiable benchmark for measuring historical trends.
(2) Fair Value: Is a market-based measure. At acquisition, historical cost and fair
value are identical. In subsequent periods, as market and economic conditions
change, the two values may diverge. It is felt that where fair value information is
available, it provides more relevant information about the expected future cash
flows related to an asset or liability. The IASB allows companies the option to use
fair value, known as the fair value option, for the measurement basis of financial
assets and financial liabilities.
b. Revenue Recognition Principle: When a company agrees to perform a service or
sell a product it has a performance obligation. Therefore, revenue is recognized in
the period in which the performance obligation is satisfied.
c. Expense Recognition Principle: Recognition of expenses is related to the
consumption of assets or incurring of liabilities. The expense recognition principle is
implemented in accordance with the definition of expense by matching efforts
(expenses) with accomplishments (revenues). Some costs are difficult to associate
with revenues and must be allocated to expense based on a “rational and systematic”
allocation policy. Product costs, like materials, labor, and overhead, are expensed
when the units they are attached to are sold. Period costs, like officers’ salaries or
other administrative expenses, are expensed as incurred.
d. Full Disclosure Principle: Financial statements should include sufficient information
to permit a knowledgeable user to make an informed decision about the financial
condition of the company in question. Users can find financial information (1) within
Loading page 19...
the main body of the financial statements, (2) in the notes to those statements, or (3)
as supplementary information.
11. (L.O. 8) In providing information with the qualitative characteristics that make it useful,
companies, must consider an overriding factor that limits the reporting. This is referred to
as the cost constraint.
a. Cost-Benefit Relationship: Rule-making bodies and governmental agencies use
cost-benefit analysis before making final their informational requirements. The
difficulty in cost-benefit analysis is that the costs and especially the benefits are not
always evident or measurable.
(1) Costs: The costs are of several kinds: costs of collecting and processing, of
disseminating, of auditing, of potential litigation, of disclosure to competitors, and
of analysis and interpretation.
(2) Benefits: Benefits to preparers may include greater management control and
access to capital at a lower cost. User benefits may include receiving better
information for allocation of resources, tax assessment, and rate regulation.
b. The IASB seeks input on costs and benefits of new standards during the due process
procedure and attempts to determine that the costs imposed by each proposed
pronouncement is justified by the overall benefits of the financial information gained.
LECTURE OUTLINE
The material in this chapter can usually be covered in two class sessions. The first class
session can be used for lecture and discussion of the concepts presented in the chapter. The
second class session can be used to develop student’s understanding of these concepts by
applying them to specific accounting situations. Students frequently believe that they understand
the concepts but have difficulty correctly identifying improper accounting procedures in
practical situations. Apparently, students are not alone in this difficulty.
A. (L.O. 1) Need for a Conceptual Framework.
1. Build on and relate to an established body of concepts.
2. Issue more useful and consistent pronouncements over time.
3. Increase financial statement users’ understanding of and confidence in financial reporting.
4. Enhance comparability among companies’ financial statements.
5. Provide a framework for quickly solving new and emerging practical problems.
B. (L.O. 2) Development of a Conceptual Framework with three levels.
C. (L.O. 3) First Level: Basic Objective. (Recall that this was discussed in Chapter 1).
as supplementary information.
11. (L.O. 8) In providing information with the qualitative characteristics that make it useful,
companies, must consider an overriding factor that limits the reporting. This is referred to
as the cost constraint.
a. Cost-Benefit Relationship: Rule-making bodies and governmental agencies use
cost-benefit analysis before making final their informational requirements. The
difficulty in cost-benefit analysis is that the costs and especially the benefits are not
always evident or measurable.
(1) Costs: The costs are of several kinds: costs of collecting and processing, of
disseminating, of auditing, of potential litigation, of disclosure to competitors, and
of analysis and interpretation.
(2) Benefits: Benefits to preparers may include greater management control and
access to capital at a lower cost. User benefits may include receiving better
information for allocation of resources, tax assessment, and rate regulation.
b. The IASB seeks input on costs and benefits of new standards during the due process
procedure and attempts to determine that the costs imposed by each proposed
pronouncement is justified by the overall benefits of the financial information gained.
LECTURE OUTLINE
The material in this chapter can usually be covered in two class sessions. The first class
session can be used for lecture and discussion of the concepts presented in the chapter. The
second class session can be used to develop student’s understanding of these concepts by
applying them to specific accounting situations. Students frequently believe that they understand
the concepts but have difficulty correctly identifying improper accounting procedures in
practical situations. Apparently, students are not alone in this difficulty.
