Acct theory summaries and defintions PDF

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Accounting theory chapter summaries and definitions

Topic 1 and Topic 2: chapters 1, 2 and 3 1.1 Reflect on the nature of accounting and the role of accountants

- accounting is not a precise uncontested technical exercise - Financial accounting requirements are principles based and the application of appropriate accounting and reporting relies on the exercise of professional judgement

- The role of the accountant is changing and is influenced by increasing complexities and changes in economic activities, societal expectations and developments in technology

1.2 Define ‘theory’

- there is no one definition of theory because theories can do different things; they can describe, predict, explain and prescribe

- Accounting theory in this text is defined as either a description, explanation or prediction of accounting practice or a set of principles on which to evaluate or guide practice

1.3 Deflect on why theory is needed and appreciate the need to evaluate theories

- theories help us to understand and make sense of the world. They help to explain, describe, predict and guide decisions and actions. Any critical analysis should be informed by theories

- In financial accounting, theories can help the understanding of current accounting practice and also provide the means to improve it by:

- Describing and explain current accounting practice - Providing principles on which to base actions and decisions in financial accounting - Identifying problems and deficiencies with current account practice - Providing suggestions for change - there are a number of reasons theories might be accepted without first-hand or direct knowledge. These include:

- The authority of the source of the theory - Whether the theory makes sense and fits with personal experiences and beliefs - Whether other people accept the theory - a researcher or professional in a particular discipline would be expected to apply more legitimate, independent and justifiable methods in assessing and evaluating theories. These include:

Accounting theory chapter summaries and definitions

- Examining the logical construction fo the theory - Considering evidence that confirms or refutes the theory 1.4 Understand the nature of research and its relationship to theory

- research in an activity that involves investigation. Research can be used to test or to derives theories

- Various types of research is undertaken in financial accounting, which contributes to knowledge of financial accounting issues and can also result in changes to financial accounting practice and developments

- Research of or about accounting considers the role of accounting itself (the bigger picture) at the macro level

- Research in accounting focuses more at the micro level on issues within accounting Definitions: Accounting theory: either a description, explanation or prediction of accounting practice or a set of principles on which to evaluate or guide practice Empirical research: research based on observation or experience Research: diligent, systematic enquiry into a subject to discover facts or principles

2.1 explain what a conceptual framework is:

- a conceptual framework is a set of guiding principles - It is a normative theory that sets out the basic principles to be followed in preparing financial statements

- You should see that it has broad principles, whereas accounting standards relate to a narrow and specific area of financial reporting

2.2 understand the history and current developments in the conceptual framework for financial reporting

- the conceptual framework for financial reporting issued by the IASB is derived from conceptual frameworks developed in several countries over the past 30 years. Limited sections of this were revised under a joint project by the IASB and the FASB and issued in 2010.

Accounting theory chapter summaries and definitions

2.3 Outline the structure and components of the Conceptual Framework and proposed framework.

- The conceptual frameworks comprise a series of hierarchical concepts. The conceptual frameworks issued in 2010 and 1989 included sections related to the objectives of financial statements, underlying assumptions, qualitative characteristics definitions and recognition criteria for the elements that make up the financial statements

- The proposed framework is more comprehensive and will be comprised of eight chapters including chapters relating to the reporting entity, measurement and presentation of the financial statements

2.5 explain and evaluate the benefits of conceptual frameworks

- technical: to improve the quality of financial statements by providing guidance to standard setters and for users and preparers

- Political: to reduce political interference in the setting of accounting requirements - Professional: to provide a claim over a body of knowledge to ensure the professional status of ‘accountant’ is maintained

2.6 Explain and evaluate the problems and criticisms of the conceptual frameworks 1. The conceptual frameworks do not work in practice because the principles are too unclear to provide adequate guidance, the guidance in applying the principles is inadequate and the conceptual frameworks are incomplete 2. The conceptual frameworks describe current practice, so they are mainly descriptive, not normative 3. The concept of faithful representation as one of the fundamental qualitative characteristics misunderstand the nature of accounting 4.

