Afs-02 Understanding Financial Statements

8/19/2019 Afs-02 Understanding Financial Statements

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UNDERSTANDING OF FINANCIAL STATEMENTS

OBJECTIVES OF FINANCIAL REPORTING

To provide informaion!

U"ef#$ for inve"or and %redior de%i"ion"&

T'a 'e$p" predi% %a"' f$o("&

A)o# e%onomi% re"o#r%e"* %$aim" o re"o#r%e"* and %'an+e" in

re"o#r%e" and %$aim"

Objectives

QualitativeCharacteristics

Understandability

Primary

Relevance

Reliability

Secondary

Comparability

Consistency


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,UALITATIVE C-ARACTERISTIC OF FINANCIAL STATEMENTS!

Attributes that MA.E T-E INFORMATION provided in a set of financial statements useful to

users

Under"anda)i$i/

Means that users must understand the information within the context of the decision being made.

This is a #"er0"pe%ifi% 1#a$i/ because users will differ in their ability to comprehend any set of

nformation,

Several end users of financial statement could be a layman or could be a trained and

knowledgeable financial analyst, i (o#$d no )e rea"ona)$e 'a finan%ia$ "aemen

need o )e #nder"anda)$e )/ ever/one&

The information contained in a set of financial statement should be understandable by a user who has reasonable knowledge of business and economics

activities willingness to study information with reasonable diligence

PRIMARY QUALITATIVE CHARACTERISTICS

The primary decision-specific ualities that make accounting information useful are relevance one of the primary

decision-specific ualities that make accounting information useful! made up of predictive value and"or feedback

value, and timeliness. and reliability the extent to which information is verifiable, representationally faithful, and

neutral. . #oth are critical. $o matter how reliable, if information is not relevant to the decision at hand, it is

useless. %onversely, relevant information is of little value if it cannot be relied on

&elevance

&eliability

SECONDARY QUALITATIVE CHARACTERISTICS

Comparability

Consistency

RELEVANCE!

nformation has the uality of relevance when it influences the economic decision of users and is

provided to users in a ime$/ manner, by helping them evaluate past, present and future events or

%onformin+ or %orre%in+ their past evaluations.

'n order to be relevant information should at least have following three characteristics

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(redictive value

%onfirmative value

Time lines

)or example, if net income and its components %onfirm investor expectations about future cash-generating ability,

hen net income has feedback value for investors. This confirmation can also be useful in predi%in+ f##re %a"'0

+enerain+ ability as expectations are revised.

nformaion i" timely if i i" avai$a)$e o #"er" )efore a de%i"ion i" made* The need for timely information

euires that companies provide information to external users on a periodic basis. The S*% reuires its registrants

o submit financial statement information not only on an annual basis, but also uarterly for the first three uarters

of each fiscal year.

T-E CONCEPT OF RELEVANCE IS CLOSEL2 RELATED TO CONCEPT OF MATERIALIT2

nformation provided by financial statements may be relevant but if not reliable then is of little use

RELIABILT2+ the extent to which information is verifiable , representationally faithful , and neutral

To be reliable information must be

erifiable )ree from material error

&epresentationally faithful

$eutral , free from bias

Verifia)$e

mplies a consensus among different measurers. )or example, the historical cost of a piece of land to be reported in

he balance sheet of a company is usually highly verifiable. The cost can be traced to an exchange transaction, the

purchase of the land. /owever, the market value of that land is much more difficult to verify. Appraisers could

differ in their assessment of market value. The erm o)3e%ivi/ ofen i" $in4ed o verifia)i$i/. The historical cost

of the land is ob0ective but the land1s market value is sub0ective, influenced by the measurer1s past experience and

pre0udices. A mea"#remen 'a i" "#)3e%ive i" diffi%#$ o verif/* ('i%' ma4e" i more diffi%#$ for #"er" o

e$/ on&

Repre"enaiona$$/ fai'f#$

*xists when there is agreement between a measure or description and the phenomenon it purports to represent. )or

xample, assume that the term inventory in a balance sheet of a retail company is understood by external users to

epresent items that are intended for sale in the ordinary course of business. 'f inventory includes, say, machines

used to produce inventory, then it lacks representational faithfulness.