A. (L.O. 1) Need for a Conceptual Framework.
1. Build on and relate to an established body of concepts.
2. Issue more useful and consistent pronouncements over time.
3. Increase financial statement users’ understanding of and confidence in financial reporting.
4. Enhance comparability among companies’ financial statements.
5. Provide a framework for quickly solving new and emerging practical problems.
B. (L.O. 2) Development of a Conceptual Framework with three levels.
C. (L.O. 3) First Level: Basic Objective. (Recall that this was discussed in Chapter 1).
Loading page 20...
1. Financial information that is useful to present and potential equity investors, lenders
and other creditors in making decisions about providing resources to the entity.
2. Financial information that is helpful to capital providers may also be useful to other
users of financial reporting who are not capital providers.
D. (L.O. 4) Second Level: Fundamental Concepts.
1. Qualitative characteristics. The overriding criterion for evaluating accounting information
is that it must be useful for decision making.
a. Fundamental qualities of useful accounting information.
(1) Relevance. Accounting information is relevant if it is capable of making
a difference in a decision. Relevant information includes:
(a) Predictive value.
(b) Confirmatory value.
(c) Materiality
(2) Faithful Representation. For accounting information to be useful, the
numbers and descriptions contained in the financial statements must faithfully
represent what really existed or happened. To be a faithful representation,
information must be:
(a) Complete
(b) Neutral
(c) Free from error
b. Enhancing qualities of useful information distinguish more useful information from
less useful information.
(1) Comparability. Information that is measured and reported in a similar
manner for different companies is considered comparable. Consistency,
another type of comparability, is when a company applies the same
accounting treatment to similar events, from period to period.
(2) Verifiability. When independent measurers, using the same methods, obtain
similar results.
(3) Timeliness. Having information available to decision-makers before it loses
its capacity to influence decisions.
(4) Understandability. When information lets reasonably informed users see the
connection between their decisions and the information contained in the
financial statements.
and other creditors in making decisions about providing resources to the entity.
2. Financial information that is helpful to capital providers may also be useful to other
users of financial reporting who are not capital providers.
D. (L.O. 4) Second Level: Fundamental Concepts.
1. Qualitative characteristics. The overriding criterion for evaluating accounting information
is that it must be useful for decision making.
a. Fundamental qualities of useful accounting information.
(1) Relevance. Accounting information is relevant if it is capable of making
a difference in a decision. Relevant information includes:
(a) Predictive value.
(b) Confirmatory value.
(c) Materiality
(2) Faithful Representation. For accounting information to be useful, the
numbers and descriptions contained in the financial statements must faithfully
represent what really existed or happened. To be a faithful representation,
information must be:
(a) Complete
(b) Neutral
(c) Free from error
b. Enhancing qualities of useful information distinguish more useful information from
less useful information.
(1) Comparability. Information that is measured and reported in a similar
manner for different companies is considered comparable. Consistency,
another type of comparability, is when a company applies the same
accounting treatment to similar events, from period to period.
(2) Verifiability. When independent measurers, using the same methods, obtain
similar results.
(3) Timeliness. Having information available to decision-makers before it loses
its capacity to influence decisions.
(4) Understandability. When information lets reasonably informed users see the
connection between their decisions and the information contained in the
financial statements.
Loading page 21...
2. (L.O. 5) Elements. (See text page 37 for definitions.) Items a-c are elements at
a moment in time. Items d and e are elements during a period of time.
a. Asset.
b. Liability.
c. Equity.
d. Income.
e. Expenses.
E. (L.O. 6) Third Level: Recognition, Measurement, and Disclosure Concepts.
1. Basic Assumptions.
a. Economic entity assumption—economic activity can be identified with a particular
unit of accountability.
b. Going concern assumption—companies will have a long enough life to justify
depreciation and amortization.
c. Monetary unit assumption—the monetary unit (i.e., the euro) is the most
effective means of expressing to interested parties changes in capital and
exchanges of goods and services. A second assumption is that the monetary unit
ignores price-level changes, like inflation and deflation.
d. Periodicity assumption—activities of an enterprise can be divided into artificial
time periods.
e. Accrual basis of accounting—revenues are recognized when earned and
expenses are recognized when incurred.
2. (L.O. 7) Basic Principles of Accounting.
a. Measurement principles
(1) Historical Cost Principle. Objective and verifiable.
(2) Fair value. A market-based measure. The IASB allows companies to choose
the fair value option to measure financial assets and financial liabilities,
because they believe it to better assess future cash flows.
b. Revenue recognition principle—revenue is recognized in the accounting period
in which the performance obligation is satisfied.
c. Expense recognition principle—efforts (expenses) should be matched with
accomplishments (revenues), if feasible.
a moment in time. Items d and e are elements during a period of time.
a. Asset.
b. Liability.
c. Equity.
d. Income.
e. Expenses.