Inconsistencies with the accounting standards call into question the effectiveness of conceptual frameworks

Accounting theory chapter summaries and definitions Definitions: 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 Fair value: the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement data Heritage assets: assets that have a cultural, environmental, historical, natural, scientific, technological or artistic significance and are held indefinitely for the benefit of present and future generations Intangible assets: identifiable non-monetary assets without physical substance 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 Principles-based standards: standards that contain a substantive accounting principle that focuses on achieving the accounting objective of the standard. The principle is based on the objective of accounting in the conceptual framework

3.3 evaluate the distinction between rules-based and principles-based standards

- principles-based standards are based on a statement of accounting principle that is consistent with the objective for accounting as outlined in the conceptual framework. The standard derives from, and is consistent with, the conceptual framework

- Principles-based standards should not allow exceptions - principles-based standards require professional judgement - Rules-based standards are characterised by quantitative tests, exceptions, a high level of detail and, often, internal inconsistencies

- Rules-based standards minimise the use of professional judgement Definitions: Rules-based standards: standards that contain specific details and mandatory definitions that attempt to meet as many potential contingencies and situations as possible Principles-based standards: standards that contain a substantive accounting principle that focuses on achieving the accounting objective of the standard. The principle is based on the objective of accounting in the conceptual framework AASB 101, presentation of financial statements, para, 15-24, 45-46

Accounting theory chapter summaries and definitions Para 1 objective: This standard prescribes the basis for presentation of general purpose financial statements to ensure comparability both with the entity’s financial statements of previous periods and with the financial statements of other entities. It sets out overall requirements for the presentation of financial statements, guidelines for their structure and minimum requirements for their content.

Para 15: financial statements shall present daily the financial position, financial performance and cash flows of an entity. Fair presentation requires the faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Framework. The application of Australian accounting standards, with additional disclosure when necessary, is presumed to result in financial statements that achieve a fair presentation.

Para 16: an entity whose financial statements comply with IFRs shall make an explicit and unreserved statement of such compliance in the notes. An entity shall not describe financial statements as complain with IFRS unless they comply with all the requirements o IFRSs.

Para 45: annuity shall retain the presentation and classification of items in the financial statements from one period to the next unless:: a) it is apparent, following a significant change in the nature of the entity’s operations or a review of tis financial statements, that another presentation or classification would be more appropriate having regard to the criteria for the section and application of accounting polices in AASB 108 or b) An Australia accounting standard requires a change in presentation

AASB 108, accounting policies, changes in accounting estimates and errors, para. 7-15, 28-29 Para 1 Objective: the objective of this standard is to prescribe the criteria for selecting and changing accounting policies, together with the accounting treatment and disclosure of changes in accounting policies, changes in accounting estimates and corrections of errors. The standard is intended to enhance the relevance and reliability of an entity’s financial

Accounting theory chapter summaries and definitions statements, and the comparability of those financial statements over time and with the financial statements of other entities.

Disclosure requirements for accounting policies, except those for changes in accounting policies, are set out in AASB 101 presentation of financial statements.

Para 7: When an Australian Accounting standard specifically applies to a transaction, other event or condition, the accounting policy or policies applied to that item shall be determined by applying the standard.

What if compliance with accounting standards does NOT result in a true and fair view? Both the corporations act and accounting standards provide authoritative guidance of what needs to be done in this rare situation.

Corporations act: if the financial statements and notes prepared in compliance with the accounting standard would not give a true and fair view, additional information must be included in the notes to the financial statements under s 295(3)©

Accounting standards: companies required to prepare financial statements under part 2M.3 of the corporations act must

- comfy with Australian accounting standards AND provide additional disclosure, if necessary, to give a true and fair view (AASB 101: Aus 19.1,23)

What does it mean to present a true and fair view? The true and fair view forms a legal requirement and benchmark for assessing the quality of financial statements. The phrase, ‘a true and fair view’ is not defined in the law and so is open to a variety of interpretations. These interpretations depend upon law and so is open to a variety of interpretations. These interpretations depend upon one’s perspective (eg. An accountant as opposed to the ‘person in the street’)

Accounting theory chapter summaries and definitions

Topic 3: chapter 4 and 10 4.1 Communicate the concept of measurement in the current context of financial reporting and demonstrate an understanding of its many benefits and limitations

- measurement in an accounting context refers to the way in which the dollar amounts to be included in the financial statements are determined

- Measurement is important from a decision usefulness perspective and the measurement choices made have an impact on the quality of accounting information produced

- Evidence suggest that there is a need for accounting measurement but there are a number of issues and problems which also need to be acknowledged

4.2 reflect on the standard setter’s approach to measurement and evaluate different measurement approaches

- a mixed measurement model approach to standard setting is followed. A number of accounting standards incorporate a number of different measurement approaches, while a particular measurement approach may also offer a number of choice in how a value may be determined. This is necessary to cater for the unique circumstances of each entity and also to cater for changes in economic circumstances over time