Severa$ /ear" a+o* a%%o#nan" #"ed 'e erm reserve for doubtful accounts o de"%ri)e ani%ipaed )ad de)"

e$aed o a%%o#n" re%eiva)$e& For man/* 'e erm reserve mean" 'a a "#m of mone/ 'a" )een "e a"ide for


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##re )ad de)"& Be%a#"e 'i" (a" no 'e %a"e* 'i" erm $a%4ed repre"enaiona$ fai'f#$ne""& T'e

de"%ripion 5re"erve67 no( 'a" )een %'an+ed o 5a$$o(an%e for #n%o$$e%i)$e a%%o#n"7 or 5a$$o(an%e for

do#)f#$ a%%o#n"&7

Ne#ra$ 8free from )ia"9

&eliability assumes the information being relied on is neutral with respect to parties potentially affected. 'n thategard* NEUTRALIT2 ne#ra$ (i' re"pe% o parie" poenia$$/ affe%ed& i" 'i+'$/ re$aed o 'e

"a)$i"'men of a%%o#nin+ "andard". %hanges in accounting standards can lead to adverse economic

onseuences to certain companies, their investors and creditors, and other interest groups. Accounting standards

hould be established with overall societal goals and specific ob0ectives in mind and should try not to favor

particular groups or companies

SECONDARY QUALITATIVE CHARACTERISTICS

COMPARABILT2!

%omparability refers to information being comparable 'ro#+' ime" and a%ro"" eniie"

%omparability over time means we can monitor the financial position of a company, its

performance from one period to another, that1s why financial statement present figures not

only for the current year but also those of previous years.

Same accounting method over years

%omparison between companies of the same industry same format

The predictive and feedback value of information is enhanced if users can compare the performance of a

company over time

CONSISTENCY

Closely related to comparability is the notion that consistencypermits valid comparisons between

diferent periods. o accountin practices over time permits valid comparisons between diferent

periods.



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APHIC 1-7

Hierarchy of Desirable Characteristics of Accouti! Ifor"atio

ELEMENTS!


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RECOGNITION AND MEASUREMENT CONCEPTS

A""#mpion"

*conomic entity

2oing concern

(eriodicity

Monetary unit

E%onomi% eni/!

An essential assumption is that all economic events can be identified with a particular economic entity.

'nvestors desire information about an economic entity that corresponds to their ownership interest. )or

example, if you we are considering buying some ownership stock in )ed*x, we want information on thevarious operating units that constitute )ed*x. we would need information not only about their 3nited

States operations but also about their *uropean and other international operations

Another key aspect of this assumption is the distinction between the economic activities of owners and

those of the company. )or example, the economic activities of a sole proprietorship, 3ncle 4im1s&estaurant, should be separated from the activities of its owner, 3ncle 4im. 3ncle 4im1s personal residencefor instance, is not an asset of the business.

Goin+ %on%ern

Another necessary assumption is that, in the absence of information to the contrary, it is anticipated that a businessntity will continue to operate indefinitely. Accountants reali5e that the GOING CONCERN ASSUMPTION does

not always hold since there certainly are many business failures. /owever, companies are begun with the hope of aong life, and many achieve that goal.

This assumption is critical to many broad and specific accounting principles. )or example, the assumption

provides 0ustification for measuring many assets based on their historical costs. 'f it were known that an enterprise

was going to cease operations in the near future, assets and liabilities would not be measured at their historical

costs but at their current liuidation values. Similarly, depreciation of a building over an estimated life of 67 years

presumes the business will operate that long

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Periodi%i/

The periodicity assumption relates to the ualitative characteristic of timeliness. *xternal users need

periodic information to make decisions. This need for periodic information reuires that the economic lifeof an enterprise presumed to be indefinite be divided into artificial time periods for financial reporting.%orporations whose securities are publicly traded are reuired to provide financial information to the S*%on a uarterly and annual basis.89 )inancial statements often are prepared on a monthly basis for banks andothers that might need more timely information.

)or many companies, the annual time period the fiscal year used to report to external users is the calendar

year. /owever, other companies have chosen a fiscal year that does not correspond to the calendar year. Theaccounting profession and the Securities and *xchange %ommission advocate that companies adopt a fiscal

year that corresponds to their natural business year. A natural business year is the :;-month period that endswhen the business activities of a company reach their lowest point in the annual cycle. )or example, manyretailers, :a$0Mar for example, have adopted a fiscal year ending on 4anuary 8:. #usiness activity in4anuary generally is uite slow following the very busy %hristmas period.