E. (L.O. 6) Third Level: Recognition, Measurement, and Disclosure Concepts.
1. Basic Assumptions.
a. Economic entity assumption—economic activity can be identified with a particular
unit of accountability.
b. Going concern assumption—companies will have a long enough life to justify
depreciation and amortization.
c. Monetary unit assumption—the monetary unit (i.e., the euro) is the most
effective means of expressing to interested parties changes in capital and
exchanges of goods and services. A second assumption is that the monetary unit
ignores price-level changes, like inflation and deflation.
d. Periodicity assumption—activities of an enterprise can be divided into artificial
time periods.
e. Accrual basis of accounting—revenues are recognized when earned and
expenses are recognized when incurred.
2. (L.O. 7) Basic Principles of Accounting.
a. Measurement principles
(1) Historical Cost Principle. Objective and verifiable.
(2) Fair value. A market-based measure. The IASB allows companies to choose
the fair value option to measure financial assets and financial liabilities,
because they believe it to better assess future cash flows.
b. Revenue recognition principle—revenue is recognized in the accounting period
in which the performance obligation is satisfied.
c. Expense recognition principle—efforts (expenses) should be matched with
accomplishments (revenues), if feasible.
Loading page 22...
Practical rules for expense recognition: Analyze costs to determine whether a
relationship exists with revenue.
(a) When a direct relationship exists, then expense costs against revenues
in the period when the revenue is recognized.
(b) When a relationship exists but is difficult to identify, then allocate costs
rationally and systematically to expenses in the periods benefited.
(c) When little if any relationship exists, expense costs as incurred.
d. Full disclosure principle—revealing in financial statements any facts of sufficient
importance to influence the judgment and decisions of an informed reader. (Develop
concept of reasonably prudent investor.) Discuss the use of the notes to the
financial statements and the supplementary information presented in financial
reports.
3. (L.O. 8) Cost Constraint: Financial information benefits must outweigh the costs of
producing the information.
a. Cost-benefit relationship—the benefit to be derived from having accounting
information should exceed the cost of providing it. Frequently it is easier to assess
the costs than it is to determine the benefits of providing a particular item of
information.
b. The IASB’s due process procedure solicits cost-benefit information for proposed
pronouncements.
relationship exists with revenue.
(a) When a direct relationship exists, then expense costs against revenues
in the period when the revenue is recognized.
(b) When a relationship exists but is difficult to identify, then allocate costs
rationally and systematically to expenses in the periods benefited.
(c) When little if any relationship exists, expense costs as incurred.
d. Full disclosure principle—revealing in financial statements any facts of sufficient
importance to influence the judgment and decisions of an informed reader. (Develop
concept of reasonably prudent investor.) Discuss the use of the notes to the
financial statements and the supplementary information presented in financial
reports.
3. (L.O. 8) Cost Constraint: Financial information benefits must outweigh the costs of
producing the information.
a. Cost-benefit relationship—the benefit to be derived from having accounting
information should exceed the cost of providing it. Frequently it is easier to assess
the costs than it is to determine the benefits of providing a particular item of
information.
b. The IASB’s due process procedure solicits cost-benefit information for proposed
pronouncements.
Loading page 23...
CHAPTER 3
The Accounting Information System
LEARNING OBJECTIVES
1. Understand basic accounting terminology.
2. Explain double-entry rules.
3. Identify steps in the accounting cycle.
4. Record transactions in journals, post to ledger accounts, and prepare a trial balance.
5. Explain the reasons for preparing adjusting entries.
6. Prepare financial statements from the adjusted trial balance.
7. Prepare closing entries.
8. Prepare financial statements for a merchandising company.
*9. Differentiate the cash basis of accounting from the accrual basis of accounting.
*10. Identify adjusting entries that may be reversed.
*11. Prepare a 10-column worksheet.
The Accounting Information System
LEARNING OBJECTIVES
1. Understand basic accounting terminology.
2. Explain double-entry rules.
3. Identify steps in the accounting cycle.
4. Record transactions in journals, post to ledger accounts, and prepare a trial balance.
5. Explain the reasons for preparing adjusting entries.
6. Prepare financial statements from the adjusted trial balance.
7. Prepare closing entries.
8. Prepare financial statements for a merchandising company.
*9. Differentiate the cash basis of accounting from the accrual basis of accounting.
*10. Identify adjusting entries that may be reversed.
*11. Prepare a 10-column worksheet.
Loading page 24...
CHAPTER REVIEW
*Note: All asterisked (*) items relate to material contained in the Appendices to the chapter.
1. Chapter 3 presents a concise yet thorough review of the accounting process. The basic
elements of the accounting process are identified and explained, and the way in which
these elements are combined in completing the accounting cycle is described.
