Conceptual Underpinings
What is the objective of general purpose financial reporting?
To provide financial information about the reporting entity that is useful in making decisions.
Information asymmetry: What is adverse selection?
It is a type of information asymmetry
whereby one or more parties to a
business transaction, or potential
transaction, have an information
advantage.
Information asymmetry: What is moral hazard?
It is a type of information asymmetry whereby one or more parties to a contract can observe their actions in fulfillment of the contract but other parties cannot.
What is the influence of information asymmetry on the risk premium?
The higher the information asymmetry, the higher the risk premium will be that risk-averse investors demand as a compensation for this uncertainty.
How can financial accounting help to reduce the asymmetries?
By providing the capital market and users of financial information with decision-useful information.
How will decision-useful information help reduce the assymetries?
Reduces the costs of capital for the corporation, since the risk premium will decrease as a function of decreasing information assymetrie.
The more informative ("decision-useful") the set of accounting rules, the lower the costs of capital.
Contracting perspective: emphasis on contracting costs
Demand for accounting information results from the contracts a firm enters into.
Contracting perspective: emphasis on corporate governance
Ensure policies that align the firm's activities with interests of investors and society.
Corporate governance: What is an efficient contract?
The best tradeoff between contracting costs and benefits.
What is the role of financial reporting for contract purposes?
To generate trust. This is costly so accounting standards help to reduce the cost of contracting.
Thehigher the precision of a set of accounting rules the lower the respective contracting costs.
What are the two theories of the role of financial accounting
Information economics perspective -> emphasizes the stewardship function of accounting = focus on reliable information.
Contracting perspective -> emphasizes the valuation function of accounting = focus on the relevance and decision usefulness of information.
What are the main objectives of IFRS?
Valuation: making the investment -> decision usefulness approach
Stewardship: protecting the investment -> monitor the management
What is the IFRS CF?
To develop the practice of financial reporting logically and consistently we need to adress fundamental issues.
-> A CF attempts to provide a structured theory of accounting.
What is the objective of general purpose financial reporting?
To provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.
The key users of financial statement are capital providers.
FS should reflect the perspective of the entity.
Useful information: What are the fundamental qualitative characteristics?
Relevance = capable of making a difference in the decisions made by users.
Faithful representation = neutral, complete, free from error.
Useful information: What are the enhancing qualitative characteristics?
Comparability, verifiability, timeliness, understandability.
What is prudence?
The exercise of caution when making judgements under conditions of uncertainty.
What is asymmetric prudence?
Need for systematic asymmetry: losses are recognized at an earlier stage than gains are.
What is the going concern assumption?
IFRS financial statements are prepared under the assumption that the entity is going concern and will continue to operate for the foreseeable future.
What are the elements of financial position
Assets, liabilities and equity.
What are the elements of financial performance
Income and expenses
What are the general recognition criteria?
Relevant information about the asset or the liability and about any income, expenses or changes in equity;
Faithful representation of the asset or the liability and of any income, expenses or changes in equity; and
Information that results in the benefits exceeding the cost of providing that information.
Under which circumstances may recognition not provide relevant information?
It is uncertain whether an asset exists, or is separable from goodwill, or whether a liability exists;
There is only a low probability that an inflow or outflow of economic benefits will result; or
A measurement is available, but the level of measurement uncertainty is so high that the resulting information has little relevance.
Measurement: Relevance of information provided by measurement basis is affected by?
Characteristics of the asset or liability.
Contribution to future CF's.
Measurement: Whether a measurement basis can provide faithful representation is affected by:
Measurement inconsistency.
Measurement uncertainty.