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)ull ?isclosure

-i"ori%a$ %o"

The )AS# recogni5ed in SFAC 5 that elements in financial statements currently are measured by different

attributes. 'n general, however, 2AA( measure assets and liabilities based on their original transaction

value, that is, their historical costs. )or an asset, this is the fair value of what is given in exchange usually

cash for the asset at its initial acuisition. )or liabilities, it is the current cash euivalent received in

exchange for assuming the liability. )or example, if a company borrowed @: million cash and signed aninterest-bearing note promising to repay the cash in the future, the liability would be valued at @: million,

the cash received in exchange


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Reven#e "'o#$d )e re%o+ni


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=& (arenthetical comments or modifying comments placed on the face of the financial statements.

>& ?isclosure notes conveying additional insights about company operations, accounting principles, contractualagreements, and pending litigation.

?& Supplemental financial statements that report more detailed information than is shown

An/ informaion #"ef#$ o de%i"ion ma4er" "'o#$d )e provided in 'e finan%ia$ "aemen"*

#)3e% o 'e %o" effe%ivene"" %on"rain

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INCOME STATEMENT


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INTRODUCTION

?*)'$'T'D$

%DM(D$$*$TS D) '$%DM* STAT*M*$T

#AS'% (&'$%'(B*S A$? S*B*%T*? A((B'%AT'D$ TD &**$3* &*%D2$'T'D$

#AS'% (&'$%'(B*S A$? S*B*%T*? A((B'%AT'D$ TD *E(*$S* &*%D2$'T'D$

$D$ &*%3&&'$2 A$? $D$ D(*&AT'$2 'T*MS

%AB%3BAT'D$ D) *(S

A$ABFS'S

NTRDUCTION!

one of 'e o)3e%ive of finan%ia$ "aemen IS TO MEASURE 'e e%onomi% performan%e of 'e %ompan/

main$/ 'ro#+' 'e in%ome of 'e /ear* 'i" indi%ae 'e e;en o ('i%' )#"ine"" a%iviie" 'a" in%rea"ed 'e

(ea$' of 'e %apia$ provider" )/ %omparin+ reven#e and e;pen"e" for a period&

?*)'$'T'D$

The income statement presents information on the financial results of a company 1 s business activities over aperiod of time! it communicates how much revenue the company generated during a period and what costs itncurred in connection with generating that revenue.

CO!"ONENTS#

The components of the income statement include+ revenue! cost of sales! sales, general, and administrativexpenses! other operating expenses! non operating income and expenses! gains and losses! nonrecurring items! netncome! and *(S.

Reven#e!

&efers to the amount charged for the delivery of goods and services in the ordinar/ a%iviie" 8an/ a%ivi/#ndera4en )/ a %ompan/ (i'in i" )#"ine""9 of the businessOr

2ross inflow of economic benefits during the period arising in the ordinar/ a%iviie" of an eni/ ('en 'o"enf$o(" re"#$ in in%rea"e in e1#i/* other than increase relating o %onri)#ion" from e1#i/ pari%ipan"

&evenue is often used synonymously with sales

&*%D2$'T'D$ refers to the process of admitting information into the basic financial statements.M*AS3&*M*$T is the process of associating numerical amounts to the elements.



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For e;amp$e* reven#e (a" previo#"$/ defined a" an inf$o( of a""e" from "e$$in+ a +ood or providin+ a "ervi%e&

B#* when "'o#$d 'e reven#e even )e re%orded* and a what amo#n@

MEASUREMENT OF REVENUE!

AT :-AT AMOUNT REVENUE S-OULD BE RECORDED@

Two principles+

%ost principle

)air value principle

COST PRINCIPLE!

)&S reuires that companies account for and report many assets and liabilities on the basis of AC,UISITIONPRICE&

BENEFIT

)aithful presentation

erifiable

Db0ectivity

FAIR VALUE PRINCIPLE!