Accounting Information System
2. (L.O. 1) The accounting information system collects and processes transaction data
and disseminates the financial information to interested parties. Factors that shape these
systems include: the nature of the business, the transactions in which it engages, the size
of the firm, the volume of data to be handled, and the informational demands of
management and other users. Financial accounting rests on a set of concepts used in
identifying, recording, classifying, and interpreting information related to the transactions
and other events of a business enterprise. To understand the accounting process, one
must be aware of the basic terminology employed in collecting accounting data. The
basic terminology includes: event, transaction, account, real accounts, nominal
accounts, ledger, journal, posting, trial balance, adjusting entries, financial
statements, and closing entries. These terms refer to the various activities that make
up the accounting cycle. As we review the steps in the accounting cycle, the individual
terms will be defined.
3. (L.O. 2) Double-entry accounting refers to the process used in recording transactions.
The terms debit and credit are used in the accounting process to indicate the effect
a transaction has on account balances. The debit side of any account is the left side; the
right side is the credit side. Assets and expenses are increased by debits and decreased
by credits. Liabilities, equity, and revenues are decreased by debits and increased by
credits.
4. In a double-entry system, for every debit there must be a credit and vice-versa. This leads
us to the accounting equation: Assets = Liabilities + Equity.
5. The equity section of the statement of financial position reports the owners’ interest in the
assets of the company. A corporation uses Share Capital, Share Premium, Dividends,
and Retained Earnings. A sole proprietorship or a partnership uses a Capital account and
a Drawing account.
6. In a corporation, dividends, revenues, and expenses are transferred to retained earnings
at the end of a period, so a change in any one of these three accounts affects equity.
The Accounting Cycle
7. (L.O. 3) The first step in the accounting cycle is analysis of transactions and selected
other events. The purpose of this analysis is to determine which events represent
transactions that should be recorded.
*Note: All asterisked (*) items relate to material contained in the Appendices to the chapter.
1. Chapter 3 presents a concise yet thorough review of the accounting process. The basic
elements of the accounting process are identified and explained, and the way in which
these elements are combined in completing the accounting cycle is described.
Accounting Information System
2. (L.O. 1) The accounting information system collects and processes transaction data
and disseminates the financial information to interested parties. Factors that shape these
systems include: the nature of the business, the transactions in which it engages, the size
of the firm, the volume of data to be handled, and the informational demands of
management and other users. Financial accounting rests on a set of concepts used in
identifying, recording, classifying, and interpreting information related to the transactions
and other events of a business enterprise. To understand the accounting process, one
must be aware of the basic terminology employed in collecting accounting data. The
basic terminology includes: event, transaction, account, real accounts, nominal
accounts, ledger, journal, posting, trial balance, adjusting entries, financial
statements, and closing entries. These terms refer to the various activities that make
up the accounting cycle. As we review the steps in the accounting cycle, the individual
terms will be defined.
3. (L.O. 2) Double-entry accounting refers to the process used in recording transactions.
The terms debit and credit are used in the accounting process to indicate the effect
a transaction has on account balances. The debit side of any account is the left side; the
right side is the credit side. Assets and expenses are increased by debits and decreased
by credits. Liabilities, equity, and revenues are decreased by debits and increased by
credits.
4. In a double-entry system, for every debit there must be a credit and vice-versa. This leads
us to the accounting equation: Assets = Liabilities + Equity.
5. The equity section of the statement of financial position reports the owners’ interest in the
assets of the company. A corporation uses Share Capital, Share Premium, Dividends,
and Retained Earnings. A sole proprietorship or a partnership uses a Capital account and
a Drawing account.
6. In a corporation, dividends, revenues, and expenses are transferred to retained earnings
at the end of a period, so a change in any one of these three accounts affects equity.
The Accounting Cycle
7. (L.O. 3) The first step in the accounting cycle is analysis of transactions and selected
other events. The purpose of this analysis is to determine which events represent
transactions that should be recorded.
Loading page 25...
8. Events can be classified as external or internal. External events are those between an
entity and its environment, whereas internal events relate to transactions totally within an
entity.
9. (L.O. 4) Transactions are initially recorded in a journal, sometimes referred to as the
book of original entry. A general journal is merely a chronological listing of transactions
expressed in terms of debits and credits to particular accounts. No distinction is made in
a general journal concerning the type of transaction involved. In addition to a general
journal, specialized journals are used to accumulate transactions possessing common
characteristics.
10. The next step in the accounting cycle involves transferring amounts entered in the journal
to the general ledger. The ledger is a book that usually contains a separate page for
each account. Transferring amounts from a journal to the ledger is called posting.
Transactions recorded in a general journal must be posted individually, whereas entries
made in specialized journals are generally posted by columnar total.
11. The next step in the accounting cycle is the preparation of a trial balance. A trial balance is
a list of all open accounts in the general ledger and their balances. An entity may prepare
a trial balance at any time in the accounting cycle. A trial balance prepared after posting
has been completed serves to check the mathematical equality of debits and credits in
the posting process and provides a listing of accounts to be used in preparing financial
statements. A trial balance does not prove that a company recorded all transactions or
that the ledger is correct, because numerous errors may exist even though the trial
balance columns agree.
