CHAPTER I

Development of Accounting
Principles and Professional
Practice
 PREVIEW OF CHAPTER 1

1-2
 1 Financial Reporting and
Accounting Standards

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Describe the growing importance of 5. Identify the objective of financial reporting.

global financial markets and its 6. Identify the major policy-setting bodies and
relation to financial reporting. their role in the standard-setting process.
2. Identify the major financial statements and 7. Explain the meaning of IFRS.
other means of financial reporting. 8. Describe the challenges facing financial
3. Explain how accounting assists in the efficient reporting.
use of scarce resources.
4. Explain the need for high-quality standards.

1-3
 Financial Statements and Financial Reporting
Essential characteristics of accounting are:
1. the identification, measurement, and communication of
financial information about

2. economic entities to

3. interested parties.

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 Economic Entity Financial Statements Additional Information

Financial Statement of President’s letter

Information Financial Position Prospectuses
Accounting? Income Statement Reports filed with
Identify or Statement of governmental
Comprehensive agencies
and Income
Measure News releases
Statement of Cash
and Flows Forecasts
Communicate Statement of Environmental
Changes in Equity impact statements
Note Disclosures
Etc.
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 GLOBAL MARKETS

Accounting and Capital Allocation

Resources are limited. Efficient use of resources often

determines whether a business thrives.
ILLUSTRATION 1-3
Capital Allocation Process

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 GLOBAL MARKETS

High Quality Standards

Globalization demands a single set of high-quality
international accounting standards. Some elements:
1. Single set of high-quality accounting standards established by
a single standard-setting body.
2. Consistency in application and interpretation.
3. Common disclosures.
4. Common high-quality auditing standards and practices.
5. Common approach to regulatory review and enforcement.
6. Education and training of market participants.
(Continued)

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 GLOBAL MARKETS

High Quality Standards

7. Common delivery systems

8. Common approach to corporate governance and legal
frameworks around the world.

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 OBJECTIVE OF FINANCIAL ACCOUNTING

Objective: 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.

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 OBJECTIVE OF FINANCIAL ACCOUNTING

General-Purpose Financial Statements

► Provide financial reporting information to a wide variety
of users.
► Provide the most useful information possible at the
least cost.

Equity Investors and Creditors

► Investors and creditors are the primary user group.

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 OBJECTIVE OF FINANCIAL ACCOUNTING

Entity Perspective
► Companies viewed as separate and distinct from their
owners (shareholders).

Decision-Usefulness
► Investors are interested in assessing
1. the company’s ability to generate net cash inflows and
2. management’s ability to protect and enhance the capital
providers’ investments.

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 STANDARD-SETTING ORGANIZATIONS

Main international standard-setting organization:

► International Accounting Standards Board (IASB)
● Issues International Financial Reporting Standards
(IFRS).
● Standards used on most foreign exchanges.
● IFRS used in over 115 countries.
● Organizations that have a role in international standard-
setting are the International Organization of Securities
Commissions (IOSCO) and the IASB.

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 STANDARD-SETTING ORGANIZATIONS

International Organization of Securities

Commissions (IOSCO)
► Does not set accounting standards.

► Dedicated to ensuring that global

markets can operate in an efficient
and effective basis.
http://www.iosco.org/
► Supports the use of IFRS as the
single set of international
standards in cross-border offerings
and listings.

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 STANDARD-SETTING ORGANIZATIONS

International Accounting Standards Board

(IASB)
Composed of four organizations—
► IFRS Foundation

► International Accounting Standards Board (IASB)

► IFRS Advisory Council

► IFRS Interpretations Committee

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 International Accounting Standards Board
ILLUSTRATION 1-4
International Standard-Setting Structure

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 International Accounting Standards Board

Due Process
The IASB due process has the following elements:
1. Independent standard-setting board;
2. 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; and
4. Collaborative efforts with the worldwide standard-setting
community.
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 International Accounting Standards Board

Types of Pronouncements
► International Financial Reporting Standards.

► Conceptual Framework for Financial Reporting.

► International Financial Reporting Standards Interpretations.

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 STANDARD-SETTING ORGANIZATIONS

Hierarchy of IFRS
Companies first look to:
1. International Financial Reporting Standards; International
Financial Reporting Standards, International Accounting
Standards (issued by the predecessor to the IASB), and IFRS
interpretations originated by the IFRS Interpretations
Committee (and its predecessor, the IAS Interpretations
Committee);
2. The Conceptual Framework for Financial Reporting; and
3. Pronouncements of other standard-setting bodies that use a
similar conceptual framework (e.g., U.S. GAAP).
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 FINANCIAL REPORTING CHALLENGES
ILLUSTRATION 1-6

IFRS in a Political Environment User Groups that Influence

the Formulation of
Accounting Standards

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 FINANCIAL REPORTING CHALLENGES

The Expectations Gap

What the public thinks accountants should do vs. what
accountants think they can do.

Significant Financial Reporting Issues

► Non-financial measurements
► Forward-looking information
► Soft assets
► Timeliness

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 FINANCIAL REPORTING CHALLENGES

Ethics in the Environment of Financial

Accounting
► Companies that concentrate on “maximizing the bottom
line,” “facing the challenges of competition,” and
“stressing short-term results” place accountants in an
environment of conflict and pressure.
► IFRS do not always provide an answer.

► Technical competence is not enough when encountering

ethical decisions.

