Chapter 5: The Conceptual Framework

Question 1

What are the objectives of financial statments?

Answer 1

“To provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions relating to providing resources to the entity”

Question 2

What are the fundamental qualitative characteristics?

Answer 2

Relevance and Faithful representation

Question 3

When is financial information ‘relevant’?

Answer 3

• Financial information is useful if it can assist users’ decision - making by helping them to evaluate past, present or future events or by confirming, or correcting their existing evaluations
• Information may be relevant in nature or materiality

Question 4

Relevant information may have what values?

Answer 4

• Predictive value = helps users in assessing the future of the business
• Confirmatory value = helps users in confirming past predictions

Question 5

In order to faithfully represent the transactions and other events, information must be what?

Answer 5

• Complete, all information necessary for a user to understand is included
• Neutral = unbiased
• Free from error
• Showing substance over form (economic reality) (implied rather than specifically listed)
  Neutrality is supported through the exercise of prudence - exercising caution in situations of uncertainty

Question 6

What are the enhancing characteristics?

Answer 6

• Comparability
• Verifiability
• Timeliness
• Understandability

Question 7

Define each of the enhancing characteristics

Answer 7

Comparability:

• Information should be produced on a consistent basis
• The financial statements should be comparable with the financial statements of other entities and the same entity for earlier periods

Verifiability:

• Information can be checked
• A consensus (not always complete agreement) could be reached by observers that the information faithfully represents transactions or events

Timeliness:

• Information should be supplied to users in time to be used in decision making
• Recent information is generally more useful
• Some information remains timely for a long time after the end of a reporting period

Understandability:
- Information must be understandable to users who have a reasonable knowledge of business and accounting

Question 8

What are the underlying assumptions of the Conceptual Framework?

Answer 8

• The going concern basis

Question 9

What are the objectives of IAS 1 Presentation of Financial Statements?

Answer 9

• To ensure comparability through prescribing the basis for presentation of general-purpose financial statements
• The objective of financial statements is to provide a summary of the accounting transactions for a period

Question 10

What is fair presentation?

Answer 10

Fair presentation requires the faithful representation of the effects of transactions in accordance with the requirements of the Conceptual Framework
Application of IFRS Standards is presumed to achieve such fair presentation

Question 11

An entity whose financial statements comply with International Accounting Standards should…

Answer 11

disclose that fact

Question 12

What does comparative information ensure?

Answer 12

That the users of the financial statements are able to compare the position and performance of a company year on year

Question 13

What does the accruals (or matching) concept require?

Answer 13

• The accruals (or matching) concept requires that transactions and events are recognised when they occur, not when cash is received or paid for them
• This means that the costs incurred in generating income are matched against the revenues they have generated

Question 14

What is the going concern concept?

Answer 14

The going concern concept requires that:

• the entity is viewed as continuing its operations for the foreseeable future (at least 12 months)
• an assumption is made that there is no intention or necessity to liquidate or curtail materially its operations

Question 15

If the management of a business do not believe that the going concern concept should apply, what should be disclosed?

Answer 15

• the fact itself
• the basis on which the accounts have been prepared
• the reasons why the entity is not a going concern

Question 16

What is materiality?

Answer 16

According to IAS 1, information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements

• materiality depends on the size or effect of the item judged in the particular circumstances of its omission or misstatement
• determining whether an item is material is therefore a subjective exercise - a % is often used as a rule of thumb
• any decisions, however, must be made in context

Question 17

What is offsetting?

Answer 17

IAS 1 Presentation of Financial Statements does not allow assets and liabilities, or income and expenses, to be offset (deducted) from one another unless another International Accounting Standard allows such treatment

Question 18

What is the historical cost convention?

Answer 18

That generally assets and liabilities are recorded in the statement of financial position at their historic cost

• assets are recorded at the amount of cash or cash equivalents paid, or the fair value of the consideration given for them
• liabilities are recorded at the amount of proceeds received in exchange for the obligation

Question 19

What is the advantage of historical cost accounting?

Answer 19

It removes the subjectivity of estimating the value of an asset or liability, e.g., there is usually objective evidence of what an asset cost

Question 20

Why do we need regulation?

Answer 20

• Regulation ensures that accounts are sufficiently reliable and useful, and prepared without unnecessary delay
• Financial accounts are used as the starting point for calculating taxable profits
• The annual financial statements are the main document used for reporting to shareholders of a company on the condition and performance of the company
• The stock markets rely on the financial statements published by companies
• International investors prefer information to be presented in a similar and comparable way, no matter where the company is based

Question 21

What 5 things regulate or affect accounting and the preparation of financial statements?

Answer 21

• Legislation: Companies Act 2006
• Accounting concepts: help where judgement is required in accounting, e.g., whether to revalue assets
• Financial Reporting Standards: Clarify how to account for and present specific items in the financial statements. The FRC sets UK standards, The International Accounting Standards Board sets international standards
• Generally accepted accounting practice (GAAP): The set of accounting practices applied in a given country
• The concept of fair presentation: IAS 1 requires that financial statements should present financial information fairly. In the UK, the Companies Act 2006 requires that financial statements should give a true and fair view