12. (L.O. 5) Preparation of adjusting journal entries is the next step in the accounting
cycle. Adjusting entries are entries made at the end of accounting period to bring all
accounts up to date on an accrual accounting basis so that correct financial statements
can be prepared. Adjusting entries are necessary to achieve a proper matching of
revenues and expenses in the determination of net income for the current period and to
achieve an accurate statement of the assets and equities existing at the end of the
period. One common characteristic of adjusting entries is that they affect at least one real
account (asset, liability, or equity account) and one nominal account (revenue or
expense account). Adjusting entries can be classified as prepaid expenses, unearned
revenues, accrued revenues, and accrued expenses.
13. Prepaid expenses and unearned revenues refer to situations where cash has been paid
or received but the corresponding expense or revenue will not be recognized until a future
period. Accrued revenues and accrued expenses are revenues and expenses recognized
in the current period for which the corresponding payment or receipt of cash is to occur in
a future period. Estimated items are expenses such as bad debts and depreciation whose
amounts are a function of unknown future events or developments.
14. After adjusting entries are recorded and posted, an adjusted trial balance is prepared.
15. (L.O. 6) From the adjusted trial balance, a company can directly prepare its financial
statements.
entity and its environment, whereas internal events relate to transactions totally within an
entity.
9. (L.O. 4) Transactions are initially recorded in a journal, sometimes referred to as the
book of original entry. A general journal is merely a chronological listing of transactions
expressed in terms of debits and credits to particular accounts. No distinction is made in
a general journal concerning the type of transaction involved. In addition to a general
journal, specialized journals are used to accumulate transactions possessing common
characteristics.
10. The next step in the accounting cycle involves transferring amounts entered in the journal
to the general ledger. The ledger is a book that usually contains a separate page for
each account. Transferring amounts from a journal to the ledger is called posting.
Transactions recorded in a general journal must be posted individually, whereas entries
made in specialized journals are generally posted by columnar total.
11. The next step in the accounting cycle is the preparation of a trial balance. A trial balance is
a list of all open accounts in the general ledger and their balances. An entity may prepare
a trial balance at any time in the accounting cycle. A trial balance prepared after posting
has been completed serves to check the mathematical equality of debits and credits in
the posting process and provides a listing of accounts to be used in preparing financial
statements. A trial balance does not prove that a company recorded all transactions or
that the ledger is correct, because numerous errors may exist even though the trial
balance columns agree.
12. (L.O. 5) Preparation of adjusting journal entries is the next step in the accounting
cycle. Adjusting entries are entries made at the end of accounting period to bring all
accounts up to date on an accrual accounting basis so that correct financial statements
can be prepared. Adjusting entries are necessary to achieve a proper matching of
revenues and expenses in the determination of net income for the current period and to
achieve an accurate statement of the assets and equities existing at the end of the
period. One common characteristic of adjusting entries is that they affect at least one real
account (asset, liability, or equity account) and one nominal account (revenue or
expense account). Adjusting entries can be classified as prepaid expenses, unearned
revenues, accrued revenues, and accrued expenses.
13. Prepaid expenses and unearned revenues refer to situations where cash has been paid
or received but the corresponding expense or revenue will not be recognized until a future
period. Accrued revenues and accrued expenses are revenues and expenses recognized
in the current period for which the corresponding payment or receipt of cash is to occur in
a future period. Estimated items are expenses such as bad debts and depreciation whose
amounts are a function of unknown future events or developments.
14. After adjusting entries are recorded and posted, an adjusted trial balance is prepared.
15. (L.O. 6) From the adjusted trial balance, a company can directly prepare its financial
statements.
Loading page 26...
16. (L.O. 7) After financial statements have been prepared, nominal (revenues and expenses)
accounts should be reduced to zero in preparation for recording the transactions of the
next period. This closing process requires recording and posting of closing entries. All
revenue and expense accounts are reduced to zero by closing them through the Income
Summary account. The net balance in the Income Summary account is equal to net
income or net loss for the period. The net income or net loss for the period is transferred to
an equity account. For a corporation, the equity account is Retained Earnings, for proprie-
torships and partnerships, it is a capital account. In a corporation, dividends are closed
directly to Retained Earnings.
17. A third trial balance may be prepared after the closing entries are recorded and posted.
This post-closing trial balance shows that the company has properly journalized and
posted the closing entries.
18. A final step, preparing reversing entries, is optional. This step is discussed in learning
objective 10, see paragraph 25 below.