- Key measurement approaches include historical cost, current and replacement cost, fair value, and net present value

4.3 Critically apply different measurement methods to evaluate the impact of measurement choice on the quality of accounting information

- there are a number of factors to consider in determining which measurement approach is more appropriate. Management choice in terms of their approach to measurement in certain circumstances can also be explained by there factors and influences

- Choice of measurement approach has an impact on the quality of accounting information produced. For example, depending on the nature of the item being measured fair value may provide more relevant information than the other measurement approaches

Accounting theory chapter summaries and definitions 4.4 communicate and justify the controversial nature of fair value as a measurement approach and consider the arguments for and against a shit towards fair value under the accounting standards.

- fair value is reflected by the market value of an item. There are a number of ways in which the market value of an item can be measured

- As a consequence a number of arguments for and against the use of fair value have been highlighted in recent debate

- The controversial nature of fair value measurement has become evident in recent events such as the global financial crisis

4.6 Communicate the issues which contribute to the controversial nature of accounting measurement

- measurement is by far the most controversial issue in accounting at present. One of the key points of controversy is the opportunity for inappropriate choices in measurement method or approach

- Other points of controversy include variability in measurement approaches used for similar assets, political influences on measurement decisions, the subjectivity and discretion involved in determination of some values, and the impact of measurement on achievement of other organisation objectives

Definitions: Current cost: the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently Fair value: the price that would be received to see an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date Intangible assets: identifiable non-monetary assets without physic substance Present value: a current estimate of the present discounted value of the future net cash flows in the normal course of business Realisable value: the amount of cash or cash equivalents that could currently be obtained by selling an asset in an orderly disposal Replacement cost: the cost the entity would incur to acquire an asset at the ned of the reporting period

Accounting theory chapter summaries and definitions 10.1 reflect on the role of fair value in accounting

- to ensure accounting information is relevant and useful to decision makers, the role of fair value is to establish a framework for measuring assets and liabilities using fair value, and to require consistent disclosures of items measured at fair value

10.2 critically evaluate the traditional definition of fair value

- the traditional definition of fair value was not consistent across all standards - While generally viewed as sufficient, there were a number of shortcomings identified with the interoperation of certain concepts within the traditional definition

10.3 communicate the key aspects of the new definition of fair value

- the new definition of fair value is ‘the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date’

- Fair value is based on exit prices - The transaction is based on one that would occur in an orderly transaction - The transaction is assumed to be between market participants - The transaction can be hypothetical - The valuation for a non - financial asset is based on its highest and best use 10.4 reflect on, and justify how, fair value should be determined for assets and liabilities

- fair value measurement is specific to the asset or liability being valued - The characteristics of the item under consideration, along with any restrictions on it, should be considered if they would influence the value placed on the item by market participants

- A non-financial asset should be valued based on its highest and best use, even if this is a different from the use it is being put to by the entity

- The highest and best use must be physically possible, legally permissible and financially feasible

- Liabilities and equity are fair valued based on the price to transfer the instrument to a third party

Accounting theory chapter summaries and definitions

- In most cases the value of a liability should match the fair value assigned to the corresponding asset by the counterpart

10.5: critically evaluate the three valuation techniques and the importance of the input hierarchy

- the market approach is based on the ability to identify a market for an identical or comparable asset or liability

- The income approach is based on converting future cash flows or income and expense into a single present value

- The cost approach is based on an estimate of the cost of replacing the ‘service capacity’ of the asst under consideration

- The approach chosen should maximise observable inputs and minimise unobservable inputs

- Some observable inputs do not need to be adjusted; they are based on active markets for identical assets or liabilities. There are termed ‘level 1 inputs’

- Other observable inputs require adjustment to reflect quantitative or qualitative differences between the item under consideration and the market observed. These are term ‘evil 2 inputs’

- Level 3 inputs are based on unobservable inputs that require estimation and inference by the entity

10.6: apply the general disclosure requirements for items measured at fair value

- there are two main goals with regards to disclosures under mer 13/IFRS 13: they should be both useful to users and consistent

- The principles for disclosure are set out in paragraph 91 of AASB 13/IFRS 13 and are quite extensive

Definitions: Cost approach: a valuation technique that reflects the amount that would be required currently to replace the service capacity of an asset Exit price: the price that would be received to sell an asset or paid to transfer a liability