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 FINANCIAL REPORTING CHALLENGES

International Convergence
Examples of how convergence is occurring:
1. China’s goal is to eliminate differences between its standards and
IFRS.
2. Japan now permits the use of IFRS for domestic companies.
3. The IASB and the FASB have spent the last 12 years working to
converge their standards.
4. Malaysia helped amend the accounting for agricultural assets.
5. Italy provided advice and counsel on the accounting for business
combinations under common control.

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Conceptual framework (FASB Vs IASB)
1. Describe the usefulness of a conceptual framework.
2. Understand the objective of financial reporting.
3. Identify the qualitative characteristics of
accounting information.
4. Define the basic elements of financial statements.
5. Describe the basic assumptions of accounting.
6. Explain the application of the basic principles of
accounting.
 Conceptual Framework
Conceptual Framework establishes the concepts that underlie financial
reporting.

Need for a Conceptual Framework

Rule-making should build on and relate to an

established body of concepts.
Enables IASB to issue more useful and consistent
pronouncements over time.
 Conceptual Framework
Overview of the Conceptual Framework

Three levels:
First Level = Basic objective

Second Level = Qualitative characteristics and

elements of financial statements

Third Level = Recognition, measurement, and

disclosure concepts
 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition 2. Materiality
3. Monetary unit 3. Expense recognition Third
4. Full disclosure
level
4. Periodicity
5. Accrual

QUALITATIVE
CHARACTERISTICS ELEMENTS
1. Fundamental 1. Assets
qualities 2. Liabilities Second level
2. Enhancing 3. Equity
qualities 4. Income
5. Expenses

OBJECTIVE
Provide information
about the reporting
entity that is useful
to present and potential First level
equity investors,
lenders, and other
creditors in their
capacity as capital
Providers.
 First Level: Basic Objective

OBJECTIVE
“To provide financial information about the reporting entity that
is useful to present and potential equity investors, lenders, and
other creditors in making decisions in their capacity as capital
providers.”

 Provided by issuing general-purpose financial statements.

 Assumption is that users have reasonable knowledge of business
and financial accounting matters to understand the information.
Second Level: Fundamental Concepts

Fundamental Quality - Relevance

Relevance is one of the two fundamental qualities that make
accounting information useful for decision-making.
Second Level: Fundamental Concepts

Fundamental Quality – Faithful Representation

Faithful representation means that the numbers and
descriptions match what really existed or happened.
Second Level: Fundamental Concepts

Enhancing Qualities
Distinguish more-useful information from less-useful
information.
Second Level: Basic Elements
Third Level: Recognition, Measurement, and
Disclosure Concepts

These concepts explain how companies should recognize,

measure, and report financial elements and events.

Recognition, Measurement, and Disclosure Concepts

ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition 2. Materiality
3. Monetary unit 3. Expense recognition
4. Periodicity 4. Full disclosure
5. Accrual
 Third Level: Assumptions

Basic Assumptions
Economic Entity – company keeps its activity separate from
its owners and other business unit.
Going Concern - company to last long enough to fulfill
objectives and commitments.
Monetary Unit - money is the common denominator.
Periodicity - company can divide its economic activities into
time periods.
Accrual Basis of Accounting – transactions are recorded in
the periods in which the events occur.
 Third Level: Principles
Principles
Measurement
Cost is generally thought to be a faithful representation of the
amount paid for a given item.
Fair value is “the amount for which an asset could be exchanged,
a liability settled, or an equity instrument granted could be
exchanged, between knowledgeable, willing parties in an arm’s
length transaction.”
IASB has taken the step of giving companies the option to use fair
value as the basis for measurement of financial assets and
financial liabilities.
 Third Level: Principles
Revenue Recognition - revenue is to be recognized when
it is probable that future economic benefits will flow to the
company and reliable measurement of the amount of revenue
is possible.
 Third Level: Principles
Expense Recognition - outflows or “using up” of assets
or incurring of liabilities (or a combination of both) during a
period as a result of delivering or producing goods and/or
rendering services.

“Let the expense follow the revenues.”

 Third Level: Principles
Full Disclosure – providing information that is of sufficient
importance to influence the judgment and decisions of an
informed user.
Provided through:
Financial Statements
Notes to the Financial Statements
Supplementary information
 Third Level: Constraints

Constraints
Cost – the cost of providing the information must be weighed
against the benefits that can be derived from using it.

Materiality - an item is material if its inclusion or omission

would influence or change the judgment of a reasonable
person.
 1.5 IFRS-based Financial Statements (IAS 1)
 IAS 1 sets out overall requirements for the presentation of financial
statements, guidelines for their structure and minimum
requirements for their content. requires an entity to present a
complete set of financial statements at least annually, with
comparative amounts for the preceding year (including
comparative amounts in the notes)
 . A complete set of financial statements comprises:
 • a statement of financial position as at the end of the period;
 • a statement of profit and loss and other comprehensive income
for the period. Other comprehensive income is those items of
income and expense that are not recognized in profit or loss in
accordance with IFRS
 Standards. IAS 1 allows an entity to present a single
combined statement of profit and loss and other
comprehensive income or two separate statements;
 • a statement of changes in equity for the period;
 • a statement of cash flows for the period;
 • notes, comprising a summary of significant accounting
policies and other explanatory information; and
 • a statement of financial position as at the beginning of the
preceding comparative period when an entity applies an
accounting policy retrospectively or makes a retrospective
restatement of items in its financial statements, or when it
reclassifies items in its financial statements.