19. In summary, the steps in the accounting cycle performed every fiscal period are as follows:
a. Enter the transactions of the period in appropriate journals.
b. Post from the journals to the ledger (or ledgers).
c. Prepare an unadjusted trial balance (trial balance).
d. Prepare adjusting journal entries and post to the ledger(s).
e. Prepare a trial balance after adjusting (adjusted trial balance).
f. Prepare the financial statements from the adjusted trial balance.
g. Prepare closing journal entries and post to the ledger(s).
h. Prepare a trial balance after closing (post-closing trial balance).
i. Prepare reversing entries (optional) and post to the ledger(s).
Financial Statements for a Merchandising Company
20. (L.O. 8) The income statement for a merchandising company differs from that of a
service company because a product is being sold rather than a service. This difference
requires classifying amounts into categories such a gross profit on sales, income from
operations, income before taxes, and net income. Earnings per share is still shown on the
face of the income statement.
accounts should be reduced to zero in preparation for recording the transactions of the
next period. This closing process requires recording and posting of closing entries. All
revenue and expense accounts are reduced to zero by closing them through the Income
Summary account. The net balance in the Income Summary account is equal to net
income or net loss for the period. The net income or net loss for the period is transferred to
an equity account. For a corporation, the equity account is Retained Earnings, for proprie-
torships and partnerships, it is a capital account. In a corporation, dividends are closed
directly to Retained Earnings.
17. A third trial balance may be prepared after the closing entries are recorded and posted.
This post-closing trial balance shows that the company has properly journalized and
posted the closing entries.
18. A final step, preparing reversing entries, is optional. This step is discussed in learning
objective 10, see paragraph 25 below.
19. In summary, the steps in the accounting cycle performed every fiscal period are as follows:
a. Enter the transactions of the period in appropriate journals.
b. Post from the journals to the ledger (or ledgers).
c. Prepare an unadjusted trial balance (trial balance).
d. Prepare adjusting journal entries and post to the ledger(s).
e. Prepare a trial balance after adjusting (adjusted trial balance).
f. Prepare the financial statements from the adjusted trial balance.
g. Prepare closing journal entries and post to the ledger(s).
h. Prepare a trial balance after closing (post-closing trial balance).
i. Prepare reversing entries (optional) and post to the ledger(s).
Financial Statements for a Merchandising Company
20. (L.O. 8) The income statement for a merchandising company differs from that of a
service company because a product is being sold rather than a service. This difference
requires classifying amounts into categories such a gross profit on sales, income from
operations, income before taxes, and net income. Earnings per share is still shown on the
face of the income statement.
Loading page 27...
21. The retained earnings statement is still formatted the same way: net income is added to
the beginning retained earnings balance, and then dividends are deducted to arrive at
ending retained earnings.
22. The only change made to the statement of financial position is the inclusion of a new
current asset inventory.
23.The closing entries for a merchandising company include a new revenue account, sales
revenue, and a new expense account, cost of goods sold.
Cash-Basis Accounting Versus Accrual-Basis Accounting
*24. (L.O. 9) Cash-Basis Accounting Versus Accrual-Basis Accounting, is presented in
Appendix A of Chapter 3 for the purpose of demonstrating the difference between cash
basis and accrual-basis accounting. Under the strict cash basis of accounting, revenue
is recognized only when cash is received, and expenses are recorded only when cash is
paid or dispersed. The accrual basis of accounting recognizes revenue when it is earned
and expenses when incurred, without regard to the time of receipt or payment of cash.
Using Reversing Entries
*25. (L.O. 10) Appendix B covers preparation and posting of reversing entries, the final
optional step in the accounting cycle. A reversing entry is made at the beginning of the
next accounting period and is the exact opposite of the adjusting entry made in the
previous period. The recording of reversing entries as an optional step in the accounting
cycle may be performed at the beginning of the next accounting period. The entries
subject to reversal are the adjusting entries for accrued revenues and accrued expenses
recorded at the close of the previous accounting period.
Using a Worksheet: The Accounting Cycle Revisited
*26. (L.O. 11) Appendix C covers the use of a ten-columnworksheet, which serves as an aid to
the accountant in adjusting the account balances and preparing the financial statements.
The worksheet provides an orderly format for the accumulation of information necessary for
preparation of financial statements. Use of a worksheet does not replace any financial
statements, nor does it alter any of the steps in the accounting cycle. Instead, the
worksheet is an informal tool that helps to accumulate and sort information needed for the
financial statements.
the beginning retained earnings balance, and then dividends are deducted to arrive at
ending retained earnings.
22. The only change made to the statement of financial position is the inclusion of a new
current asset inventory.
23.The closing entries for a merchandising company include a new revenue account, sales
revenue, and a new expense account, cost of goods sold.
