Topic 1 - Financial Reporting Principles And Accounting Standards

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This article is a topic within the subject Accounting 1B.

Contents

Required Reading

Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning, pp. 285-313.

Accounting

Accounting identifies, measures, records and communicates financial information to users – shareholders, creditors, regulators & other via the 4 financial statements. ASIC administers the Corporation Act 2001 to ensure financial statements give a true & fair view of position & performance. Financial Reporting Council oversees AASB operations.

Generally Accepted Accounting Principles (GAAP)

[1] GAAP is a common set of standards & procedures developed by the accounting profession that are expected to be upheld in the preparation of financial statements

  • AASB Framework (AASB, AAS)
    • Harmonised with the IASB’s principle based approach (Adopted content & wording from IASB)
      • Principle (Flexibility) Vs. Rules (Consistency) – Flexibility may cause creative accounting but it’s harder to overcome the idea behind the principle in comparison to rules.
    • IASB develops general guidelines & standards for international financial reporting
    • Reliant on ethical use of professional judgement
  • SAC – Statement of Accounting Concepts, AAG – Accounting Guidance Releases
  • Corporations Law, ASX Listing Requirements, Customs & Tradition

The AASB Framework covers the objectives & assumptions underlying general purpose financial reports as well as the qualitative characteristics that determine their usefulness. The definition, recognition & measurement of fundamentals of financial accounting are included, namely assets, liabilities, equity, revenues and expenses.

(SAC1) Reporting Entity Concept requires individual reporting entities to be identified by reference to the existence of users who are reliant on general purpose reporting statements for decision making & evaluation.

(SAC2) The Objectives of Financial Reporting is to provide useful information on a firm’s financial performance, position (structure, assets, liquidity) and cash flows to allow for economic decision making to be made by a range of users (primarily investors). Decisions require an evaluation of the firm’s cash generating ability - amount, certainty & timing.

Assumptions And Conventions

[2] There are 4 key conventions or qualitative characteristics that make financial reports useful:

  • Understandibility‘Readily understandable by users’, must still include complex events
  • RelevanceInformation influences economic decisions. Past, present & future events can be evaluated
    • Relevance affected by nature and magnitude – materiality (if omission would affect decisions)
  • ReliabilityInformation is free from bias and material error (Completeness) and can be depended upon by users to faithfully represent economic reality
    • Faithful Representation – What actually happened
    • Substance Over Form - Events are reported in accordance with substance/economic reality, not merely laws or requirements
    • Neutrality – Freedom from bias
    • Prudence – Conservatism, caution in making estimates, ensure assets aren’t overstated and liabilities aren’t understated - trade-off with neutrality
  • ComparabilityCompare financial reports over time, across firms, countries etc. Helped by IFRS harmonisation

There is a trade-off between Relevance & Reliability. Relevance is enhanced by future predictions whilst reliability comes from a historical focus. For example, accounts receivable reliably shows how much is owed, BUT how much will be received is more relevant. E.g. Revaluation of noncurrent assets or inventory cost method.

Assumptions

[3] Accrual Basis, Going Concern (Operate in foreseeable future), Historical Cost, Accounting Entity & Period, Monetary

Equity is the residual interest in the assets of the company after the deduction of its liabilities. Income is increases in economic benefits during the accounting period (other than the issue of shares), resulting in an increase in equity due to an increase in assets or a decrease in liabilities. Expenses are decreases in economic benefits during the accounting period, resulting in a decrease in equity via lower assets (paying cash or depletion) or higher liabilities (increase in provisions). The Matching Principle attempts to match revenues with the expenses incurred to create the sales.

Accounting Measurement

[4]

  1. Historical Cost
  2. Realisable Value - Sale of Asset - Liquidation Value
  3. Present Value - Discounted value of future cash flows
  4. Price-Level-Adjusted Historical Cost - Adjust historical cost via CPI index
  5. Market Value - Input MV = Current/Replacement Cost, Output MV = Net Realisable Value, Fair Value

End

This is the end of this topic. Click Accounting 1B to go back to the main subject page for Accounting 1B

References

Textbook refers to Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning

  1. Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning, pp. 289-291
  2. Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning, pp. 291-293
  3. Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning, pp. 291-297
  4. Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning, pp. 298-303
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