The amount for which an asset could be exchanged, a liability settled or an euity instrument granted can bexchanged, fair value is therefore a mar4e )a"ed mea"#re* IFRS 'a" in%rea"in+$/ %a$$ed for #"e of fair va$#e

mea"#remen" in 'e finan%ia$ "aemen"&

BENEFITS!

More useful than historical cost for certain type of assets ,liabilities and in certain industries

#rokerage house, mutual funds

Agricultural industry, biological assets crops, live stock are measured on the basis of net reali5able

value approximates fair value of these assets

'nitially historical cost and fair value are same , in subseuent period market and economic condition

changes historical cost and market value often diverge, thus fair value measures or estimates provides more relevant information about the expected future cash flows related to asset andliability. 'mpairment in case of long lived assets.

Fair va$#e opion 8finan%ia$ a""e" and $ia)i$iie"9


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A finan%ia$ a""e is an intangible asset that derives value because of a contractual claim. *xamples

include bank deposits, bonds, and stocks. )inancial assets are usually more liuid than tangibleassets, such as land or real estate, and are traded on financial markets

LAST POINT!

PRESENTL2 :E -AVE MIED ATTRIBUTE S2STEM* T-AT PERMITS T-E USE OF

-ISTORICAL COST AND FAIR VALUE * ALT-OUG- -ISTORICAL COST PRINCIPLE

CONTINUES TO BE IMPORTANT BASIS FOR VALUATION * RECORDING AND REPORTING

OF FAIR VALUE INFORMATION IS INCREASING

The uestion of measurement involves two choices+ : the choice of a unit of measurement, and ; the choice ofan attribute to be measured. SFAC 5 essentially confirmed existing practice in both of these areas. The monetaryunit or measurement scale used in financial statements is nominal units of money without any ad0ustment forhanges in purchasing power. 'n addition, the board acknowledged that different attributes such as historical cost,

net reali5able value, and present value of future cash flows are presently used to measure different financialtatement elements, and that they expect that practice to continue. )or example, property, plant, and euipment are

measured at historical cost! accounts receivable are measured at their net reali5able value! and most long-termiabilities, such as bonds, are measured at the present value of future cash payments.

RECOGNITION OF REVENUE

:-EN S-OULD COMPAN2 RECORD REVENUE@

&evenue is recogni5ed in the period it is earned, which may or may not be in the same period as the related cashollection. &ecognition of revenue when earned is a fundamental principal of a%%r#a$ a%%o#nin+&

OR

&evenue is to be recogni5ed when it is probable that future economic benefits will flow to the company and reliablemeasurement of revenue is possible 8+enera$$/ a 'e poin of "a$e9

ASB PROVIDES T-AT REVENUE FOR T-E SALE OF GOODS IS TO BE RECOGNIED :-EN

FOLLO:ING CONDITIONS ARE SATISFIED

Transfer of significant risk and rewards of the ownership to buyer 8norma$$/ ('en +ood" are de$ivered or

$e+a$ i$e o +ood" ran"fer"9

The entity neither continuing managerial involvement to the degree usually associated with the ownership,

nor effective control over the goodsThe amount of revenue can be measured reliably

't is probable that economic benefits associated with transaction will flow to entity

The cost incurred or to be incurred in respect of transaction can be measured reliably

http://en.wikipedia.org/wiki/Assethttp://en.wikipedia.org/wiki/Bank_depositshttp://en.wikipedia.org/wiki/Bond_(finance)http://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Liquidityhttp://en.wikipedia.org/wiki/Liquidityhttp://en.wikipedia.org/wiki/Tangible_propertyhttp://en.wikipedia.org/wiki/Tangible_propertyhttp://en.wikipedia.org/wiki/Financial_marketshttp://en.wikipedia.org/wiki/Assethttp://en.wikipedia.org/wiki/Bank_depositshttp://en.wikipedia.org/wiki/Bond_(finance)http://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Liquidityhttp://en.wikipedia.org/wiki/Tangible_propertyhttp://en.wikipedia.org/wiki/Tangible_propertyhttp://en.wikipedia.org/wiki/Financial_markets


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n limited circumstances reven#e ma/ )e re%o+ni


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Bisted below are several terms and phrases associated with basic assumptions, underlying

principles, and constraints. (air each item from Bist A by letter with the item from Bist # that is

most appropriately associated with it.

Afs-02 Understanding Financial Statements

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