Cash-Basis Accounting Versus Accrual-Basis Accounting
*24. (L.O. 9) Cash-Basis Accounting Versus Accrual-Basis Accounting, is presented in
Appendix A of Chapter 3 for the purpose of demonstrating the difference between cash
basis and accrual-basis accounting. Under the strict cash basis of accounting, revenue
is recognized only when cash is received, and expenses are recorded only when cash is
paid or dispersed. The accrual basis of accounting recognizes revenue when it is earned
and expenses when incurred, without regard to the time of receipt or payment of cash.
Using Reversing Entries
*25. (L.O. 10) Appendix B covers preparation and posting of reversing entries, the final
optional step in the accounting cycle. A reversing entry is made at the beginning of the
next accounting period and is the exact opposite of the adjusting entry made in the
previous period. The recording of reversing entries as an optional step in the accounting
cycle may be performed at the beginning of the next accounting period. The entries
subject to reversal are the adjusting entries for accrued revenues and accrued expenses
recorded at the close of the previous accounting period.
Using a Worksheet: The Accounting Cycle Revisited
*26. (L.O. 11) Appendix C covers the use of a ten-columnworksheet, which serves as an aid to
the accountant in adjusting the account balances and preparing the financial statements.
The worksheet provides an orderly format for the accumulation of information necessary for
preparation of financial statements. Use of a worksheet does not replace any financial
statements, nor does it alter any of the steps in the accounting cycle. Instead, the
worksheet is an informal tool that helps to accumulate and sort information needed for the
financial statements.
Loading page 28...
LECTURE OUTLINE
Chapter 3 provides a review of accounting procedures throughout the accounting cycle.
Depending on time constraints and students’ accounting course background, Chapter 3 can be
approached in several different ways: (1) Spend 2-3 class sessions reviewing the chapter and
Appendices 3-A through 3-C. (2) Spend 1-2 class sessions reviewing selected portions of the
chapter and Appendix 3-A. (3) Omit the chapter entirely.
It is assumed that all students have completed at least one course in financial accounting.
Therefore, students should already be familiar with the mechanics of journalizing, posting, and
preparing adjusting entries and financial statements, etc. An important objective of a review of
these procedural details is to prepare students: (1) to progress from mere memorization of
required journal entries to an understanding of the entries’ impact on the financial statements,
and (2) to visualize the effect of errors (both the failure to record transactions and the improper
recording of transactions) on the financial statements.
The following lecture outline can be expanded upon or reduced to suit the needs of your class.
A. (L.O. 1) Basic Terminology. Review the 11 terms defined on text page 3-4.
B. (L.O. 2) Double-Entry Accounting. Review the mechanics of debits and credits and the
accounting equation.
C. (L.O. 3) The Accounting Cycle.
1. Identifying and Recording Transactions and Other Events
2. (L.O. 4) Journalization.
a. General Journal.
b. Special Journals.
3. Posting to the Ledger.
4. Trial Balance.
5. (L.O. 5) Adjusting Entries. The ability to classify adjusting entries into one of these four
categories is necessary to an understanding of reversing entries.
a. Prepaid expenses.
b. Unearned revenues.
c. Accrued liabilities (expenses).
d. Accrued assets (revenues).
6. Prepare an adjusted trial balance.
7. (L.O. 6) Prepare financial statements from adjusted trial balance.
Chapter 3 provides a review of accounting procedures throughout the accounting cycle.
Depending on time constraints and students’ accounting course background, Chapter 3 can be
approached in several different ways: (1) Spend 2-3 class sessions reviewing the chapter and
Appendices 3-A through 3-C. (2) Spend 1-2 class sessions reviewing selected portions of the
chapter and Appendix 3-A. (3) Omit the chapter entirely.
It is assumed that all students have completed at least one course in financial accounting.
Therefore, students should already be familiar with the mechanics of journalizing, posting, and
preparing adjusting entries and financial statements, etc. An important objective of a review of
these procedural details is to prepare students: (1) to progress from mere memorization of
required journal entries to an understanding of the entries’ impact on the financial statements,
and (2) to visualize the effect of errors (both the failure to record transactions and the improper
recording of transactions) on the financial statements.
The following lecture outline can be expanded upon or reduced to suit the needs of your class.
A. (L.O. 1) Basic Terminology. Review the 11 terms defined on text page 3-4.
B. (L.O. 2) Double-Entry Accounting. Review the mechanics of debits and credits and the
accounting equation.
C. (L.O. 3) The Accounting Cycle.
1. Identifying and Recording Transactions and Other Events
2. (L.O. 4) Journalization.
a. General Journal.
b. Special Journals.
3. Posting to the Ledger.
4. Trial Balance.
5. (L.O. 5) Adjusting Entries. The ability to classify adjusting entries into one of these four
categories is necessary to an understanding of reversing entries.
a. Prepaid expenses.
b. Unearned revenues.
c. Accrued liabilities (expenses).
d. Accrued assets (revenues).
6. Prepare an adjusted trial balance.
7. (L.O. 6) Prepare financial statements from adjusted trial balance.
Loading page 29...
8. (L.O. 7) Prepare closing entries.
a. Temporary accounts vs. permanent accounts.
b. Post-closing trial balance.
c. Reversing entries.
D. (L.O. 8) Financial statements for a merchandising company.
1. Income statement
a. Net sales
b. Cost of goods sold
c. Gross profit on sales
d. Selling and administrative expenses
e. Income from operations
f. Other revenues and gains
g. Other expenses and losses
h. Income before income taxes
i. Income taxes
j. Net income
2. Retained earnings statement
a. Beginning Retained Earnings plus Net income
b. Less Dividends is equal to Ending Retained Earnings
3. Statement of financial position
a. Non-current assets
b. Current assets–Inventory
c. Cash
d. Equity
e. Non-current liabilities
f. Current liabilities
a. Temporary accounts vs. permanent accounts.
b. Post-closing trial balance.
c. Reversing entries.
D. (L.O. 8) Financial statements for a merchandising company.
1. Income statement
a. Net sales
b. Cost of goods sold
c. Gross profit on sales
d. Selling and administrative expenses
e. Income from operations
f. Other revenues and gains
g. Other expenses and losses
h. Income before income taxes
i. Income taxes
j. Net income
2. Retained earnings statement
a. Beginning Retained Earnings plus Net income
b. Less Dividends is equal to Ending Retained Earnings
3. Statement of financial position
a. Non-current assets
b. Current assets–Inventory
c. Cash
d. Equity
e. Non-current liabilities
f. Current liabilities
Loading page 30...
4. Closing entries
a. Sales revenue closed to Income Summary
b. Cost of goods sold and other expenses closed to Income Summary
c. Income Summary closed to Retained Earnings
c. Dividends closed to Retained Earnings
E. (L.O. 9) APPENDIX 3-A. Cash basis versus accrual-basis accounting.
1. Strict cash basis. Recognize revenue when cash is received and expenses when cash
is paid.
a. Used by small businesses and individual taxpayers.
b. Not in conformity with IFRS.
2. Modified cash basis. Recognize revenue when cash is received. Depreciable assets
are capitalized and depreciated; prepaid assets are capitalized and expensed as used;
and all other expenses are recognized as paid. Used by service organizations
(accountants, lawyers, doctors, and architects).
3. Accrual basis. Revenues are recognized when earned and expenses when incurred.
4. Conversion from cash to accrual basis.
F (L.O. 10) APPENDIX 3-B. Using reversing entries.
1. Use of reversing entries is optional.
2. In an accounting system which uses reversing entries, the following types of
adjusting entries should be reversed:
a. adjusting entries for unearned and prepaid items where the original amount
was entered in a revenue or expense account.
b. adjusting entries for all accrued items.
G. (L.O. 11) APPENDIX 3-C. Using a worksheet: The accounting cycle revisited.
1. The worksheet does not replace the financial statements.
2. Worksheet columns.
3. Preparing the worksheet.
4. Preparing the financial statements from a worksheet.
a. Sales revenue closed to Income Summary
b. Cost of goods sold and other expenses closed to Income Summary
c. Income Summary closed to Retained Earnings
c. Dividends closed to Retained Earnings
E. (L.O. 9) APPENDIX 3-A. Cash basis versus accrual-basis accounting.
1. Strict cash basis. Recognize revenue when cash is received and expenses when cash
is paid.
a. Used by small businesses and individual taxpayers.
b. Not in conformity with IFRS.
2. Modified cash basis. Recognize revenue when cash is received. Depreciable assets
are capitalized and depreciated; prepaid assets are capitalized and expensed as used;
and all other expenses are recognized as paid. Used by service organizations
(accountants, lawyers, doctors, and architects).
3. Accrual basis. Revenues are recognized when earned and expenses when incurred.
4. Conversion from cash to accrual basis.
F (L.O. 10) APPENDIX 3-B. Using reversing entries.
1. Use of reversing entries is optional.
2. In an accounting system which uses reversing entries, the following types of
adjusting entries should be reversed:
a. adjusting entries for unearned and prepaid items where the original amount
was entered in a revenue or expense account.
b. adjusting entries for all accrued items.
G. (L.O. 11) APPENDIX 3-C. Using a worksheet: The accounting cycle revisited.
1. The worksheet does not replace the financial statements.
2. Worksheet columns.
3. Preparing the worksheet.
4. Preparing the financial statements from a worksheet.
Loading page 31...
30 more pages available. Scroll down to load them.
Preview Mode
Sign in to access the full document!
100%
Study Now!
XY-Copilot AI
Unlimited Access
Secure Payment
Instant Access
24/7 Support
AI Assistant
Document Details
Subject
Accounting